Joseph v. R., [1996] 2 CTC 2388 (Informal Procedure)

Taylor J.T.C.C.: — These are appeals heard in Toronto, Ontario, on December 12, 1995, under the informal procedure, against income tax assessments for the years 1989, 1990, 1991 and 1992 in which the Respondent disallowed claims for losses sustained from property rental operations in the amounts of $11,000, $12,713.34, $12,767.98 and $19,780.29 respectively.

The Notice of Appeal for the 1991 taxation year read as follows:

I hereby elect to appeal under your Informal Procedure the assessment of my Taxes for the Year 1991, for the following reasons:

1. The Rental Loss of $12,767.98 which I claimed was caused by several economic factors which were beyond my control.

(a) Mortgage rates were high. Of the $46,019.97 expenses incurred for operating the Rental Business, Mortgage Interest amounted to $31,508.83.

(b) Property Taxes amounted to $4,629.72.

(c) Utilities amounted to $3,606.67.

(d) Insurance amounted to $1,408.44.

(e) Rents were controlled by the Ontario Government and as occurs in all rental businesses, there were vacancies throughout the year. It is also extremely difficult to collect rents from people who lost their jobs or were laid off in the midst of a serious recession. Revenue from Rent amounted to $24,740.00.

(f) It is a long and tedious process to evict tenants who do not pay their rent. The process is determined by the Government of Ontario and must be rigorously adhered to.

(g) Repairs & Maintenance amounted to $966.22.

2.1 entered the Rental Business with the objective of making a profit. I am a single person, now disabled who used all her other resources to support the Rental Business. I often relied on my son, Colin Joseph for financial support.

3. All my Business Expenses are legitimate and supported by documen- tation with which I provided the auditor.

4. I persisted in operating the business because I feel that the business will eventually make money.

5. When the Business makes money Revenue Canada will claim its share as it always does.

6. I deem it unfair that which [sic] I make a loss, Revenue Canada refuses to accept my business as valid and bona fide.

I trust that justice will be done and my claims allowed.

The above Notice of Appeal is virtually identical to those filed for the other three years, the significant differences relating to the amounts of rental income and expenses, which are detailed as part of the Respondent’s Reply to Notice:

7. In reassessing the Appellant for the 1989, 1990, 1991 and 1992 taxation years by concurrent Notices of Reassessment mailed on May 26, 1994, the Minister disallowed the deduction of the rental losses on 43 Emperor, 36 Camelly and 152 Cadillac. In that a Waiver in Respect of the Normal Reassessment Period (the “Waiver”) had been filed with the Minister, the Minister reassessed the Appellant’s 1989 taxation year in accordance with subparagraph 152(4)(a)(ii) of the Income Tax Act (the “Act”).

8. In so reassessing the Appellant, the Minister made the following assumptions of fact:

(a) in August 1984, the Appellant purchased 43 Emperor at a cost of $79,500.00 for use as her principal residence;

(b) the purchase of 43 Emperor was financed by a first mortgage of $66,163.00;

(c) in January 1986, the Appellant purchased 36 Carnelly at a cost of $86,000.00;

(d) the purchase of 36 Carnelly was financed by a first mortgage of $64,500.00 and a second mortgage of $20,250.00;

(e) in October 1989, the Appellant, in partnership with Colin Joseph, purchased 152 Cadillac at a cost of $179,000.00;

(f) the purchase of 152 Cadillac was financed by a first mortgage of $158,875.00 and a second mortgage of $25,250.00;

(g) the Appellant reported rental income, expenses and losses as per Schedules “A” and “B”, attached;

(h) the rent charged on 43 Emperor, 36 Camelly and 152 Cadillac was not sufficient to pay the operating costs on the Properties;

(i) the Appellant had no reasonable expectation of profit from renting the

Properties during the 1989, 1990, 1991 and 1992 taxation years;

(j) the rental expenses were personal or living expenses of the Appellant; (k) on September 15, 1993, the Appellant signed the Waiver;

(l) the Appellant filed with the Minister a waiver in the prescribed form within the normal reassessment period for the Appellant for the 1989 taxation year.

B. ISSUES TO BE DECIDED

9. The issue is whether the Appellant had a reasonable expectation of profit from renting the Properties in the 1989, 1990, 1991 and 1992 taxation years.

C. STATUTORY PROVISIONS, GROUNDS RELIED ON AND RELIEF SOUGHT

10. He relies on sections 9 and 152, subsection 248(1), paragraphs 18(1 )(a) and 18(1 )(h) and subparagraph 152(4)(a)(ii) of the Act as amended for the 1989, 1990, 1991 and 1992 taxation years.

