Judy Tollefson v. Her Majesty the Queen (Informal Procedure), [1994] 1 CTC 2507

Margeson, J.T.C.C.:— This matter was heard under the informal procedure and the decision is given thereunder.

The appellant appeals from a reassessment for the years 1988 and 1989, notice of which is dated March 3, 1993, the result of which was to disallow rental losses for the principal residence property, reduce rental losses and carrying charges in the years 1988 and 1989 for the second property, reduce the capital loss in 1989 and deny an ABIL in 1988 on the second property.

Facts

The appellant and her family resided at 9016-16 Avenue North Battleford, Saskatchewan (the "first property"). In the year 1988 she provided room and board to three tenants in the property for approximately two months of the year and one tenant for approximately one month of the year. The family of the appellant had access to the rental portion of the property but it was alleged that they did not go into those areas. The appellant based her rental on the amount of floor spaces she felt the tenants made use of. With respect to the board, the appellant provided some food but the arrangement for board was a very casual one. The appellant was only there for one-third of the year as she was attending to her father who was ill and the children were there for less that period of time.

The appellant claimed two-thirds of the expenses for the whole year based upon the floor space she said she allotted to the prospective tenants, based upon the fact that the space was available for rent for the whole year and she felt she made reasonable efforts to rent the property. She only claimed expenses related to property taxes, interest and insurance.

The second property was purchased in December of 1987 and sold on November 15, 1989. Before sale of the second property it was leased to Duggan Holdings Ltd. on October 13, 1988, and this lease included a clause giving the tenant the right of first refusal on any offer to purchase and a right to purchase the property at the end of the lease with all rental moneys paid being applied to the purchase price. There was no clause requiring the tenant to purchase the property.

Issues

1. Was the appellant entitled to deduct any of the expenses related to the first property against her other income for the year 1988?

2. What was the proper amount of rental income from the second property in the years 1988 and 1989?

3. What was the proper capital loss from the disposition of the second property in 1989?

4, What was the proper amount of expenses to be allowed for the second property in 1988 and 1989?

5. Is the appellant entitled to an ABIL in 1988 and 1989 on the second property? If so, What is the amount of such ABIL?

It is to be noted that the appellant introduced documentary evidence and gave viva voce evidence which revealed facts she had not placed before the respondent at the time of the reassessment or before the trial and that at the trial she claimed an ABIL for both 1988 and 1989.

Respondent's position

1. The respondent argues that there was no reasonable expectation of profit from the first property in 1988, that the losses were personal or living expenses and that the appellant was properly assessed thereto in accordance with paragraphs 18(1 )(a) and 18(1)(b) of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the "Act"). He refers to Mason v. M.N.R., [1984] C.T.C. 2003, 84 D.T.C. 1001 (T.R.B.); Cecato v. M.N.R., [1984] C.T.C. 2125, 84 D.T.C. 1110 (T.C.C.).

2. The respondent submits that the Minister correctly calculated the rental income from the second property in the years 1988 and 1989 in the amounts of $1,000 and $5,000 respectively and that such amounts were not capital receipts.

3. The respondent submits that there should be an adjustment made to the adjusted cost base (the “A.C.B.”) for the "second property" as referred to in paragraph 11 (i) of the reply to notice of appeal. The correct amount according to the respondent should be $46,299.24. Similarly there should be a change in the capital loss calculated by the Minister in paragraph 11 (p) of the reply and that amount should now be $5,508.39.

The respondent argues that these changes were necessary because of new information provided by the appellant at the time of trial which was not previously known to the Minister.

4, The respondent argues that due to information provided at trial, which was previously unknown to the Minister, there should be an adjustment to the allowable expenses in the year 1988 and that the proper amount for interest in 1988 on the "second property" should be $2,593.13.

Further, the respondent argues that the proper amount of interest allowable on loan No. 2 in 1989 should be $2,970.01 representing 54 per cent of the total interest paid on loan No. 2 in 1989 as only 54 per cent of the loan and interest thereon related to the rental property.

The respondent's position is that no interest payments should be allowed after October 31, 1989 because the rental property was sold in November of 1989. After that point the interest payments would be carrying charges against her interest income because she had accepted a mortgage arrangement with the purchasers and was receiving interest from them. These amounts had already been allowed as carrying charges as per paragraph 11 (r) of the reply.

