Date: 19990813

Docket: 98-1011-IT-I

BETWEEN:

GUY FAVREAU,

Appellant,

and

HER MAJESTY THE QUEEN,

Respondent.

Reasons for Judgment

Lamarre Proulx, J.T.C.C.

[1] These are appeals concerning the deduction of rental losses for the 1993, 1994 and 1995 taxation years.

[2] In making reassessments, the Minister of National Revenue (the "Minister") relied on the facts set out in paragraph 12 of the Reply to the Notice of Appeal (the "Reply") as follows:

[TRANSLATION]

(a) during the years in issue, the appellant was the owner of the property located at 890, 892 and 894 St-Édouard Street in St-Jude, in the Province of Quebec (hereinafter the "property");

(b) on July 12, 1996, the appellant informed the Minister that the initial purpose in purchasing the property had been to provide his children with living accommodations;

(c) the appellant also informed the Minister that he had used advertisements at the "video club" and "word of mouth" in renting his units;

(d) for the 1993, 1994 and 1995 taxation years, the appellant reported the following rental income and expenses:

Description 1993 1994 1995

Income: $3,150 $3,000 $3,875

Expenses:

Taxes $1,556 $1,206 $1,225

Electricity $ 850 $ 883 $ 773

Insurance $ 953 $ 963 $1,516

Interest/mortgage $6,622 $5,902 $6,241

Maintenance/repairs $1,993 $ 134 $1,152

Subtotal $11,974 $9,088 $10,907

NET LOSS ($ 8,824) ($6,088) ($ 7,032)

(e) the fixed costs alone totalled $9,981 in 1993, $8,954 in 1994 and $9,755 in 1995;

(f) the appellant has incurred the following net losses over the past years:

Year Net loss

1991 $10,630

1992 $10,002

1993 $ 8,824

1994 $ 6,088

1995 $ 7,032

(g) during the years in issue, 894 St-Édouard Street was used by the appellant, who owned a video club;

(h) during the years in issue, the appellant reported a monthly rent for 894 St-Édouard Street of $100, which was far less than fair market value;

(i) the Minister's examination of the video club's books showed that the rents referred to in paragraph (h) above were never paid to the appellant;

(j) for the 1993 and 1994 taxation years, the appellant gave 890 St-Édouard, St-Jude as his personal address on his income tax returns;

(k) during the years in issue, the property was leased by the appellant's children at a price below fair market value;

(l) during the years in issue, 892 St-Édouard Street was not rented;

(m) consequently, there was no expectation of profit from leasing the property;

(n) during the years in issue, the appellant was thus unable to show that the expenses of $8,824 for the 1993 taxation year, $6,088 for the 1994 taxation year and $7,032 for the 1995 taxation year were incurred for the purpose of gaining or producing income from a business or property.

[3] The witnesses were the appellant himself and Robert Lévesque. The latter testified at the request of counsel for the respondent.

[4] The appellant is a mechanic by trade and was employed by a Montréal business from which he is now retired.

[5] The appellant admitted subparagraphs 12(a) to 12(j) and 12(l) of the Reply.

[6] With respect to subparagraph 12(a) of the Reply, the appellant indicated that the property had been purchased in 1991.

[7] With respect to subparagraph 12(b), the appellant added that, while it was true that the initial purpose was to provide his children with living accommodations, this was to be done in exchange for the payment of a reasonable rent of $300. On this point, he filed Exhibit A-1, which is the lease between his daughter's husband and himself concerning the unit at 890 St-Édouard. The term was from January 1, 1993 to January 1, 1994.

[8] Two other leases for 890 St-Édouard, which was a 6 1/2-room unit, were filed as Exhibit A-3. The first of the two commenced on July 1, 1995 and terminated on June 30, 1997. The rent was $375 a month. The second lease ran from July 1, 1997 to June 30, 1998 and the rent was $390 a month.

[9] As to subparagraph 12(j) of the Reply, the appellant explained that, in 1993, his grandson, the son of his daughter who lived at 890 St-Édouard, fell ill. The appellant therefore suggested that his daughter change units, that she take his house and that he would take the apartment. This was done in 1993. This was how the appellant came to live at 890 St-Édouard in 1993 and 1994.

[10] With respect to subparagraph 12(l) of the Reply, 892 St-Édouard was not leased because it was being renovated. Exhibit A-4 shows a lease for 892 St-Édouard commencing on March 1, 1996 at $350 a month. It was a 3 1/2-room unit, according to the rental property questionnaire (Exhibit I-2), which the appellant completed on July 12, 1996.

[11] The appellant answered questions 6, 13 and 15 of the questionnaire (Exhibit I-2) as follows:

[TRANSLATION]

6. What financing was obtained for the purpose of renting the property? Indicate the specific dates of the loans, their purpose, amount and conditions.

Personal loan.

13. Is the rental property rented at this time? If not, please explain why. If the property has been sold, please indicate the date and the proceeds of disposition.

Yes, renovations on the apartment are complete and I am renting it with electricity included. Since the loan has been repaid, I am able to achieve profitability.

15. What measures were taken to ensure the financing, expansion and improvement of your rental property? Specifically, state the funding source and methods.

See No. 6.

[12] Exhibit A-2 is a contract dated March 31, 1995 under which the appellant and Club Vidéo Fleur d'Elysée Inc., as lessor, leased 894 St-Édouard, and the chattels on the premises which were used to operate the business, for $400 a month during the first year and $500 a month thereafter. The tenant went out of business in 1997. The appellant explained that the entire rental income was included in computing his income and none of it in the income of Club Vidéo Fleur d'Elysée Inc.

