Date: 20001016
Docket: 1999-3847-IT-I
BETWEEN:
CHEE ANG LOONG,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
Reasons for Judgment
(Delivered orally from the bench at Montréal, Quebec,
on September 1, 2000 and subsequently revised)
The Honourable P.R. Dussault, J.T.C.C.
[1]
This is an appeal from an assessment for the 1997 taxation
year.
[2]
By that assessment, the Minister of National Revenue, (the
"Minister") disallowed the deduction of a rental loss
in the amount $7,100 and of a terminal loss in the amount of
$32,900 relating to a condominium located at 304-1200
Curé-Poirier in Longueuil, Quebec, which was called
"Les Tours du Parc".
[3]
The losses were disallowed on the basis that, in 1997, the
Appellant had no reasonable expectation of profit from the
condominium during that year. At this point, I might add that the
Appellant had previously claimed rental losses with respect to
the condominium from 1990 to 1996 and that the losses were also
disallowed for 1995 and 1996.
[4]
The Appellant, who is a research scientist working for the
National Research Council in Boucherville, Quebec, claimed to
have always been interested in various investments such as
stocks, bonds, mutual funds and real estate.
[5]
In 1990, he was looking for a long-term investment and after
having evaluated the potential of other condominiums, he decided
to invest in Les Tours du Parc, as he considered the
project's potential for appreciation in value to be high. It
was located across from a park, near a hospital and close to a
Pratt and Whitney plant, and it had many other amenities.
[6]
According to the Appellant, the total price paid was close to
$113,000. It was financed through the developer with as security
a first hypothec for an amount of approximately $88,000 (see the
financial statements accompanying Exhibit R-1). The Appellant
also obtained a second hypothec for an amount of approximately
$25,000 and paid $500 in cash (I note that these figures differ
slightly from those set out in paragraph 3(b) of the Reply to the
Notice of Appeal, but this is not material to the issue
raised).
[7]
In his testimony, the Appellant stated more than once that he was
expecting a conservative 5% a year appreciation in value over a
ten- to fifteen-year period together with an increase in rental
income.
[8]
The arrangement with the developer was that the condominium would
be managed by the developer of the project or a related entity
for the period from 1990 to 1993 inclusive. According to the
Appellant, the management arrangement included a guaranteed
rental income of $8,400 a year for 1991, 1992 and 1993. For 1990,
the guaranteed amount was $2,100 for three months
(Exhibit A-10 is a closing statement by Les Tours du
Parc showing those figures as "rent revenue"). The
Appellant said that he had received no income directly during
those years and that he had relied on the financial statements
provided by the management company to complete his income tax
return.
[9]
The Appellant filed in evidence a lease signed by Placements
Tours du Parc with a Mr. and Mrs. Plourde for a period of
24 months from July 1 1991 to June 30, 1993
(Exhibit A-2). In it, the rent for July 1991 is said
to be free. The rent from August 1991 to June 1992 is
set at $735.00 a month and the rent from July 1992 to
June 1993 is set at $772.00 a month. The total amount of the
lease is $17,349 for the 24-month period.
[10]In his testimony, the Appellant said that he took over the
management of his condominium in 1994 and that he was able to
rent it for a 24-month period from July 1, 1994 to July 1, 1996
at $772.00 per month. Despite numerous attempts and newspaper
ads, the Appellant could not rent it thereafter and he finally
disposed of it in 1997, the year in issue. In fact, the
transaction that occurred in 1997 was more an exchange for a
condominium of a different nature located on Lake Memphremagog,
which, the Appellant said, appeared more profitable.
[11]The Appellant said that in 1994, he also paid the debt in
the amount of some $24,000 secured by the second hypothec.
[12]In cross-examination, the Appellant's tax
returns for the years 1992 to 1997 were filed in evidence
(Exhibits R-1 to R-6).
