Date: 20010727
Docket: 1999-2081-IT-I
BETWEEN:
LONE SMITH,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
____________________________________________________________________
For the Appellant: The Appellant herself
Counsel for the Respondent: Jocelyn Espejo
Clarke and Scott Simser
___________________________________________________________________
Reasons for Judgment
(Delivered orally from the Bench
at Toronto, Ontario, on September 20,
2000)
Bowie J.
[1]
There are two appeals before me that are brought under the
informal procedure; one for 1994 and the other for 1995. They
concern the Appellant's claim to deduct the losses incurred
in connection with a triplex housing unit in those two years from
her other income pursuant to section 3 of the Income Tax
Act.
[2]
The Appellant is a school principal; before that, she was a
teacher. In both of those occupations she has had a substantial
salary. She started to invest in rental properties in the Toronto
area in 1977. First, she bought a house containing three
apartments. In 1978, she bought a second house having four
apartments. At one point she was renting out a total of 13
apartments. In 1987, she and her husband bought a house in which
they have lived ever since.
[3]
By the beginning of 1990, the Appellant had sold all of the
rental properties, except one at 577 Indian Road. In February
1990, she bought the property at 53 9th Street in Mimico, which
is the subject of these appeals. I shall refer to it as "the
property". I say that "she" bought it because it
was her contention at the hearing of these appeals that she was
the sole owner of the property. It is registered in the name of
her husband, Larry Smith, however, and one of the assumptions
pleaded by the Deputy Attorney General is that Larry Smith
bought the house and is the owner of it. Oddly, another of the
assumptions pleaded is that the losses incurred in connection
with the property were personal or living expenses of the
Appellant.
[4]
At the outset, there were three matters of contention between the
parties in this case:
(i)
Whether the Appellant or her husband was the owner and suffered
the losses in question;
(ii)
Whether the property, or the business of operating it, was in
1994 and 1995 a source of income. The Minister contends that it
was not, and he relies on the doctrine of absence of a reasonable
expectation of profit as it has been expounded in Moldowan v.
The Queen,[1] Tonn v. The Queen,[2] Mohammad v. The Queen[3] and Mastri
v. The Queen;[4] and
(iii) The
quantum of the losses for the two years under appeal.
[5]
In filing her returns for the 1994 and 1995 taxation years, the
Appellant claimed to be entitled to deduct losses of $22,541.91
and $26,306.85, respectively. After an adjournment and some
discussion, the parties agreed that for those two years the
expenses in connection with the property were respectively
$41,776 and $40,749. The agreed upon losses are therefore
calculated as follows:
|
|
Gross Rental Income
|
Expenses
|
Losses
|
|
1994
|
$22,340
|
$41,776
|
$19,436
|
|
1995
|
$22,891
|
$40,749
|
$17,858
|
There remain the issues whether the property was a source of
income, within the meaning of that expression as it is used in
section 3 of the Act, and whether the Appellant or her
husband is entitled to the loss.
[6]
The property was purchased in February 1990 for $363,000 which
was made up as follows:
1st mortgage with Royal Trust
Company:
$271,500
2nd
mortgage
$ 41,900
3rd
mortgage
$ 25,000
Total
$338,400
Balance in
cash:
$24,600
The house had three apartments and all of them were rented at
the time of purchase. The rent being obtained for the first floor
apartment was $900 per month, for the second floor $763.58 per
month; and the basement $800 per month, a total of $2,463.58 per
month, which amounts to $29,563 per year.
[7]
The evidence of the Appellant was somewhat vague as to the
precise terms of the various mortgages, including the interest
rates. The annual taxes at the time of acquisition were about
$4,000 and have increased considerably since that time. By
February 1990, the Appellant and her husband had acquired
considerable experience in operating apartment buildings of a
similar kind, and I am satisfied that they went into this
property with not only the intention of making it commercially
viable in the short run, but also with a reasonable prospect of
doing so. The Appellant had a substantial salary from the school
board from which she could reasonably expect to make significant
payments on the mortgages. She expected to be able to collect
$30,000 per year in rent, and in fact, it was her expectation
that these rents could be increased by about 8%. For his part,
her husband was able to do much of the work of managing the
business aspects of the property and the maintenance and repairs
in connection with it. Both the Appellant and her husband,
according to the evidence, from time to time did maintenance,
renovation and repairs.