[13] The appellant's agent asked Mr. Lévesque, an appeals officer with Revenue Canada, whether he knew that the appellant had taken depreciation in 1996 and 1997. Mr. Lévesque answered that this did not appear in the computerized statements and that he was not aware of the fact. I was surprised that it had been possible to do so in view of the large amounts of interest paid during the years in issue. But based on the answer given in 1996 to question 13 of the questionnaire (Exhibit I-2), namely that the loan had been fully repaid, it becomes understandable. However, there was no evidence as to the initial amount of the loan, why the interest was so high during the years in issue and how the loan could have been repaid from one year to the next.

[14] Exhibit I-3 contains the appellant's returns of income for 1996, 1997 and 1998. For 1996, only a gross rental income of $14,700 is reported, which, in Mr. Lévesque's view, indicates that expenses were as great as income. For 1997, a gross rental income of $14,490 and a net rental income of $1,637, and, for 1998, a gross rental income of $3,875 and losses of $8,994 are shown.

[15] Both parties referred to the Federal Court of Appeal's decisions in Tonn v. Canada, [1996] 2 F.C. 73 and Mohammad v. Canada, [1998] 1 F.C. 1020.

[16] The appellant's agentstated that the appellant is a good carpenter and that he has renovated a number of houses. He thus had real estate experience. It is true that the property in question here had been purchased in part to provide the appellant's children with accommodation and for the appellant's video business, but the rent charged to his children was to be the normal rent for this type of dwelling. The idea was not to do any favours. It is therefore not for the Court to judge the appellant's business sense.

[17] The appellant's agent emphasized the fact that there had been positive income in the years following the years in issue and that the property could generate a profit. He submitted that a lessor must be allowed time to get organized so that his business becomes profitable. He also argued that, although the appellant did not state in his returns of income that he had personally occupied one of the units, he had made attempts to correct this situation in negotiations with the appeals division at Revenue Canada. A document was shown to the Court. It was not a request for correction of the return of income, but solely a negotiation document in which a number of items in the calculation of rental income were changed. This document therefore could not be accepted as an exhibit in support of anything.

[18] Counsel for the respondent argued that there was an undeniable personal element and that, in the circumstances, the task at hand was not merely to assess a taxpayer's business judgment, but to determine the influence that personal elements which normally have no place in a strictly commercial undertaking may have had on that judgment.

Conclusion

[19] I refer to Dickson J.'s remarks in the Supreme Court of Canada's decision in Moldowan v. The Queen, [1978] 1 S.C.R. 480, at pages 485 and 486:

There is a vast case literature on what reasonable expectation of profit means and it is by no means entirely consistent. In my view, whether a taxpayer has a reasonable expectation of profit is an objective determination to be made from all of the facts. The following criteria should be considered: the profit and loss experience in past years, the taxpayer's training, the taxpayer's intended course of action, the capability of the venture as capitalized to show a profit after charging capital cost allowance. The list is not intended to be exhaustive. The factors will differ with the nature and extent of the undertaking . . . .

(My emphasis.)

[20] I refer also to the comments by Linden J.A. in the Federal Court of Appeal's decision in Tonn, supra, pages 102 and 103-104:

The primary use of Moldowan as an objective test, therefore, is the prevention of inappropriate reductions in tax; it is not intended as a vehicle for the wholesale judicial second-guessing of business judgments. A note of caution must be sounded for instances where the test is applied to commercial operations. Errors in business judgment, unless the Act stipulates otherwise, do not prohibit one from claiming deductions for losses arising from those errors. . . .

. . . I otherwise agree that the Moldowan test should be applied sparingly where a taxpayer's "business judgment" is involved, where no personal element is in evidence, and where the extent of the deductions claimed are not on their face questionable. However, where circumstances suggest that a personal or other-than-business motivation existed, or where the expectation of profit was so unreasonable as to raise a suspicion, the taxpayer will be called upon to justify objectively that the operation was in fact a business. Suspicious circumstances, therefore, will more often lead to closer scrutiny than those that are in no way suspect.

[21] In my view, the evidence revealed a significant personal element in the instant case. Such an element is not necessarily fatal, but the Court must ensure that the normal characteristics of a commercial undertaking are present in order to allow the appeal. It is not just a matter of assessing a taxpayer's business judgment.

[22] It is important to note at the outset that the Minister allowed the appellant two years with respect to his rental operations. In 1991 and 1992, the Minister allowed losses of $10,630 and $10,002 respectively.

[23] The factual circumstances which do not appear to be consistent with a normal rental business are as follows:

- one of the units, 892 St-Édouard, was not renovated until 1996, despite what was a considerable capital investment judging from the high interest claimed on a loan taken out for the property;

- the appellant lived in one of the units, 890 St-Édouard, and lent his house to his daughter and her family;

- the appellant used one of the units, 894 St-Édouard, for his video business at a rent below market value;

- the fixed costs alone, that is, taxes, electricity, insurance and interest, totalled $9,981 in 1993, $8,954 in 1994 and $9,755 in 1995. Gross income was $3,150 in 1993, $3,000 in 1994 and $3,875 in 1995.

[24] With regard to this last aspect, the financial structure of the property did not permit any profit to be made. Although the appellant's agent said that the appellant's rental operations produced profits in the years following the years in issue, this was in fact the case in only one year and there was furthermore no explanation of the change in capitalization. As capitalized, the property therefore did not have any capability to show a profit in the years in issue.

[25] Ultimately, having regard to all the factual circumstances of the appellant's rental operation, it can only be concluded that this operation did not have the normal characteristics of a commercial undertaking.

[26] The appeal is accordingly dismissed.

Signed at Ottawa, Canada, this 13th day of August 1999.

"Louise Lamarre Proulx"

J.T.C.C.

[OFFICIAL ENGLISH TRANSLATION]