[13]For 1992, the rental income of $8,400 was reduced to
$3,885 after taxes, condominium fees, administration fees and
various expenses but before the payment of interest on the first
hypothec in the amount of $8,686, a special fee for financial
services and guarantees in the amount of $6,549 and interest on
personal loans in the amount of $2,098. The loss was $13,448.[1] It is obvious that
the guaranteed rent of $8,400 a year did not even cover the
interest on the first hypothec.
[14]For 1993, the rental income of $8,400 was likewise reduced
to $3,820 after taxes and the various fees. At page 2 of the
financial statements filed with the return, it can be seen that
the interest paid on the first hypothec was $8,587 and that the
fee for financial services and guarantees was in the amount of
$6,281. The interest on personal loans was indicated to be $4,382
for a total of $19,250 in interest and fees, which brought the
loss to $15,430.[2]
Here again, the guaranteed income of $8,400 was not even
sufficient to cover the interest on the first hypothecary
loan.
[15]I refer to these figures because, in cross-examination,
the Appellant admitted that he was aware of the developer's
projections, that he had seen an English version of the document
filed in evidence by the Respondent as Exhibit R-7,
and that he knew about the potential tax losses. The document in
question contains detailed calculations of losses before
secondary financing, interest payable on a line of credit, the
total tax losses generated and the tax savings from 1990 (3
months) to 1993 inclusive. The tax savings, the interest payable
on a line of credit and the $500.00 cash paid at the time of the
offer are then taken into consideration to establish the positive
cash flow for the period. In fact, the schedules of cash flow
projections found in the promoter's documents are based on a
maximization of losses for tax purposes and on 100% financing. I
will simply comment here that the document is anything but a
well-defined plan to make a profit from rentals.
[16]What is well defined is the utilization of the losses
generated for tax purposes. In this context, it is somewhat
difficult to refer to the "reasonable expectation of
profit" criteria in any serious manner. The expressions
expectation and reasonable expectation can be used here only in
relation to the tax losses generated, their utilization to reduce
income from other sources, the tax savings and the projected cash
flow. There is nothing even remotely akin to an expectation of
profit, in the commercial sense, from rentals. Despite that, the
Appellant was able to deduct the losses claimed in all the years
from 1990 to 1994.
[17]I now come to 1994, and I refer to Exhibit R-3.
During that year, the Appellant's gross rental income
amounted to $7,720. Taking into account the payment of the second
hypothecary loan, the claim for interest has been reduced to
$6,192.89. However, property taxes of $1,798.60 and various fixed
fees for a total of $2,406.69 ($1,677.69 + $494.00 + $235.00)
bring the loss to $2,678.18 for that year.
[18]For 1995, Exhibit R-4 shows gross rental income of
$7,720, interest on the hypothecary loan of $6,319.25, property
taxes of $1,809.53 and various fees for a total of $2,054.62,
which results in a loss of $2,463.40.
[19]I might add here that for 1994 and 1995, gross rental
income amounted to approximately 75% of the fixed costs.
[20]In 1996, the Appellant's condominium was rented for
only the first six months of the year. Exhibit R-5
indicates that gross rental income was $3,860. Interests amounted
to $5,825.95, property taxes to $1,808.91 and fixed fees to
$1,813.24. Other expenses, including maintenance and repairs and
advertising, were claimed for a total of $1,371.99. If we
extrapolate from this, by doubling the rent received, to
determine what the situation would have been had the condominium
been rented the entire year, we are still faced with the bare
fact that rental income would have been only 82% of the fixed
costs, not to mention the other costs such as maintenance and
repairs which should be seen as simply normal during the seventh
year.
[21]The 1997 taxation year is the only one in issue. Exhibit
R-6 shows no income, as the condominium was not rented. The
Appellant explained that it was disposed of during that year.
Approximately half the expenses are claimed as deductions.
