Date: 20000407
Docket: 1999-300-IT-I
BETWEEN:
JEAN-MARIE LALANDE,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
Reasons for Judgment
Lamarre Proulx, J.T.C.C.
[1] This is an appeal under the informal procedure for the
1994, 1995 and 1996 taxation years. The point at issue is whether
the appellant had a reasonable expectation of profit from the
rental of a condominium purchased in 1983. From its purchase
until its disposition in 1999, the property never produced a
profit. The losses claimed for the years in issue are $5,149,
$5,086 and $5,238.
[2] The appellant was the only person who testified in this
case. Counsel for the respondent filed as Exhibit I-1
a book of documents with 21 tabs.
[3] The appellant is now retired. In 1984, he was an assistant
deputy minister at the Ministère de la Fonction Publique
(Civil Service Department) of Quebec. He explained that, in 1984,
wishing to supplement his pension and at the same time take
advantage of the government's rental property building
incentive program known by the acronym MURB (multiple unit
residential building program), he purchased a few properties, one
of which was located on Richmond Road in Ottawa. He disposed of
the others, which were located in Toronto, a few years after
purchasing them. The appellant explained that, according to the
advice of a colleague, a former Ottawa resident, it was
advantageous to purchase MURBs and to purchase them from the
builder Mastercraft for the following reasons: (a) to obtain
the MURB designation, the properties had to be of high-quality
construction and (b) Mastercraft was a recognized builder in
the Ottawa area with expertise in rental apartment management.
This colleague provided him with written information on the
Richmond Road project. In addition, insisted the colleague, the
appellant should consider the Ottawa area's economic future
in the electronics field.
[4] The appellant referred to tab 19 of
Exhibit I-1, which contains an analytical chart,
prepared by the developer, showing the tax benefits of a $16,200
investment. It is presented as a tax savings incentive. The chart
shows that net rental income was always negative from 1983 to
1991, and even more so after capital cost allowance.
[5] The appellant realized that this scenario brought out the
tax benefits, but he said that, at the time, he had made his own
projection up to the time he would reach retirement age. He
stated that he had tried to reproduce those figures with his
son-in-law's help. This worksheet was filed as
Exhibit A-1. It shows positive net income starting in 1994:
$397 for 1994, $1,026 for 1995 and $2,056 for 1996. For each of
those years, the gross income hoped for was 15,087, $16,100 and
$17,227. These figures were solely assumptions because, in actual
fact, the property never generated gross rental income in the
order of that stated in Exhibit A-1 and accordingly never
produced net profits even in 1998.
[6] According to the documentary evidence, the rental losses
claimed over the years were $15,497.81 (1984), $15,508 (1985),
$13,592 (1986), $13,275 (1992) and $11,373 (1993). These losses
included capital cost allowance.
[7] The appellant sold the property in 1999.
[8] The property was part of a pool of apartments collectively
managed by a rental business. Tab 8 contains a letter from
the appellant to Revenue Canada dated November 15, 1997,
which reads in part:
[TRANSLATION]
The property was always part of a pool managed by a rental
manager who paid himself out of the rental income and sent me the
rest by monthly cheque . . . .
[9] The appellant thus never knew how much profit his own
apartment generated except in 1998, when the property was managed
on an individual basis. Mastercraft abandoned management of the
apartments in 1987. After that, according to the appellant, the
individual who handled the management was not up to the task.
Legal action was instituted against Mastercraft in 1990 on
grounds of defective construction. Tab 13 contains a report
by Carleton Condominium Corporation No. 268 (Marina Bay).
This report to the condominium owners states that 1992 was a good
year. The various problems with the building had been resolved,
although there were still some problems with the elevators that
were to be solved in 1993.
[10] In 1997, the appellant withdrew his property from the
rental pool and handed it over to a rental agent. The appellant
testified that he did so in order to improve the rental results.
From what the evidence showed, however, the rental income did not
improve. The appellant's explanation for this was that the
building had earned a bad reputation as a result of all the
construction and rental management problems.
[11] Tab 10 of Exhibit I-1 contains the
contract of purchase between the appellant and Mastercraft
Development Corporation. Clause 6(f) states: "The
building shall be a multiple unit residential building qualifying
as Class 31 asset under Regulation 1100(14) of the
Income Tax Act (Canada)." The contract of purchase
was signed by the appellant on April 28, 1983. The vendor
signed on September 13, 1983. Schedule J found at the
end of tab 10 of Exhibit I-1 identifies the
property purchased, its cost and the various elements of that
cost. The total price of $107,999 was paid as follows: $2,500
cash, a mortgage of $91,799 and a promissory note for $13,700.