[8]
Unfortunately, a number of adverse circumstances came together to
thwart their plans. The first of these was the economic downturn
of 1990, which had the result that tenants became unemployed and
were unable to pay the rent, and it was difficult to replace
them, leading to vacancies which they had not anticipated and had
no particular reason to anticipate. From time to time, there were
difficulties in collecting the rent, although the only time when
a tenant who was not paying rent was difficult to evict from the
property was after the years in question here. All of these
things have conspired to limit the gross rental income to
something considerably less than had been expected. It fluctuated
between a high of $38,435 in 1991, according to the
Minister's assumptions (although the Appellant was doubtful
about that particular assumption) to a low of $21,350 in
1996.
[9]
In addition to the other difficulties, the imposition of
statutory rent controls in Ontario prevented any significant rent
increase for a period of years, and this, of course, was not
something that could necessarily have been foreseen in 1990. In
August 1990, soon after the purchase of this property, the
Appellant's husband's business failed. This had the
result that they had to divert a certain amount of cash to paying
debts associated with that, and in order to do so, they were
required to sell the triplex at 577 Indian Road in the spring of
1991.
[10] In late
1990, the third mortgage on the property, which was a mortgage
taken back by the vendors, went into default. The Appellant was
able to obtain funds from a family source to pay off this
mortgage, which she did. She also replaced the second mortgage in
July 1991, with a first mortgage on the family home in which she
and her husband lived. Despite these measures, however, the
property has continued to lose money at a rate averaging $18,500
per year up to and including 1999, which is to say, for the first
ten years following its acquisition.
[11] This,
together with the absence of any definite plan to remedy the
situation, it is argued by counsel for the Respondent,
establishes that there could have been no reasonable expectation
of profit in the years 1994 and 1995. I did not understand him to
be taking the position that the acquisition initially was an
unreasonable one, but simply that by 1994 the Appellant must have
realized that the property, as financed at that time, could not
make money and so she should have sold the property at whatever
price she could get for it and cut her losses at that point.
[12] I have no
doubt that the Appellant went into this purchase with both the
intention and the expectation of making a profit. Was that
expectation reasonable? I believe, given the climate of late 1989
and the first month or two of 1990, that it was. Certainly, there
was no personal use made of this property by the Appellant or any
of her family members. Quite the contrary, it has clearly
required a great deal of time and effort by her and her husband
to operate it over the last decade.
[13] The
Appellant testified that she attempted to sell the property in
1991, but that nobody showed the least interest in purchasing it.
Counsel for the Respondent takes the position that the Appellant
should have attempted to sell it again in 1994. The Appellant
testified that she was aware of the market conditions generally
throughout this period, and that, in particular, she was aware
that values in the location of this property remained depressed
at that time. By December 1995, the first mortgage principal had
been reduced to $248,600, the second mortgage liability had been
transferred from this house to the residence of the Appellant and
her husband, and the third mortgage had been paid off. However,
from the evidence of sales that was introduced by the Appellant,
I infer that the first mortgage balance outstanding alone was
substantially more than the market value of the property at that
time.
[14] The
Appellant and her husband did not have the resources available to
them to pay the difference between the reduced value of the house
and the outstanding principal on the first mortgage. A sale of
the property was, therefore, simply not possible. The Appellant
remains convinced that this property will prove to be profitable
in the near future, and she has recently been advised that the
rents currently charged are below the market rate. She intends to
continue to reduce the mortgage principal.
[15] Counsel
for the Respondent relies heavily on the decisions of the Federal
Court of Appeal in Mohammad and Mastri. This is
not, however, a case where it was obvious from the outset that
the property could not produce a profit, nor is it a case in
which there is any personal element in connection with the
acquisition or use of the property. As the Federal Court of
Appeal said in Tonn, at paragraph 64, where there is no
personal element in evidence, the Moldowan test should be
applied sparingly. As it was put in Mastri, at paragraph
12:
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.
Immediately following this passage, the Court referred, with
apparent approval, to a number of cases, including Wallace v.
The Queen,[5]
in which I held that the taxpayer was entitled to deduct the
losses suffered in respect of a property acquired as an
investment in circumstances very similar to those of the present
case. In the Wallace case, in fact, the financing of the
acquisition was entirely with borrowed money. The Appellant
there, like the Appellant here, was a victim of the recession of
the early 1990s. It is easy, with the benefit of hindsight, to
say that the purchase in this case was at too high a price and
too high a leverage. The fact is that in 1990 it was a reasonable
business judgment to make, and it is also a fact that having
purchased the property, the Appellant simply was not in a
position to sell it by 1994 or by 1995.