Interest is claimed in the amount of $2,088.00, property taxes in
the amount of $780.57 and management and administration fees in
the amount of $847.20. Maintenance, repairs and miscellaneous
other current expenses amount to $549.59. Finally, an amount of
$2,835.00 is claimed as legal, accounting and other professional
fees for a total rental loss for the year of $7,100.36. The
Appellant explained that the amount of $2,835.00 was for expenses
in connection with the sale, or rather the exchange of his
condominium for another one located on Lake Memphremagog, which
leads to the question whether these expenses were properly
claimed as current expenses. However, these particular expenses
were not challenged on that basis and I will refrain from
commenting any further on this point.
[22]In his testimony, the Appellant stressed the facts that he
had paid off the second hypothec in 1994 and that by 1997 he had
considerably reduced (by some 30%) the debt secured by the first
hypothec. He referred to adverse market conditions in 1996 and
1997 and to the efforts made to secure a tenant, especially by
advertising extensively in newspapers.
[23]The Appellant also presented a document entitled
"Analysis of Profitability of Investment of Condo at 1200
Curé-Poirier (304B) in 1997" (Exhibit A-5). In
this document, the rent is set at $772.00 a month for a total of
$9,264 for the year. Interest on the hypothec is set at $5,010,
property taxes at $1,808, condo fees at $1,692 and other expenses
(advertisements and minor maintenance) at $500.00 for a projected
profit of $254.00.
[24]This document warrants a few comments. First, the
hypothetical rent at $772.00 a month is obviously based on the
rent set in the lease entered into for the period of
July 1, 1994 to July 1, 1996 (this should actually read
June 30). However, in 1996, the reported rent was $3,860 for
six months, or an average of $643.00, not $772.00, a month. In
1995, the reported rent was $7,720 for 12 months, thus once
again an average of $643.00 a month, not $772.00.
[25]For 1994, the reported gross rent is also $7,720. I find
it somewhat strange that the reported rent does not correspond to
the rent stated in the leases. Based on the actual figures and
the fact that the various fixed fees have always exceeded $1,700
a year, there certainly would not be much left by way of a
profit. In any case, the document in question was prepared after
the fact and, in my view, definitely does not constitute a
realistic plan for profitability.
[26]Another document, a three-month lease for the new
condominium on Lake Memphremagog was also filed in evidence
(Exhibit A-8), as proof that the Appellant's objective
was profitability. The lease for three months is for $1,000 per
month. However, no other details were given to demonstrate
profitability.
[27]In his argument, the Appellant claimed that he had made a
long-term investment with a view to an appreciation in value over
time and a possible increase in the rent. According to him, this
was merely a business decision involving no personal element. He
says that, in 1997 (the eighth year of ownership), he still had a
reasonable expectation of profit that was thwarted only because
of adverse market conditions which made it impossible for him to
rent the condominium after June 1996. The Appellant said
that he might have made an error in judgment but that it was his
error and, from what I understand, that he should not be
penalized for it. The Appellant is relying on Tonn v. The
Queen, 96 DTC 6001, in support of the proposition
that taxpayers' business decisions should not be
second-guessed after the fact. He is also relying on Saunders
v. R., 1998 CarswellNat 156, also reported at [1998] 2 C.T.C.
3196, a case whose circumstances are similar.
[28]The Respondent's position is that the Appellant had no
reasonable expectation of profit, that he was interested in
making a long-term investment so as to benefit from the tax
deductions with a view to realizing a capital gain later.
According to the Respondent's representative, until 1994, the
Appellant was simply following the developer's plan and the
losses claimed were consistent with the developer's
projections and figures.
[29]Even from 1994 on, the Appellant could never have realized
a profit from renting the condominium because of the scale of the
interest payments, despite the fact that he undertook to pay off
the loan secured by the second hypothec. Taking into
consideration the facts that the Appellant had no particular
training or experience in real estate, that he had let others
manage the property until 1994 and that losses had been claimed
year after year from the very beginning, the Respondent's
representative concludes that the Appellant had no reasonable
expectation of profit in 1997 and that the losses claimed,
namely, the rental loss and the terminal loss, should therefore
be disallowed in their entirety.