This promissory note was given to Mastercraft Development
Corporation and was to be paid not later than December 31,
1984. The appellant took out another loan to pay this promissory
note.
[12] According to the sales prospectus filed as
Exhibit A-3, the purpose of the purchase was as
follows: "The objective of investing in multi-unit
residential income property is to earn cash income, to realize
capital appreciation and to provide an opportunity for income tax
deferrals." At pages 10 and 11 of the prospectus,
attractive rental income is not among the 15 reasons
"Why you should invest in Marina Bay". Those
reasons are given as being "tax shelter, return of
investment, capital appreciation, strong market for condominiums,
retroactive tax refunds, etc." At page 13, the
guarantees enumerated include a "Revenue Guarantee",
which reads as follows: "During the first two years after
the Transfer Date, Mastercraft shall also provide a Revenue
Guarantee that will ensure that the monthly rental revenue for
each unit shall not be less than the scheduled rent. In the event
that monthly rental revenue exceeds the guaranteed rent, the
excess shall accrue to the benefit of the investor."
[13] Tab 9 contains the [TRANSLATION] "Rental
Property Questionnaire". To question 4, [TRANSLATION]
For what purpose was the property originally purchased?
the answer is: [TRANSLATION] To supplement my retirement
because it was class 31 property with tax benefits. The
purpose of this program was to improve Canada's building
inventory. To question 5, [TRANSLATION] When did you
begin renting the property? Please state the month and the
year, the answer is: [TRANSLATION] I don't know
because the property was part of a pool. To question 9,
[TRANSLATION] How do you determine the rental cost for each
unit? the answer is: [TRANSLATION] These costs are
established by the manager. To question 10,
[TRANSLATION] If during a given period of time the unit was
not rented, please state whether it was available for rental. If
not, please explain why not, the answer is:
[TRANSLATION] It was the manager's duty to find a
tenant.
Argument
[14] Counsel for the appellant emphasized the reasons for the
purchase. The appellant wanted to supplement his pension income.
Consequently, the purpose of the purchase was to generate good
rental income. The tax consequences were a plus, but not an end
in themselves. In addition, the appellant had conducted serious
analyses and research. If he encountered difficulties, they were
the sort of unforeseeable and acceptable problems that arise when
one has no personal interest in the property leased. Counsel also
argued that the property was a MURB for which, until 1994, there
was even an exception regarding the use of capital cost allowance
to increase or create a rental loss under
subsection 1100(14) of the Income Tax Regulations
(the "Regulations"), and that the rental losses
claimed were thus in accordance with the spirit of the
Regulations.
[15] Counsel for the respondent referred to the Supreme Court
of Canada's decision in Moldowan v. The Queen, [1978]
1 S.C.R. 480, at page 485:
Although originally disputed, it is now accepted that in order
to have a "source of income" the taxpayer must have a
profit or a reasonable expectation of profit. . . .
She referred as well to the Federal Court of Appeal's
judgment in Tonn v. Canada, [1996] 2 F.C. 73, at
pages 103 and 104:
[39] . . . Though I do not support the use in the
Nichol case of the word "patently", 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.
Counsel also referred to the decision of the Federal Court of
Appeal in Mastri v. Canada, [1998] 1 F.C. 66, at
pages 74, 75 and 76:
[9] First, it was decided in Moldowan that in order to
have a source of income a taxpayer must have a reasonable
expectation of profit. Second, "whether a taxpayer has a
reasonable expectation of profit is an objective determination to
be made from all of the facts" (supra, at pages
485-486). If as a matter of fact a taxpayer is found not to have
a reasonable expectation of profit then there is no source of
income and, therefore, no basis upon which the taxpayer is able
to calculate a rental loss. There is no doubt that,
post-Moldowan, this Court has followed and applied that
decision: see Landry (C.) v. Canada, [1995] 2 C.T.C.
3 (F.C.A.); Poetker v. Minister of National Revenue,
[1996] 1 C.T.C. 202 (F.C.A.); and Hugill (R.) v. Canada,
[1995] 2 C.T.C. 16 (F.C.A.). The only remaining issue is whether
Tonn departs from that jurisprudence by postulating that
the reasonable expectation of profit test remains irrelevant to
the question of deductibility of losses until such time as it can
be established that the case involves an inappropriate deduction
of tax, the presence of a strong personal element or suspicious
circumstances. . . .
. . .
[10] In my respectful view, neither of the above passages
support the legal proposition espoused by both the Minister and
the taxpayers. It is simply unreasonable to posit that the Court
intended 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. . . .
. . .
[12] In summary, the decision of this Court in Tonn
does not purport to alter the law as stated in Moldowan.
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. . . .
The Federal Court of Appeal's decision in Mohammad v.
