Riepl v. R., [1996] 1 CTC 2611, 96 DTC 1882

Sobier J.T.C.C.: — The appellant appeals from assessments by the Minister of National Revenue (the “Minister”), for his 1988, 1989 and 1990 taxation years.

The appeals are two-pronged, the first dealing with the disallowance of certain automobile expenses in those years, and the second dealing with disallowed rental losses on a property known as the “Manning Park Property”, also for the same taxation years.

The appellant owns a 1983 Mercedes-Benz automobile (the “automobile”). It was assumed by the Minister that the automobile was used by the appellant to travel from his home to his office, and that no more than 20 per cent of the use of the automobile was for business.

It was the appellant’s evidence that he took the odometer reading at the beginning of each year. He claimed to have kept daily records of business use on a mileage basis, and totalled these at the end of the year. He then took the odometer reading at the end of the year for a total mileage for the entire year and from this total, he deducted the business use and formulated a percentage for business and personal use for the year.

In this regard, he produced adding machine tapes showing the actual business mileage.

There are two problems with this evidence. First is that in claiming the automobile expenses in his tax returns each year, Mr. Riepl used figures which he maintained were estimates and not the actual figures he alleged to have kept during the year. The second problem is that the record of mileage and the expenses based upon it, were not prepared by the appellant at the time. That 1s, the information was prepared only after Revenue Canada required proof of the actual mileage for business purposes. The appellant took his desk diaries for the three years under appeal and attempted to recreate the mileage based upon his estimates of the distances from the point of commencement to the point where he claimed to have driven for business purposes. For the most part, this involved driving to or from his home, to or from the place he claimed to have had business appointments. In many instances the evidence was that this was to and from his house in Delta, British Columbia to the downtown Vancouver area. In cross-examination, the appellant stated that he was advised that so long as he was going to or returning from a business appointment, he could use his home as a starting or finishing point. The statement in his Notice of Appeal and his evidence in chief that accurate records were contemporaneously kept is at least misleading as to: (1) when the mileage log and calculations were made, (2) the basis on which they were made, and, (3) he never claimed mileage to and from his home to his office. This was of course not the case.

No explanation was given to clear up the discrepancy between the estimated mileage set forth in the tax return and the so-called “mileage” which was later recreated. The appellant has not satisfied the onus on this issue, that he used his automobile for business purposes more than 40 per cent of the time. Accordingly, the appeals on this issue are dismissed.

In the autumn of 1980, the appellant purchased a partially built structure near the east gate of Manning Park (the “Park”), 150 kilometres east of Vancouver, British Columbia, on the Hope-Princeton Highway (the “Property”). The Park was a provincial recreation areas, which included a ski facility. According to the appellant, plans were afoot to also build a golf course, hotel and a residential sub-division at the Park.

In 1980, the adjacent village of Eastgate had a population of approximately 2,000. Two hundred persons were employed by the province at the Park.

It was the appellant’s intention to complete the building and rent it to employees of the Park. Mr. Riepl claimed there was a shortage of rental property in the area. He anticipated that he could rent rooms to about five persons, each of whom would have his own bedroom and the common areas of the house would be shared. He estimated that the rent would be $250 per person per month.

At the time of purchase the Property was not serviced by electricity or sewers. Electricity did not arrive for about 24 months.

The appellant completed the building in two and one-half years later, that is in 1983.

Prior to completion, the province of British Columbia announced that it would privatize the Park and that approximately 200 park employees would be laid off. The ski hill was closed for two years. The 200 employees were laid off and everything came to a standstill prior to completion and in 1983 and 1984, the property was not rented.

Because of the drastic change, the appellant’s original plans were no longer viable. No long-term tenants could be found. Others with plans similar to the appellant’s were also negatively affected by the turn of events which left a surplus of rental property and a shortage of tenants.

The appellant suffered losses from the Property every year from 1985 until it was sold in 1991. The taxation years under appeal are 1988, 1989 and 1990.

