J.H. Kuhlmann v. Her Majesty the Queen (Informal Procedure), [1995] 1 CTC 2910

Bowman J.T.C.C.:-These appeals, from assessments for the 1987 and 1988 taxation years raise the question of the deductibility of so-called "soft costs".

In 1987 the appellant agreed to purchase a condominium unit from Carlyle Residences Inc. in an apartment complex known as "Carlyle Residences". He stated that the total purchase price was about $148,000. Neither the agreement of purchase and sale nor the prospectus was put in evidence, but his testimony was that one of the inducements which the developer put to him was the substantial tax write-offs in respect of "soft costs" to which he would be entitled.

He paid about $5,500 in 1987 and over the following several years paid off the purchase price, it appears, in part with bank borrowing.

Among the assumptions pleaded by the Minister were that the unit was not substantially completed by the end of 1988, that title to the unit had not been transferred to the appellant by the end of 1988, that the appellant was not the legal or beneficial owner of the unit in 1987 and 1988, that the appellant had no legal obligation to incur the expenses in 1987 and 1988, and the unit was not rented out in 1987 or 1988.

These assumptions have not been rebutted by the appellant and they appear to be consistent with the appellant’s evidence.

In filing his return for 1987 the appellant included unaudited financial statements prepared by a firm of chartered accountants. They contained the usual disclaimer of any type of responsibility for the accuracy of the statements; such disclaimers traditionally accompany unaudited financial statements. They showed a loss in respect of the project for the period ended December 31, 1987 of $2,715,890. The loss resulted from expenses of $30,847 (general & administrative), $1,173,249 (selling) and $1,530,525 (municipal and other levies). Either all or in any event some portion of the loss was allocated to the appellant in the amount of $19,154.80, the amount claimed in his 1987 income tax return.

For 1988 a different accountant prepared what was described as a "schedule of initial services", again with the usual disclaimer. That docu- ment reads as follows:

The accountant also provided Mr. Kuhlmann with a further document which reads in part as follows:

These singularly unilluminating documents were filed with the appellant’s 1988 return. No explanation was given in these documents or in the evidence before this court as to where the amount claimed came from or what portion of expenses relating to the project were allocated to the appellant.

In short, it is not clear that the appellant had any liability for these expenses or whether they simply formed part of the $148,000 cost of the unit that he purchased. It is not clear whether a portion of the amount claimed was for such capital expenditures as financing fees. Even the landscaping costs of $245,966 which are deductible under paragraph 20(l)(aa) of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72,

c. 63) (the "Act”) must be for the landscaping of grounds around "a building...of the taxpayer”. It is not clear whether these amounts were incurred by anybody -either Carlyle Residences Inc. or the appellant.

I need not therefore consider the legal effect of the fact that title to the condominium unit did not pass to the appellant until 1989. This was a point that appeared to have carried some weight in the decisions of this court in Ryan et al, v. M.N.R., [1986] 1 C.T.C. 2142, 86 D.T.C. 1108; Tertulliani v. M.N.R., [1988] 2 C.T.C. 2068, 88 D.T.C. 1447; and Schneider v. M.N.R., [1989] 2 C.T.C. 2068, 89 D.T.C. 198. The problem here is more fundamental than that. It is sought here to deduct what are somewhat ambiguously called "soft costs"-a term of some elasticity comprising, I gather, costs not directly attributable to the bricks and mortar and labour involved in creating the building, such as financing costs, legal fees, commissions, carrying costs, municipal taxes, landscaping and similar expenses. Where a taxpayer seeks to deduct such costs, a few basic questions should be asked:

A. did the taxpayer who seeks to deduct the expenses actually incur them as a legal liability in the year?

B. are they currently deductible expenses or are they capital costs that should form part of the capital cost of the project?

C. is their deduction permitted, subject to, or prohibited by some specific statutory provision, such as subsection 18(3.1) or paragraph 20(1 )(aa)?

D. were they expenses incurred by the developer which the developer has, in effect, sought to assign to the purchaser?

Here, the appellant had an obligation to pay $148,000 for the unit. It is probable that many of these expenses, if incurred at all, entered into the computation of the price that the developer was exacting from the investors. To the investors the unit price, which may have subsumed the developer’s first time soft costs, was the capital cost to them of the unit. If they were sold the units on the basis that they would become entitled, in years before the building was completed or before they had title, to large write- offs for tax purposes, they were misled. The promise of deductibility of these "soft costs" undoubtedly enhanced the price at which the units were sold.

Mr. Kuhlmann acted in good faith and honestly on the basis of assurances made to him by the developer and of material provided to him by the accountants. Nonetheless the evidence does not establish that the amounts which the accountants told him he could deduct in 1987 and 1988 were expenses incurred by him.

The appeals are therefore dismissed.

Appeals dismissed.