Canada, [1998] 1 F.C. 165, at pages 173 and 175, was
likewise cited:
[7] Frequently, taxpayers acquire a residential property for
rental purposes by financing the entire purchase price.
Typically, the taxpayer is engaged in unrelated full-time
employment. Too frequently, the amount of yearly interest payable
on the loan greatly exceeds the rental income that might
reasonably have been earned. This is true irrespective of any
unanticipated downturn in the rental market or the occurrence of
other events impacting negatively on the profitability of the
rental venture, e.g. maintenance and non-capital repairs.
In many cases, the interest component is so large that a rental
loss arises even before other permissible rental expenses are
factored into the profit and loss statement. The facts are such
that one does not have to possess the experience of a real estate
market analyst to grasp the reality that a profit cannot be
realized until such time as the interest expense is reduced by
paying down the principal amount of the indebtedness. Bluntly
stated, these are cases where the taxpayer is unable, prima
facie, to satisfy the reasonable expectation doctrine. These
are not cases where the Tax Court is being asked to second-guess
the business acumen of a taxpayer whose commercial or investment
venture turns out to be less profitable than anticipated. Rather
these are cases where, from the outset, taxpayers are aware that
they are going to realize a loss and that they will have to rely
on other income sources to meet their debt obligations relating
to the rental property.
. . .
[11] The above analysis is to the effect that there can be no
reasonable expectation of profit so long as no significant
payments are made against the principal amount of the
indebtedness. This inevitably leads to the question of whether a
rental loss can be claimed even though no such payment(s) were
made in the taxation years under review. I say yes, but not
without qualification. The taxpayer must establish to the
satisfaction of the Tax Court that he or she had a realistic plan
to reduce the principal amount of the borrowed monies. . . .
Conclusion
[16] First I shall speak briefly about the MURB program by
referring to the passage dealing with the purpose of the
legislation in the Federal Court of Appeal's decision in
Vaillancourt v. The Queen, [1991] 3 F.C. 663 (91 DTC
5352), at pages 677-678 (DTC, page 5358):
Purpose of legislation and budget speech
In the budget speech he made on November 18, 1974, the
Minister of Finance said the following:
For reasons already discussed, I am particularly anxious to
provide a quick and strong incentive to the construction of new
rental housing units. I therefore propose to relax for a period
the rule whereby capital cost allowances on rental construction
could not be charged against income from other sources.
Specifically, in respect of new, multiple-unit residential
buildings for rent, started between tonight and December
31, 1975, the capital cost allowance rule will not apply. This
means that an owner of an eligible rental unit will be
permitted to deduct capital cost allowance against any source of
income at any time. I am confident that this measure will attract
a significant amount of private equity capital into the
construction of new rental housing. [My emphasis.]
Although these observations do not have the decisive scope
claimed for them by counsel for the appellant, they illustrate
quite clearly the Government's intention to encourage the
construction of multiple-unit residential buildings and to induce
taxpayers to invest in such buildings in return for significant
depreciation potential. . . .
[17] The purpose of the MURB program was to promote the
construction of residential rental properties. Nowhere do we read
that its purpose was to alter the conditions for the
applicability of section 9 and
paragraph 18(1)(a) of the Act or the
principles developed by the Supreme Court of Canada in
Moldowan, supra, and commented on in the Federal Court of
Appeal decisions cited above. According to this case law, in
order to have a source of income one must have a profit in view
or at least one must have a reasonable expectation of profit.
[18] It should be kept in mind in the instant case that the
developer's forecasts at the outset were that there would be
no net profit, even before capital cost allowance and on the
basis of a guaranteed rental income. If we disregard the entire
advertising aspect, which goes back to 1983 and consider the
appellant's conduct, we are forced to recognize that the
appellant had incurred significant rental losses since 1983.
Since the years in issue are 1994, 1995 and 1996, there was ample
time to turn the situation around. It is easy to understand that
the reason expenses always greatly exceeded gross rental income
was because the amount of the purchase price was almost entirely
borrowed. The appellant did not put in place the necessary
capital structure to deal with normal rental problems. He did not
correct the problem of insufficient capital. The only corrective
action he suggests he took was to withdraw the rental property
from the rental pool and hand it over to a rental agent. This
occurred after the years in issue and, as the evidence showed,
had no effect on the usual negative income.
[19] In my opinion, the evidence clearly showed that the
rental property in question was not a source of income for the
appellant: its purpose was not to generate a rental profit nor a
reasonable expectation of such profit.
[20] Accordingly, the appeal is dismissed.
Signed at Ottawa, Canada, this 7th day of April 2000.
"Louise Lamarre Proulx"
J.T.C.C.
[OFFICIAL ENGLISH TRANSLATION]
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