Date: 20001011
Docket: 2000-353-IT-I, 2000-355-IT-I
BETWEEN:
ERNESTO OXCIANO and VIOLETA OXCIANO,
Appellants,
and
HER MAJESTY THE QUEEN,
Respondent.
Reasons for Judgment
Rip, J.T.C.C.
[1]
Ernesto Oxciano and Violeta Oxciano have appealed income tax
assessments for 1995 and 1996 which denied their claims for
losses from renting property. The appeals were heard on common
evidence. Mrs. Oxciano testified on her own behalf and on
behalf of her husband.
[2]
In 1988 Mr. and Mrs. Oxciano purchased a lot in Delta,
British Columbia and completed the building of a home on
that property ("Delta Property") in May 1989. They
subsequently moved to their home. In late 1989 the appellants
started to finish the basement of their home to include a
bedroom, a bathroom and a small kitchen. The basement suite was
available to rent by July 1990 but until 1996 the suite was
rented at below market rent to Mr. Oxciano's mother.
In 1996 the suite was rented to an unrelated tenant for about
$600 to $650 per month.
[3]
During 1995 and 1996 the suite in the Delta Property yielded a
net rental income of $632 and $6,196 respectively. The Minister
of National Revenue ("Minister") is not questioning
the commercial viability of the Delta Property. The Minister,
however, does question the commercial viability of a rental
property the appellants acquired in Maple, Ontario, north of
Toronto, in 1994 ("Maple Property"). In filing their
income tax returns for each of the years in appeal, the Oxcianos
prepared a statement of income and combined the gross incomes
from both the Delta Property and the Maple Property, and from the
aggregate gross incomes there were deducted the total expenses
from each of the two properties. This resulted in a loss. The
loss was attributable solely to the Maple Property and was
allocated equally to each appellant. The Minister, among other
things, has refused the appellants to reduce their income from
the Delta Property by deducting the losses from the Maple
Property.
[4]
The cost of the Maple Property was $175,900 and was financed by
way of mortgage on the property in the amount of $152,505 with
interest at 8.95% for a five-year term and by mortgage on
the Delta Property in the amount of $65,000 with interest at
7.25% for five years. Each mortgage was for a five-year term. The
property included three bedrooms, an unfinished basement and a
single car garage. Borrowed money in excess of the purchase price
was applied to upgrade the property and to purchase furniture and
light fixtures.
[5]
The Maple Property was purchased, Mrs. Oxciano testified, to rent
to students attending York University in Toronto. Each of three
students would have his or her own room and share the rest of the
house. In February 1996, at a time when not all three bedrooms
were rented, the appellants completed the basement of the
property by adding two additional bedrooms.
[6]
At all relevant times, Mr. & Mrs. Oxciano's daughter,
Katherina, attended York University as a full-time student. She
also managed the Maple Property. She placed advertisements for
rent on the York University campus and in local neighbourhood
newspapers. She lived "on and off" in the Maple
Property during 1996 when the property was not fully rented. She
had her own room at one of the University's residences and
also spent time at an uncle's residence in Toronto.
[7]
In 1995 the appellants rented rooms to students for an
eight-month term at a rent of $325 per month. Rooms were
available for rent during the four summer months at the same
rent. Katherina posted advertisements at Wonderland, an amusement
park northwest of Toronto, to rent the vacant units during the
summer. Mrs. Oxciano stated she determined the monthly rent in
the area of the Maple Property by "checking newspapers for
ongoing rates".
[8]
According to the respondent's assumptions of facts the
Maple Property was not situated near any public transportation,
Mrs. Oxciano recalled that there was a bus line
"nearby". She also said the property was a
"five minute drive to York". She did not verify
representations by the sales agent who sold her the property that
eventually there would be public transportation within the Maple
Property's subdivision.
[9]
Mrs. Oxciano testified that she and her husband believed they
could make money from the Maple Property; they thought it would
be a good idea to rent to students. If anything went wrong with
the property, relatives in the Toronto area agreed to attend to
the property.
[10] The
appellants claimed gross rents of $3,400 and expenses of $19,594
in 1994 from the Maple Property.
[11] In 1995
the appellants rented two rooms in the Maple Property and claimed
expenses of $29,600 from that property in computing their income
tax return for that year. Income from Maple Property was $6,950.
The largest expense item was the mortgage interest of $17,627.
Other charges that exceeded $2,000 were furniture and fixtures
($2,778), hydro, cable and gas ($2,027) and property tax
($2,974).
[12] Expenses
from Maple Property increased to $31,279 in 1996. Income was
$3,125. Again mortgage interest, $19,742, was the greatest
expense. The appellants rented two rooms in 1996 from August and
September to the end of December 1996. It appears that some
tenants were unable to pay rent.
[13] During
the next two years the Maple Property continued to lose money.
The appellants claimed losses in computing their total real
estate income of $12,711 and $6,683 in 1997 and 1998
respectively; again, losses were attributable to the Maple
Property. Losses continued in 1999 when the appellants claimed as
a current expense, the installation of a new furnace in the Maple
Property.