The respondent also submitted that due to information provided at the trial, and not before, the appellant is entitled to deduct $2,042.54 as a current expense in 1988, representing 1988 taxes not paid until 1989.

The respondent conceded that the appellant was entitled to deduct the sum of $300 with respect to a real estate commission paid on the second property.

The expenses for 1988, therefore, should be $4,998.17 and for 1989 the amount of $4,506.10 resulting in a net rental loss of $3,188.17 in 1988 and a net rental income of $493.90 in 1989.

5. The respondent conceded that as a result of information provided at trial, not previously known by the Minister, that the appellant was entitled to deduct in the computation of her income tax for the 1988 taxation year, the amount of $3,447.15, as an ABIL. The only contentious amount in that calculation was the proper amount to be deducted for principal and interest paid on the Battleford Credit Union loan No. 1. The respondent submits that this amount should be $966.89. This amount, the respondent contends properly represents the principal paid on the Battleford Credit Union loan No. 1, which was a company line of credit which was guaranteed by the appellant.

The respondent concedes that the appellant may have had a business purpose in mind when she guaranteed the company line of credit and therefore, when she paid $966.80 from the Battleford Credit Union loan No. 1 to pay down the principal on the line of credit this payment satisfied the income purpose test as set out in subparagraph 40(2)(g)(ii) of the Act. However, it was argued that the amounts expended to pay interest on the Battleford Credit Union loan No. 1 do not meet the income purpose test in subparagraph 40(2)(g)(ii) of the Act and therefore the amount of interest thereon, $2,615.71 cannot be included in the calculation of the appellant’s ABIL for 1988.

The respondent argues that the appellant is only entitled to claim two-thirds of the business investment losses and not three-quarters of the losses in calculating the ABIL in accordance with S.C. 1988 chap. 55, section 19(2) applicable to the appellant taxpayer in the relevant years. In the year 1988, the correct amount was $3,447.15. With respect to the ABIL for 1989, the respondent submits that the interest paid on the Battleford Credit Union loan No. 1 is not to be included in the calculations for the same reason as the disallowance in 1988 and only the principal payment of the loan is includable. Further, the proper fraction to be used in calculating the ABIL for 1989 is two-thirds and not three-quarters. Accordingly, in the appellant’s ABIL for 1989 was two-thirds of $22,439.61 or $14,959.74.

The respondent submits that no costs should be allowed under the circumstances.

Appellant’s position

The appellant argues that the expenses incurred in 1988 for the first property were all deductible in calculating her income for that year as she made reasonable efforts to rent the property for the whole year, was partly successful and the expenses were reasonable. Further, the appellant argues that the expenses were not personal, that she had the full intention of making a profit and that the percentage of space for which she was claiming expenses was reasonable.

1. The appellant submitted that the number of tenants was irrelevant, that none of the expenses claimed related to the number of tenants and that is why only taxes, interest and insurance were claimed.

2. The appellant argued that the amounts of $1,000 in 1988 and $5,000 in 1989 were not income but capital receipts because the lessee had the right to purchase the property and have the rental payment deducted from the purchase price.

3. The appellant submitted that the A.C.B. for the second property was $46,299.24 and there was a capital gain of $492.

4. The appellant agreed with the respondent that the proper amount for interest on the second property for 1988 was $25,093.13; that the proper amount for interest allowable for loan No. 2 in 1989 was $2,970 according to her evidence as seen at page 19 of the transcript at lines 5 to 7. However, in her written submission she refers to $2,790.01.

The appellant claimed an additional deduction of $1,184.78 as interest paid in 1989.

5. The appellant disputes the calculation of the ABIL for 1988 and 1989 and argues that both principal and interest on the Battleford Credit Union loan No. 1 should be included in the calculation. Further the appellant argued that she should be allowed to claim three-quarters of the total business investment loss as an ABIL and not only two-thirds of that amount.

It was the appellant's position that her ABIL in 1988 was $5,839.82 and in 1989 was $17,711.68.

Analysis and decision

Issue No. 1

The Court is satisfied that there was no reasonable expectation of profit from rental of the first property in 1988. The evidence discloses that the property was only partially rented for about three months of the year. Further, the appellant provided some food for the tenants, only claimed expenses related to taxes, insurance and interest, whereas other expenses were obviously incurred and must be considered.