[30]The Respondent's representative is relying more
specifically on Moldowan v. The Queen,
[1978] 1 S.C.R. 480; Landry v. The Queen,
94 DTC 6624; Tonn v. The Queen,
96 DTC 6001; Mastri v. Canada, [1998] 1
F.C. 66; Mohammad v. Canada,
[1998] 1 F.C. 165; Stewart v. Canada,
[2000] F.C.J. No. 238; and, finally, Audet v.
The Queen, 2000 DTC 1648. I will just mention here
that Audet has been appealed to the Federal Court of
Appeal.
[31]The Respondent's representative also argues, if my
understanding is correct, that a terminal loss could not be
claimed in 1997 because the Appellant owned another building of
the same class during the year, namely the condominium on Lake
Memphremagog acquired through the exchange. This point of law is
not raised in the pleadings and I do not think that it can have
any application in the present case because two rental buildings
worth $50,000 or more belong to separate classes: (see subsection
1101 (1ac) of the Income Tax Regulations).
[32]As to the question of reasonable expectation of profit, I
will start by referring to a very recent Federal Court of Appeal
decision in Stewart v. Canada, [2000] F.C.J. No.
238. In that decision, the Federal Court of Appeal made it quite
clear that the reasonable expectation of profit test, derived
from the well-known Supreme Court decision in Moldowan
v. The Queen, has not been altered by any subsequent Supreme
Court decision and that its application is not restricted to
situations involving an element of personal use.
[33]I think that a brief reference to what Dickson J. said in
Moldowan would be useful here. At pages 485-86 of the
decision, he stated:
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:
The Queen v. Matthews. One would not expect
a farmer who purchased a productive going operation to suffer the
same start-up losses as the man who begins a tree farm on raw
land.
[34]In the present case, the Appellant claimed consecutive
losses for a period of eight years. The losses were quite
substantial in the first four years when compared to his rental
income, which was not necessarily generated by the condominium
but was guaranteed under the arrangement with the developer.
[35]From 1994 on, the losses were smaller because of the
reduction of the interest expense due to payment of the debt
secured by the second hypothec. However, the annual rental income
was never high enough to cover the fixed costs. This was true for
1994 and 1995 and also for 1996 and 1997. It would be true even
had a full year's rent, based on the gross rental income
reported in 1995 or for six months in 1996, been received in 1996
and 1997. I am obviously ignoring the unfavourable market
conditions that, according to the Appellant, prevailed during
those two years. My conclusion here is that the losses were not
incurred because of unforeseen or unfavourable market conditions.
It was the structure of the venture itself that caused them.
[36]This brings me automatically to another factor mentioned
by Dickson J.: "the capability of the venture as
capitalized to show a profit after charging capital cost
allowance." I have already commented on the projection of
losses made by the developer and the Appellant's reliance on
someone else to finance the acquisition of his condominium with a
bare $500.00 cash. It is obvious to me, as I said earlier, that
since the guaranteed rent of $8,400 could not initially cover
even the interest paid on the first hypothec, not to mention the
other fixed costs, there could hardly have been a reasonable
expectation of profit at that point in time. But these were the
first few years and I will not comment further.
[37]What is more troubling though is that, even after the
repayment of the debt secured by the second hypothec, the fixed
costs could not be covered by the rental income. Property taxes
and condominium and related fixed fees should come as no surprise
to someone buying a condominium and should definitely be taken
into account in any serious plan to ensure profitability.
[38]After six or seven years, maintenance and repairs should
also be taken into account. The fact that the fixed costs could
never be covered during eight years in the present case, even if
one assumes normal market conditions, certainly raises serious
doubts about the existence of a well-defined plan, or for
that matter of any plan, to ensure profitability of the
condominium as a rental property.