After 1984, the Property was rented, sporadically yielding insufficient rent to cover costs, especially interest expense. The losses for the years under appeal were $11,111.84 in 1988, $8,801.48 in 1989 and $8,585.37 in 1990. It should be noted that losses were also claimed from 1985 to 1987 inclusive, in the $9,000 per year range. In no year was a profit shown, even before capital cost allowance. In all years, no capital cost allowance was claimed.

There was no market for the sale of the property, unless it was to be sold at a loss, which the appellant claims he was unwilling to do.

Improvements in the form of an extended deck and a hot tub were made to the Property in 1988. According to the appellant, this was done to improve its saleability.

Since no long-term tenants were found, the appellant stated that he was required to visit the Property to see to its maintenance, especially in winter. However, he did admit that he and his family used the Property for skiing every second weekend during the skiing season. This would amount to 16 times per season. This is contrary to his claim in the Notice of Appeal.

The denial of deductibility of the losses was made on the basis that the appellant did not have a reasonable expectation of profit from the Property.

The tests for reasonable expectation of profit have as their modern beginning Mo Ido wan v. R. (sub nom. Moldowan v. The Queen), [1978] 1 S.C.R. 480, [1977] C.T.C. 310, 77 D.T.C. 5213 (S.C.C.). In his reasons for judgment, at page S.C.R. 485 (C.T.C. 313, D.T.C. 5215), Mr. Justice Dickson (as he then was) said:

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. Source of income, thus, is an equivalent term to business: Dorfman v. Minister of National Revenue, [1972] C.T.C. 151, 72 D.T.C. 6131.

He goes on to say:

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 Courts over the years have revisited Moldowan with varying results. On the one hand, in Baker v. Minister of National Revenue, [1987] 2 C.T.C. 2271, 87 D.T.C. 566 (T.C.C.), Chief Judge Couture of this Court allowed the appeal concerning a rental property in Florida. At page 2274 (D.T.C. 568), he states:

I understand this to mean that a reasonable expectation of profit exists where given all the facts pertinent to a venture it could, within a realistic time (the period will vary depending on the nature of the operation), yield a profit barring abnormal circumstances. In other words, is the venture as structured and normally operated capable of generating a profit?

In a number of appeals reported in the jurisprudence the Courts answered no to this question because the venture that was the object of the litigation could not, in the opinion of the Court, achieve that objective for a number of reasons, but mainly because the likelihood of its being financially successful was only a dream in the mind of the operator and rested entirely on his subjective aspirations and hopes which were unrealistic.

In the present appeal, it appears to me that the appellant conducted himself like a normal average investor, an investor who was not sophisticated because of lack of professional training, but who nonetheless had a working knowledge of the basic rules of the investment process. He knew the area where the property was located. He had received assurances from the real estate agent that there would not be any problem renting the property throughout the year and furthermore the agent had indicated the rent that could be obtained. Being familiar with the area and with the situation with regard to the development across the road, he regarded the proposal as reasonable. Also before buying the property he had consulted his accountant. Of course, risks are inherent in most business undertakings of the kind under discussion.

I have also had an opportunity to review the reasons for judgment in Landry v. Canada, [1995] 2 C.T.C. 3, 94 D.T.C. 6624, 173 N.R. 213 (F.C.A.). Mr. Justice Décary said at page 6 (D.T.C. 6626, N.R. 217-18):

Apart from the tests set out by Mr. Justice Dickson, the tests that have been applied in the case law to date in order to determine whether there was a reasonable expectation of profit include the following: the time required to make an activity of this nature profitable, the presence of the necessary ingredients for profits ultimately to be earned, the profit and loss situation for the years subsequent to the years in issue, the number of consecutive years during which losses were incurred, the increase in expenses and decrease in income in the course of the relevant periods, the persistence of the factors causing the losses, the absence of planning, and failure to adjust. Moreover, it is apparent from these decisions that the taxpayer’s good faith and reputation, the quality of the results obtained and the time and energy devoted are not in themselves sufficient to turn the activity carried on into a business.