On the basis of the evidence the Court concludes that it was unlikely that two- thirds of the house was allotted to tenants in light of the evidence of the freedom of access to the rental portion by the appellant and her children. Therefore, there wasobviously a personal use made of a portion of these premises allegedly set aside for the tenants. The two-thirds portion claimed by the tenant as rentable premises was unreasonable.

The Court is satisfied that there was no reasonable expectation that the appellant could have rented a sufficient portion of the premises to make the operation profitable in light of the limited efforts she made to do so. In light of the amounts charged for the premises she did rent, there was little likelihood that she could have realized a profit.

The Court is satisfied that the appellant had an intention to make a profit. However, this amounted to nothing more than “subjective optimism" as referred to by Bonner, J. in Mason, supra, at page 2004 (D.T.C. 1002): "The expectation of profit as referred to in the definition of "personal or living expenses" must be assessed objectively.”

The appellant is not entitled to deduct any of the expenses related to the first property against her other income in the year 1988. In that regard the appeal is dismissed.

Issue No. 2

The Court is satisfied that the Minister correctly calculated the rental income for property No. 2, the “second property” in 1988 and 1989. The only sums in dispute were $1,000 and $5,000 received respectively in those years.

These amounts were clearly received as rental and cannot be classified as capital receipts even though the lease agreement allowed the "lessor" to deduct them from the purchase price as a result of a purchase option in the lease agreement.

The important time to consider the character of the payments was when the moneys were received. These payments were received as rent and such character was not lost because of the fact that the tenant exercised an option to purchase the property later on. It is to be noted that the tenant was not even bound to purchase the property under the lease. See Ages v. M.N.R., [1971] Tax A.B.C. 86, 71 D.T.C. 86, at page 86 (D.T.C. 87).

In that respect the appeal is dismissed.

Issue No. 3

As a result of evidence given at the trial, with respect to the proper amount of tax arrears respecting the second property, the (A.C.B.) adjusted cost base for that property should be changed to $46,299.24. This information was not known to the Minister before the trial.

Consequently, the capital loss arising from the sale of the second property is determined to be $5,508.39.

The appeal is allowed with respect to those two items.

Issue No. 4

As a result of evidence given at the trial, not previously available to the Minister, the Court finds that there must be an adjustment to the expenses in the year 1988 and 1989 on the second property.

The Court finds that the amount of interest paid for the Battleford Credit Union loan No. 1 in 1988 was $2,593.13. This amount was not in dispute at the end of the trial.

Further, the Court finds that the amount of interest to be deducted in 1989 was $2,970.01. This amount is not disputed by the appellant but she claimed an additional $1,184.78. It is obvious from the evidence given that this amount is included in the $2,970.01 figure.

The Court finds that as a result of information provided at trial not previously known to the Minister, the appellant is entitled to claim as expenses in 1988 the sum of $2,042.54 as a current expense.

The Court finds that the appellant is entitled to claim an amount of $300 as an expense in 1988 respecting a real estate commission.

As a result, the net rental (loss) in 1988 was ($3,188.17) and the net rental income in 1989 was $493.90.

The appeal is allowed in respect to these items.

Issue No. 5

The respondent conceded that the portion of the Battleford Credit Union loan No. 1 representing principal repayment in the amount of $966.89 could be included in the calculation of the ABIL for that year because it met the income purpose test under subparagraph 40(2)(g)(ii) of the Act and that amount will be allowed.

The Court is not persuaded by the evidence presented that the interest portion of the same loan meets that test and so the amount of $2,615.71 will not be included in the calculation.

There can be no doubt that the proper portion of the total business investment loss to be used in calculation of the ABIL is three-quarters and that amount is allowed.

Consequently, I find that the ABIL for 1988 was $3,447.15.

The same arguments apply with respect to 1989 and I find that the proper ABIL in that year was $14,959.74.

The appeal will be allowed in respect thereto.

On the matter of costs I agree completely with the respondent's submission. Indeed, if it had not been for the very reasonable approach taken by the respondent at the time of the hearing and his concerted efforts to have all the facts elicited the appellant could not have been successful to any extent in the appeal. No costs will be allowed.

The matter will be remitted to the Minister for reconsideration and reassessment based upon the above findings.

Appeal allowed in part.