[39]What transpires from the evidence is that the objective of
the whole initial financial structure seems not to have been to
derive a profit from the rental of the property but, in the short
term, to maximize losses to ensure a positive cash flow and, in
the long term, to receive the benefit of a capital appreciation
giving rise eventually to a capital gain.
[40]I will not comment on the question of capital cost
allowance because, as everyone knows, it cannot be deducted if
the effect is to increase a loss. However, I have to wonder in
what year the Appellant would have been able to show a profit
from the venture if he had kept the condominium and capital cost
allowance had eventually been taken into account.
[41]As to the Appellant's training and experience in real
estate ventures, the simple conclusion is that he had none. Which
brings me to "the intended course of action." As I have
already said, the Appellant's initial course of action
essentially followed the plan laid out by the promoter. He thus
claimed substantial losses and was able to realize significant
tax savings from 1990 to 1993 inclusive.
[42]In 1994, there was certainly a step in the right
direction. By paying the debt secured by the second hypothec, the
Appellant reduced the interest expense and thus a substantial
component of the fixed costs. However, this was not even enough
in the fifth year from purchase to cover those costs. Far from
it: in the next year, 1995, he did not do much better even though
the condominium was rented for the full year. The last two years
were even worse, as we know. The situation just worsened due to
market conditions.
[43]In this respect, I must say that I do not accept the
Appellant's evidence that he could have earned a gross rental
income of over $9,000 during 1997 but for the unfavourable market
conditions. This figure is based on the rent fixed in the
two-year lease from July 1994 to July 1996. However, as we
have seen, no such rental income covering the whole year of 1995
was ever declared. In 1995, the Appellant declared a rental
income of $7,720, not $9,264.
[44]My review and analysis of the evidence as a whole, and of
the Appellant's testimony in particular, lead me to conclude
that the Appellant never had a real and objective expectation of
profit from the rental of his condominium and that he did not
have a realistic plan to ensure its profitability. This was even
more true in 1997, the year in issue, considering that the
condominium was bought in 1990.
[45]What the evidence reveals is that the Appellant was more
concerned over the years with tax savings in the short term and
with a potential capital gain in the long term.
[46]A reasonable expectation of a capital gain is not the
equivalent of a reasonable expectation of profit from a property.
Indeed, subsection 9(3) of the Income Tax Act states the
following:
In this Act, "income from a property" does not include
any capital gain from the disposition of that property and
"loss from a property" does not include any capital
loss from the disposition of that property.
[47]Subsection 9(1) states the basic principle that income for
a taxation year from a business or property is the taxpayer's
profit from that business or property for that year. In
Moldowan, supra, Dickson J. stated at page 485
that:
. . . in order to have a "source of income" the
taxpayer must have a profit or a reasonable expectation of
profit.
[48]This principle applied to a rental property simply means
that a taxpayer must have a profit or a reasonable expectation of
profit from the rental thereof and from the rental alone (see
Foldy and Jarian v. M.N.R., 91 DTC 361 at
363).
[49]The burden of proof with respect to such an expectation of
profit rests with the taxpayer. My conclusion in the present case
is that the Appellant has failed to convince me on a balance of
probabilities that he had such an expectation.
[50]Finally, I will make a few comments on the decision in
Saunders v. The Queen, referred to by the
Appellant. First, in that case, the years in issue were the
third, fourth and fifth years from the date of purchase. Second,
the taxpayers clearly demonstrated that they had a realistic plan
to attain profitability, even though the purchase of the
condominium was financed at 100%, by showing, inter alia,
the possibility of increasing the rent, which was in fact
steadily increased over time. Third, they did in fact make a
profit in the eighth year according to their plan.
[51]I think these factors are sufficient to distinguish that
case from the situation in the present appeal.
[52]For the above reasons, the appeal from the assessment for
the 1997 taxation year is dismissed.
Signed at Ottawa, Canada, this 16th day of October 2000.
"P.R. Dussault"
J.T.C.C.
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