11. He submits that the Appellant did not have a reasonable expectation of profit from renting the Properties in the 1989, 1990, 1991 and 1992 taxation years, that the losses were personal or living expenses of the Appellant, and that the Appellant was properly reassessed in accordance with paragraphs 18(l)(a) and 18(l)(h) of the Act.

12. He requests that the appeal be dismissed.

[Schedule A to Myrla Joseph Reply to Notice of

Appeal.]

JOSEPH

Rental Information Provided by the Taxpayer

Consolidated - All Properties

[Schedule B to Myrla Joseph Reply to Notice of

Appeal. I

JOSEPH

Rental Information Provided by the Taxpayer

Carnelly Crescent

1996-07-31

At the commencement of the hearing, Counsel for the Appellant abandoned the claim for the loss with respect to the Emperor Street property - principal residence — ($4,632.00 in 1989) and also extracted the following amounts from the other expenses claimed:

	1989	1990	1991
Entertainment $450		$475	$250
Condo fee	$360

Accordingly, as Counsel reconstructed the claim, the losses to be shared would be reduced to:

	1989	1990	1991	1992
Net Loss	$7,828 $ 16,475$21,026		$22,966

It is assumed for purposes of these reasons, that the amount of the losses claimed by Colin Joseph (see above) would not change.

The testimony from the Appellant gave some detail regarding the operations, but added very little to the outline of the issues and material already provided above, and there was no substantive change or challenge to the factual information available. The Appellant had other earned income against which the disputed losses were claimed. There had been some periods of vacancies, certain difficulties with zoning, and a decision by the municipal council that affected the number of apartments that the Appellant could have in one of the buildings, the “Cadillac property” (see above). This was the one property in particular on which Counsel for the Appellant stated he wished to argue “adventure in the nature of trade”. The purchase of the properties had been largely on the advice of a friend - someone experienced as a real estate agent.

Argument

In the end analysis the point of dispute came down to the contention of Counsel for the Appellant that the losses from all the operations should be regarded as meeting the proper standards for “reasonable expectation of profit”, or even an “adventure in the nature of trade”. In the eyes of Counsel for the Appellant the operation was a commercial venture. Counsel detailed his views with regard to the application of sections 3 and 9 of the Act as well as the relevant definitions under section 248 — simply stating there was no evidence of “personal or living expenses” not even any provided by the Respondent, now that the adjustments made at the commencement of the trial had been taken into account. His position was that there were a “number of Courts reluctant to apply the reasonable expectation of profit to purely commercial ventures”. Counsel provided the Court with a series of cases upon which he relied in putting forward his argument Moldowan v. R. (sub nom. Moldowan v. Minister of National Revenue), [1978] 1 S.C.R. 480, [1977] C.T.C. 310, 77 D.T.C. 5213; Baker v. Minister of National Revenue, [1987] 2 C.T.C. 2271, 87 D.T.C. 566 (T.C.C.); McNeill v. R. (sub nom. McNeill v. Canada), [1989] 2 C.T.C. 310, 89 D.T.C. 5516 (F.C.T.D.); Lemieux v. Minister of National Revenue, [1991] 1 C.T.C. 2180, 91 D.T.C. 454 (T.C.C.); Aucoin v. Minister of National Revenue, [1991] 1 C.T.C. 2191, 91 D.T.C. 313 (T.C.C.); Nichol v. R. (sub nom. Nichol v. Canada), [1993] 2 C.T.C. 2906, 93 D.T.C. 1216 (T.C.C.); Landry v. R. (sub nom. Landry v. Canada), [1994] 1 C.T.C. 2049, (T.C.C.); McGovern v. Minister of National Revenue, [1993] 2 C.T.C. 231 (sub nom. McGovern v. R.), 94 D.T.C. 6527 (F.C.T.D.); Jones v. R., [1996] 1 C.T.C. 15 (note), 95 D.T.C. 5614 (F.C.A.); Eleuteri v. R. [1995] E.T.C. 329; Narine v. R. (sub nom. Narine v. Canada), [1995] 2 C.T.C. 2055 (T.C.C.); Friesen v. R. (sub nom. Friesen v. Canada), [1995] 3 S.C.R. 103, [1995] 2 C.T.C. 369, 95 D.T.C. 5551; Jasani v. R. (sub nom. Jasani v. Canada), [1995] 2 C.T.C. 2744 (T.C.C.); Bélec v. R. (sub nom. Bélec v. Canada), [1995] 1 C.T.C. 2809, 95 D.T.C. 121 (T.C.C.) and he made reference to several portions he considered relevant. A major part of these references dealt with the alleged use of “hindsight” by the Minister of National Revenue in assessing, to substitute his own judgement for that of the taxpayer, (the second-guessing of business judgements view). As Counsel noted:

So again it’s a reluctance to interfere with the business judgment of a taxpayer who is engaging in purely commercial ventures.