[14] At the
time of trial the appellants stopped renting to students and now
rent to "working adults". Also, the appellants have
since negotiated a lower rate of interest for the mortgage on the
Maple Property.
[15] The
expenses claimed by the appellants may have been overstated since
they included in expenses the cost of capital property. For
example, a new furnace was installed on the Maple Property.
Furniture and capital assets such as appliances and a microwave
were also purchased. There is no breakdown as to what portion of
the expenses were of a capital nature. In computing income, the
appellants did not claim capital cost allowance. (The appellants
did not allocate the purchase price of the Maple Property as to
land and building.)
[16] The
respondent assumed, in assessing, that $255.50 was deducted by
each appellant for 1996 although the amount was a capital
expense. The respondent also assumed that personal expenditures
of $2,804.15 were claimed by each appellant in 1996. These
expenditures related to the Maple Property. There was no evidence
led by the appellants to refute these assumptions.
[17] Of course
the respondent's main reason for denying the losses to Mr.
and Mrs. Oxciano is her view that they did not have a
reasonable expectation of profit from the Maple Property in 1995
and 1996. The respondent also states that the appellants did not
vouch the following expenses in 1995 and 1996:
1995
1996
Interest
$9,416.20
$1,716.59
Furniture &
Fixtures
$2,777.59
The appellants did not raise this issue in evidence or
argument.
[18] In the
reasons for judgment of the Supreme Court of Canada in
Moldowan v. The Queen,[1] Dickson J. (as he then was) opined at
page 5215, that:
... in order to have a "source of income" the
taxpayer must have a profit or a reasonable expectation of
profit.
Mr. Justice Dickson added that:
... 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: ...
[19] The
Federal Court of Appeal held in Tonn et al. v. The
Queen,[2]the "reasonable expectation of
profit" test in Moldowan is stricter than the
business purpose tests set out in subsection 9(1) and paragraph
18(1)(a) of the Income Tax Act
("Act") because, in addition to requiring the
presence of a subjective profit motive, it also requires that
such profit motive be objectively reasonable. Linden J.A.,
writing for the Court, stated 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.[3]
[20]
Tonn sought to bring a sense of commercial reality into
the minefield of "reasonable expectation of profit"
appeals.
[21]
Subsequently the Federal Court of Appeal heard the appeals of
A.G. of Canada v. Mastri et al.[4] In Mastri, Robertson J.A.
explained at 5423 that in Tonn the Court did not
intend
...to establish a rule of law to the effect that, even
though there was no reasonable expectation of profit, losses are
deductible from other income sources unless, for example, the
income earning activity involved a personal element. The
reference to the Moldowan test being applied
"sparingly" is not intended as a rule of law, but as
a common-sense guideline for the judges of the Tax Court. In
other words, the term "sparingly" was meant to convey
the understanding that in cases, for example, where there is no
personal element the judge should apply the reasonable
expectation of profit test less assiduously than he or she might
do if such a factor were present.
Robertson J.A. explained that:
Tonn simply affirms the common-sense understanding that
it is not the place of the courts to second-guess the business
acumen of a taxpayer whose commercial venture turns out to be
less profitable than anticipated.
[22] Later, in
Kuhlmann et al. v. The Queen,[5] the Federal Court of Appeal
placed the burden on the Crown to establish that on a balance of
probability, the expectation of profit was "irrational,
absurd or ridiculous" and therefore was not reasonable.
Since the Crown did not succeed in satisfying this burden, the
taxpayers' appeals were allowed.
[23] In The
Queen v. Milewski,[6]the Minister disallowed certain losses
incurred by a partnership that were deducted by the appellant,
one of the partners. In the Minister's view the appellant
had no reasonable expectation of profit because of significant
borrowing to finance the investment and related interest
expenses. The principal of the borrowing was to be paid according
to an amortization schedule of 25 years. No evidence suggested
the payments were not or would not be made according to the
amortization schedule. The Federal Court of Appeal agreed that
the finding of Bowman T.C.C.J. (as he then was), that the
investment was bona fide with the expectation that all of
the debt ultimately would be paid off, and the appellant and his
partners would have a lasting investment, satisfied the
reasonable expectation of profit test on the facts of that
appeal.
[24] The
Federal Court of Appeal held that a 25-year amortization
period is not unusual for long-term investments in real estate.
All things being equal, profitability will "in the fullness
of time" be achieved.
[25] On the
facts at bar, the Minister has conceded that one of the
properties owned by the appellants had a reasonable expectation
of profit but another did not.
The concession was due to the fact a net profit was realized
by the appellants from the Delta Property; the Minister really
had no choice. It is the Maple Property that is in dispute.
[26] One
should be leery to always conclude that losing investments never
have a reasonable expectation of profit. I would assume that the
same thought process that went on in the minds of the appellants
when they decided to improve the Delta Property repeated itself
when it came to acquire the Maple Property. It is true they lived
in British Columbia and the Maple Property was in Ontario. But
the appellants had family in the Toronto area who they could
trust and who were prepared to help them if there were problems.
The appellants felt comfortable in acquiring the Maple Property.