[16] I turn
now to the question of whose loss is it? The Appellant explained
in her evidence that she had the property transferred into her
husband's name at the time of acquisition because he had more
time than she did to attend at lawyer's offices, to sign
papers, and to do all the other running around that was required.
She was, she said, working very long hours and simply did not
have the time available that her husband had. For the same
reason, her husband dealt with the tenants, looked after the
paying of bills, and various business aspects of the enterprise.
No trust document of any kind was prepared at the time of the
acquisition or since then, and the Appellant gave no evidence of
any specific oral agreement between them with respect to either
the ownership or the operation of the property.
[17] The
Appellant testified that she had the high income, and she
provided the purchase money, and her husband gave evidence to the
same effect. Their evidence in this regard is, of course,
self-serving because, at least during the years under
appeal and, it would appear, in most years, the Appellant had by
far a higher income than her husband and was, in fact, subject to
income tax at the highest marginal rate, so that their joint
economic interests are best served if the losses are hers.
[18] When the
Appellant's husband testified, he made repeated references to
the acquisition as being by "we" rather than by his
wife, and he continued to use the plural in respect of the
operation of the property and their decision-making, even
after I had brought this to his attention. When the hearing was
resumed, some weeks later, only the Appellant gave evidence, and
she avoided the use of the plural pronoun.
[19]
Mr. and Mrs. Smith operated a joint account into which
the rents from the property were deposited and from which
associated bills were paid. As I understood it, their only other
bank account was an account of hers into which her paycheque from
the school board was deposited and from which she wrote cheques
to her husband to deposit in the joint account. In addition to
the deposits to the joint account, required for their ordinary
living expenses, she transferred money from her sole account to
the joint account as required to cover the losses in connection
with this property. There was no suggestion in the evidence that
she paid Mr. Smith any amount for assisting her with the
business aspects of the property, the running around, which she
referred to him doing, or any of the maintenance and repair work
which he did. The amount of $24,600 cash, which was paid as a
down payment, she said came from the sale of another property,
which I take it was registered in her name. When it became
necessary to raise money to retire the second mortgage of some
$40,000 or so, the source of this was a mortgage placed on the
family residence.
[20] In the
absence of any specific evidence as to an agreement between the
Appellant and her husband, and having regard to the pooling of
funds in the joint account, the mortgage on the family residence,
the proceeds of which went into this property, and the sharing of
responsibilities in respect of management and upkeep of the
property, and the husband's covenant on the various mortgages
given at the time it was acquired, I have reached the conclusion
that the operation of this property was in fact a 50/50
partnership between the Appellant and her husband. The
Appellant's contribution to the partnership was mostly, but
not entirely, a financial one. The husband's contribution was
mostly, but not entirely, made up of his labour and management
services.
[21] In the
result then, I reach the conclusion that in 1994 and 1995, this
partnership business did in fact comprise a source of income
within the meaning of that expression in section 3 of the
Income Tax Act, and that the Appellant is entitled to
deduct, in those years, her 50% share of the losses, which
amounts to $9,718 in 1994 and $8,929 in 1995.
[22] The
appeals will, therefore, be allowed and the reassessments
referred back to the Minister of National Revenue for
reconsideration and reassessment on that basis.
Signed at Ottawa, Canada, this 27th day of July, 2001.
"E.A. Bowie"
J.T.C.C.
COURT FILE
NO.:
1999-2081(IT)G
STYLE OF
CAUSE:
Lone Smith and Her Majesty the Queen
PLACE OF
HEARING:
Toronto, Ontario
DATE OF
HEARING:
July 20 and September 19, 2000
REASONS FOR JUDGMENT BY: The
Honourable Judge E.A. Bowie
DATE OF JUDGMENT:
September 25, 2000
APPEARANCES:
For the
Appellant:
The Appellant herself
Counsel for the Respondent: Jocelyn Espejo Clarke and
Scott Simser
COUNSEL OF RECORD:
For the Appellant:
Name: The
Appellant herself
Firm: N/A
For the Respondent: Morris
Rosenberg
Deputy Attorney General of Canada
Ottawa, Canada
Email this Content