These cases were specifically amplified by a very recent decision of the Federal Court of Appeal in Tonn v. R., [1996] 1 C.T.C. 205, 96 D.T.C. 6001. In summary, Counsel’s view was that the case law which supported the Appellant’s position, particularly Tonn, supra was in accord with the words of the Act, and should be followed by this Court. Further in his view, any other decisions which took a different approach - (i.e., a source of income required) represented “judge made law”, and were a distortion of the fundamentals expressed in the Act, - certainly a misunderstanding of Moldowan, supra. Mr. Kutkevicius added that some consideration should be given to possible property value appreciation. This prospect could have been in the mind of the investortaxpayer at acquisition and during operation, and should not be ignored when considering potential profitability. Counsel’s view was. summarized in the statements:

...all that would be needed would be for Your Honour to believe Ms. Joseph when she stood up here and said she trying [sic] to make rental income...

Counsel for the Respondent look the position that the assumption of the demise of the “reasonable expectation of profit” (a source of income) perspective might be a bit premature. Mr. Calabrese relied primarily on the standard case of Moldowan, supra and some of the case law that has flowed therefrom over several years. This was not a case of a business decision resulting in unexpected losses according to Counsel. The lack of prior financial planning and preparation, plus the continued and active program of expenditures exceeding revenue, even any calculable anticipated revenue, did not indicate a commercial basis from which profit could be realized or even anticipated. The additional property purchases showed no better prospects and no better business judgement. As Counsel put it:

the application of a reasonable expectation of profit is not contingent on finding that there was a personal element to the expenses that have been incurred.

Analysis

First, I would point out that I heard nothing in the argument of Counsel for the Appellant which would provide a substantive basis for distinguishing the Cadillac property from Carnelly, sufficient to rely on the “adventure in the nature of trade” argument, as opposed to the more standard “reasonable expectation of profit” contention. But I do not see that as any impediment for the Appellant in this matter. It will be on this “reasonable expectation of profit”, “source of income” point that the evidence and testimony here will be analyzed and compared.

In addition to the case law provided, I would refer to a recent judgement of this Court, Heenan v. R. (sub nom. Heenan v. Canada), [1995] 2 C.T.C. 2969 (T.C.C.) which touches on this question. There are certain selections therein which provided support for the conclusion to dismiss that case, and I note some as follows to which I subscribe:

I agree that the use of “hindsight” as such use was described by Counsel, should not be available to the Respondent. In assessing, the Minister should look at the information available to the investors and the plans and structures for profit making, at the time relevant — December 1987 to determine whether it was reasonable that the motivation for their participation in the partnerships was profit which could be expected, or whether there was another reason, or no obvious reason at all. In this,

Counsel for the Respondent would concur, as he stated:

So even if one describes the most optimistic, be it naive aspirations of the Appellants to be in the music business, that is not, of itself, sufficient, one must look at the concrete facts.

...I find nothing sinister about that approach — it appears to me to be well-balanced — that should not be described as the Minister substituting his own business judgment for that of a taxpayer; as any unwarranted incursion on the basic rights of an entrepreneur to arrange and manage his own affairs; or as the Minister using “hindsight” in striking an assessment.

and

I would cite with approval certain comments from Vern Krishna in The Law Times, May 8-14, 1995:

The profit motive test is crucial to the integrity of the tax system. It draws the line between providing limitless tax subsidies for personal pursuits with minimal economic flavour and economic enterprises conducted on a commercial basis for profit. It distinguishes the idiosyncratic collector and hobbyist from the entrepreneur. Taxpayers cannot expect other taxpayers to subsidize their personal hobbies.

On the other hand, the legal test should not be so stringent as to discourage valid entrepreneurial activities. Risk taking is to be encouraged if society is to prosper. Thus, the test is: Did the taxpayer have a reasonable expectation of profit? The test is not whether the expectation was of reasonable profits.

and

As Judge Hamlyn of this Court commented so ably in Watt Estate v. The Queen, 95 D.T.C. 423, at page 425:

When there has been no actual profit it would appear that fact alone is a presumption against a finding of a reasonable expectation of profit. That presumption, however, may be rebutted by the evidence submitted on behalf of the taxpayer.