There is absolutely no evidence that the appellants'
expectation of profit from the Maple Property was any different
from that of the Delta Property or that it was "irrational,
absurd or ridiculous".
[27] In fact,
the appellants negotiated a reduction in the interest rate of the
mortgage on the Maple Property. The initial mortgages were for
five-year terms. Mrs. Oxciano impressed me as a
hard-working individual whose goal is to reduce the
expenses from the Maple Property and make it profitable. There is
no evidence the appellants purchased the property to sell for a
gain. Theirs is a long-term, bona fide investment. I
do not see why this couple of modest means cannot "in the
fullness of time" accomplish their goal.
[28] However,
there is some problem with respect to the expenses actually
incurred by the appellants. The Minister has assumed that
interest in the amounts of $9,416.20 and $1,716.59 in 1995 and
1996, respectively, were not vouched. There are also no vouchers
for furniture and fixtures in the amount of $2,777.59 for 1995.
The Minister also assumed that the appellants deducted personal
expenses of $2,804.15 in 1996 and claimed capital expenditures of
$255.50 for 1996.
[29] Based on
the annual rates of interest on the money borrowed to acquire the
Maple Property, which was secured by two mortgages, it appears
the amount of interest the appellants would have had to pay in
1995 was approximately $18,300. They claimed they paid $17,627.
If they did not pay the $9,416 which the Minister says is not
vouched, I would assume their mortgagees would have had something
to say about the delinquent payments. The $9,416 is a significant
amount. But, there is no evidence, one way or the other.
[30] As far as
the other expenses questioned by the Minister are concerned, the
appellants did not challenge that capital or personal
expenditures were actually deducted. Also, the appellants did not
challenge the disallowance of expenses for furniture and fixtures
in 1995. Therefore these amounts ought not be included among the
operating expenses of the Maple Property. The reason I am
reluctant to do the same with the interest expense is that the
appellants were liable for these amounts to mortgagees. I cannot
imagine the mortgagees tolerating such a default in payments. The
non-payment in 1996 of an amount of interest of $1,716.59, on the
other hand, may have been overlooked.
[31]
Therefore, the appeals for 1995 and 1996 will be allowed and the
assessments are referred back to the Minister of National Revenue
for reconsideration and reassessment on the basis that:
The Maple Property was acquired by the appellants with a
reasonable expectation of profit;
for 1995, the amount of $2,777.59 (furniture and fixtures) not
be included in computing expenses for the Maple Property;
for 1996, the amounts of $255.50 (capital expense), $2,804.15
(personal expenditures) and $1,716.59 (interest) not be included
in computing expenses for the Maple Property;
with respect to the amount of interest of $9,416 deducted in
computing income from the Maple Property in 1995, that the
appellants provide the Minister with acceptable proof within
60 days that the amount of $9,416 was paid to the creditors
of the appellants for money borrowed to acquire the Maple
Property; and
the appellants shall be entitled to costs, if any.
Signed at Montreal, Canada this 11th day of October
2000.
"Gerald J. Rip"
J.T.C.C.
COURT FILE
NO.:
2000-353(IT)I
2000-355(IT)I
STYLE OF
CAUSE:
Ernesto Oxciano and Violeta Oxciano and
Her Majesty the Queen
PLACE OF
HEARING:
Vancouver, British Columbia
DATE OF
HEARING:
June 26, 2000
REASONS FOR JUDGMENT BY: The
Honourable Judge Gerald J. Rip
DATE OF
JUDGMENT:
October 11, 2000
APPEARANCES:
Agent for the
appellant:
Violeta Oxciano
Counsel for the
respondent:
Kristy Foreman Gear
COUNSEL OF RECORD:
For the
respondent:
Morris Rosenberg
Deputy Attorney General of Canada
Ottawa, Canada
2000-353(IT)I
BETWEEN:
ERNESTO OXCIANO,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
Appeals heard on common evidence with the
appeals of Violeta Oxciano (2000-355(IT)I) on June
26, 2000, at Vancouver, British Columbia, by
the Honourable Judge Gerald J. Rip
Appearances
Agent for the
Appellant:
Violeta Oxciano
Counsel for the
Respondent:
Kristy Foreman Gear
JUDGMENT
The
appeals from the assessments made under the Income Tax Act
for the 1995 and 1996 taxation years are allowed and the matter
is referred back to the Minister of National Revenue for
reconsideration and reassessment on the following bases:
a) The Maple Property was acquired by
the appellants with a reasonable expectation of profit;
.../2
b) for 1995, the amount of $2,777.59
(furniture and fixtures) not be included in computing expenses
for the Maple Property;
c) for 1996, the amounts of $255.50
(capital expense), $2,804.15 (personal expenditures) and
$1,716.59 (interest) not be included in computing expenses for
the Maple Property;
d) with respect to the amount of interest of
$9,416 deducted in computing income from the Maple Property in
1995, that the appellants provide the Minister with acceptable
proof within 60 days that the amount of $9,416 was paid to
the creditors of the appellants for money borrowed to acquire the
Maple Property; and
e) the appellants shall be entitled to
costs, if any.
Signed at Montreal, Canada this 11th day of October
2000.
J.T.C.C.
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