These comments by Chief Justice Couture in Zolis v. Minister of National Revenue, [1987] 1 C.T.C. 2199, 87 D.T.C. 183 (T.C.C.) appear to me to provide a good summary of the approach, that should be taken by a judge who must determine whether there is a reasonable expectation of profit:

... The aspirations or ambitions that a taxpayer may have entertained in respect of activity in which he was engaged are not alone sufficient to bring it within the strict meaning of business in the relevant legislation no matter how genuine they might have been. What must be examined apart from the structural features of the undertaking is the manner in which it is carried on or operated by the taxpayer and from the interplay of these elements a determination made whether it is capable of yielding a profit in due course. The Court has to deal with concrete facts and from facts alone assess the validity of the contention of the existence of a business for the purpose of the Act.

However, more recently, Associate Chief Justice Jerome of the Federal Court, Trial Division stated in McGovern v. Minister of National Revenue, [1994] 2 C.T.C. 231, 94 D.T.C. 6527, 79 F.T.R. 169 at pages 233 (D.T.C. 6528-29, F.T.R. 171):

There is no question the Minister is entitled to disallow losses with respect to a business venture which have been accepted in previous taxation years. Generally, this will occur where the project, which may have initially possessed a reasonable expectation of profit, suffers consecutive losses such as would indicate it has become a losing proposition. However, where the business venture, under normal circumstances, would have realized a profit but fails to do so because of a dramatic change in conditions, a taxpayer should be granted a reasonable period of time in which to ascertain that no income is likely to be earned.

This was the principle applied by the Tax Court of Canada in Aucoin v. Minister of National Revenue, [1991] 1 C.T.C. 2191,91 D.T.C. 313 (T.C.C.). In that case, the taxpayer purchased a condominium in Florida for the purpose of earning rental income. He rented the condominium for a one year period at a monthly rental of $750, but owing to a sharp decline in property values throughout Florida, the taxpayer was forced to reduce the monthly rent to $525. Shortly thereafter, Mr. Aucoin attempted, without success, to sell the property but finally decided to withdraw it from the market because of poor real estate market conditions. In computing his income for his 1984, 1985 and 1986 taxation years, the taxpayer sought to deduct rental losses generated from the property which the Minister disallowed on the grounds Mr. Aucoin had no reasonable expectation of profit. In allowing the appeal from the Minister’s reassessment, Garon, J. made the following comments at page 2191 (D.T.C. 316):

... It would be unreasonable to conclude that the appellant ceased overnight to have a reasonable expectation of profit in connection with the rental property as soon as the slump in the real estate market occurred. He could have reasonably believed that the drop in the rental market was temporary. However, it would also be unrealistic for the appellant to expect to earn income from the property after a string of five years of losses and no real improvement in the market situation. There is a point between these two extremes where a reasonably prudent and informed person would have realized that no income would likely be earned for quite some time from that property. That point must have been reached two or three years after the drastic change in the real estate market.

[Emphasis in original.]

It is quite apparent that there was no reasonable expectation of profit in this case because there was no business. There was no source of income. There was only the revenue generated from sporadic and infrequent rentals, mostly on a daily or weekend basis.

In 1988, far from $1,000 to $1,250 per month rent anticipated, the appellant received rent for five months from Mr. Hamill at $250 per month, for a total of $1,250 and from one Sharon Muir amounting to $450, for a total in 1988 of $1,700. Yet, this was the year that the hot tub was added for $3,500.

In 1989, the Property was rented for a total of 22 days at $60 per day, for a total of $1,320. Similarly, 1990 saw gross rental of $1,800 being 18 days at $100. This type of activity belies the existence of a business entitling the appellant to deduct the losses.

The appellant had between 1985 and 1987 to attempt to turn things around. It should have been clear to him that this was not possible.

Whatever his expectations were when he began the venture, they proved incorrect in the cold light of reality. The expectations as originally envisaged disappeared without any hope of turning this activity into a business. The venture did not have any trappings of a business, no books of account were kept, no bank account was opened. No business plan was developed at the outset because the appellant believed that his experience as a money lender was enough and that his vision of the venture was reasonable under the circumstances. However, when things turned around, no change in strategy was forthcoming.

Even if there was a reasonable expectation of profit in the beginning years, in the years under appeal it was not realistic for Mr. Riepl to expect any profit from the venture.

For these reasons, the appeals are dismissed with costs.

Appeals dismissed.