In the Court of Appeal judgement of Tonn, supra, a phrase which is quoted from the Tax Court judgement, [1995] 2 C.T.C. 2979 reads as follows:

...the Income Tax Act is designed to tax profits, it isn’t designed to add the load to other people across the country.

While bluntly worded, possibly a consequence of the spontaneous nature of an oral judgement, it did serve to put into perspective the main point addressed by the Federal Court of Appeal. It also places in juxtaposition the views of opposing Counsel in this matter, whether a “reasonable expectation of profit” is mandated, or whether the absence of demonstrated “personal or living expenses” is sufficient base for determination.

The comments of Counsel for the Respondent indicate that in cases of claimed losses it is not a simple task for the Respondent to ascertain all aspects of the “personal or living expenses” which may be involved or what “use or benefit” a taxpayer may see or anticipate in a particular venture (Section 248 of the Act). It is not entirely clear that it should be for the Respondent to so establish, in order to fulfil the provisions of section 248 of the Act, since the total specific knowledge on that aspect rests entirely with the taxpayer. Where a deduction is claimed for “losses” against otherwise imposable income (as is the case here), the support and proof by the taxpayer of the commercially viable base for the “losses” might be more readily considered a requirement. Indeed, any such an analysis by the Respondent of the pros and cons of the investment or venture — usually long since past history - rather than looking to the taxpayer who has claimed the losses to support the viability of the project, might more likely lay the Respondent open to that insidious charge of “second guessing business judgements”. To label the Respondent’s assessments here the result of “second-guessing of business judgements” does not seem an entirely appropriate route to me, since all the information available was supplied by the taxpayer and there was no evidence in that information, of serious forethought or analysis. “Second guessing” is not a method of assessing that has appeared to be at all pervasive or intrusive in the practices of Revenue Canada officials, at least in my experience. On those rare occasions when it has been observed, the case law shows it has been dealt with vigorously in the judicial process. The personal agenda, or the social and psychological urges which would warrant this taxpayer to commence and to pursue a course so evidently unprofitable from a simply economic perspective, might well be an area not only beyond the responsibility of the Respondent to critically examine, but perhaps even beyond the right or capability so to do. The difficulties encountered did not appear to be of an unknown or unexpected nature, and it appears that the mortgage interest alone exceeded rental revenue in this matter, for the three last years. Counsel for the Respondent made no concession or distinction, with respect to the initial year 1989, to which I would be required to give separate consideration, even within the broad context of the Tonn, supra, judgement.

Two statements from Mrs. Joseph’s Notice of Appeal (supra) are of specific interest:

5. When the Business makes money Revenue Canada will claim its share as it always does.

6. I deem it unfair that which [sic] I make a loss, Revenue Canada refuses to accept my business as valid and bona fide.

Whether it was in her mind I do not know, but it raises the intriguing prospect of using the provisions of section 111 of the Act, part of which reads:

Losses deductible

(1) For the purpose of computing the taxable income of a taxpayer for a taxation year there may be deducted such portion as he may claim of:

(a) non-capital losses — his non-capital losses for the 7 taxation years immediately preceding and the 3 taxation years immediately following the year;

I can appreciate that in her understandable zeal to utilize to the fullest extent the more immediate deduction provisions in the Act, this taxpayer might have tended to reject consideration of the above provision. Whether she could claim such “loss” deductions (even if initially denied by Revenue Canada) against profits actually realized later on, which profits would then help to prove her claim of the viability of the questioned venture would require examination. Such a practice might even lend itself to an added incentive for earlier profit production from such a venture, or conversely acceptance of the reality that the financial results demonstrated. A small ultimate profit in one year, still might not be adequate to overturn years of losses — to make a “source of income” - but I need make no determination of that point at this time. It might also be argued that the provisions of Section III above were inserted in the Act for the express purpose of providing a reliable and useful route for recording, even possibly reporting, but not immediately deducting, early or “start-up” losses incurred, as opposed to the more contentions “front-end loading” avenue frequently pursued.

I pay tribute to the rationale from Tonn, supra at the Federal Court of Appeal level and it is tempting to rely on a quotation therefrom in resolving this case:

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.

Nevertheless, out of deference to the learned Justices in Tonn, supra, and the result of their deliberations, plus the fact that the Respondent’s Counsel relied largely on Moldowan, supra, 1 accept for purposes of my decision in this matter, two of their other comments adjacent to that comment above, as more directive to this Court:

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.

[...]

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.

The appeals are allowed, and party and party costs are awarded.

Appeals allowed.