Arnold Salamon v. Her Majesty the Queen (Informal Procedure), [1993] 2 CTC 2819

Kempo, T.C.C.J. (orally):—These informal procedure appeals pertain to Mr. Salamon's 1988, 1989 and 1990 taxation years.

The reply to the notice of appeal described the circumstances of the matter from the perspective of the Minister of National Revenue (the "Minister") as follows:

3. In computing income for the 1988, 1989 and 1990 taxation years, the appellant:

(a) deducted the amounts of $4,207.47, $4,625.32 and $4,906.65, respectively as farming losses; and

(b) deducted the amounts of $2,999.85, $2,705.39 and $3,019.32, respectively as rental losses on RR #1 Puslinch, Ontario; and

(c) deducted the amounts of $2,800.67, $3,450.59 and $3,746.64, respectively as losses on the rental of vacant land.

4. In reassessing the appellant for the 1988, 1989 and 1990 taxation years, the Minister of National Revenue (the"Minister"):

(a) disallowed the deduction of farming losses; and

(b) disallowed the deduction of the rental losses on RR #1 Puslinch, Ontario;

and

(c) disallowed the losses on the rental of the vacant land.

5. In so reassessing the appellant, the Minister made the following assumptions of fact:

(a) the appellant was, at all material times, employed full time by the Halton Board of Education;

(b) the appellant's employment income for the 1988, 1989 and 1990 taxation years was $57,254.30, $60,024.70 and $62,468.98, respectively;

(c) in 1980 the appellant purchased RR #1 Puslinch, Ontario (the"property");

(d) the appellant's principal residence (the"house") was located on the property which consisted of approximately 91 acres of land, of which approximately 30 acres were bush, and approximately 50 acres were vacant land (the"lot");

(e) the appellant reported farming income (losses) during the 1988, 1989 and 1990 taxation years as follows:

TAXATION CROSS			NET	LOSS
YEAR	INCOME	EXPENSES	INCOME (LOSS) CLAIMED
1998	$1,992.02	$7,907.03	($5,914.94)	($4,207.47)
1989	$2,251.46	$9,002.10	($6,750.64)	($4,625.32)
1990	$1,701.59	$9,014.88	($7,313.29)	($4,906.65)

(f) the appellant's farming operation consisted of the keeping of some bees and the sale of the honey produced and the sale of firewood;

(g) the appellant had no reasonable expectation of profit from the farming activity in any of the 1988, 1989 and 1990 taxation years;

(h) the appellant made available for rent two bedrooms and a bathroom in the house;

(i) from 1988 to 1990 the appellant reported rental income, expenses and losses as per Schedule A, attached;

(j) the rent charged was not sufficient to pay the proportional share of the operating expenses;

(k) the appellant had no reasonable expectation of profit from the rental of the house during the 1988, 1989 and 1990 taxation years;

(l) the rental expenses were personal or living expenses of the appellant;

(m) in 1988,1989 and 1990 the appellant received revenue from the rental of the lot in the amounts of $955.18, $1,008.52 and $897.91, respectively;

(n) the expenses claimed by the appellant in respect of the rental of the lot were property taxes and interest in each of the said taxation years;

(o) the lot was not used in the course of a business carried on by the appellant; (p) the lot was not held in 1988, 1989 and 1990 primarily for the purpose of gaining or producing income of the appellant for the 1988, 1989 and 1990 taxation years;

(q) the appellant has no operational plan to make the farming and rental activities profitable.

16. The appellant's chief source of income during the 1988, 1989 and 199 taxation years was neither farming nor a combination of farming and some other source of income.

7. The issues are:

(a) whether the appellant had a reasonable expectation of profit from the farming activity in the 1988, 1989 and 1990 taxation years; and

(b) whether the appellant is entitled to deduct rental losses on the house; and

(c) whether the appellant is entitled to deduct rental losses on vacant land.

8. He relies on sections 3 and 9, on subsections 18(2), 31(1) and 248(1) and on paragraphs 18(1)(a), 18(1)(h) and 20(1)(c) of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the "Act") as amended for the 1988, 1989 and 1990 taxation years.

9. He submits that the appellant did not have a reasonable expectation of profit from the farming activity in the 1988, 1989 and 1990 taxation years, that the farming losses were personal or living expenses of the appellant, and that the appellant was properly reassessed in accordance with paragraphs 18(1)(a) and 18(1)(h) of the Act.

10. He further submits that the appellant did not have a reasonable expectation of profit from renting the house in the 1988, 1989 and 1990 taxation years, that the losses were personal or living expenses of the appellant, and that the appellant was properly denied the deduction of the rental losses in accordance with the provisions of paragraphs 18(1)(a) and 18(1)(h) of the Act.

11. He further submits that the appellant was properly denied the deduction of the rental losses on vacant land in accordance with the provisions of subsection 18(2) of the Act.

Arnold Salamon

Schedule A to

reply to notice of appeal

RENTAL INCOME AND EXPENSES RR #1 PUSLINCH 1988

Rental Income		$380.00
Expenses
Property Taxes	$	716.80
Interest		4,607.60
Insurance		523.57
Maintenance, Repairs		270.00
Utilities		2,102.92
Telephone		228.74
	$ 8,449.63
Personal Element (60 per cent)		5,069.78
		3,379.85
Rental Loss		($2,999.85)

1989
Rental Income		$1,102.00
Expenses
Property Taxes	$	789.34
Interest		5,531.78
Insurance		551.45
Maintenance, Repairs		568.26
Utilities		1,925.98
Telephone		151.66
	$ 9,518.47
Personal Element (60 per cent)		5,711.08
		3,807.39
Rental Loss		($2,705.39)
1990
Rental Income		$1,031.00
Expenses
Property Taxes	$	846.32
Interest		5,736.82
Insurance		612.95
Maintenance, Repairs		641.85
Utilities		2,167.86
Advertising		120.00
	$10,125.80
Personal Element (60 per cent)		6,075.48
		4,050.32
Rental Loss		($3,019.32)

Mr. Salamon indicated during the hearing he was not pursuing, and was conceding, rental losses on the vacant land issue. Therefore the matter proceeded on the issues described in paragraphs 7(a) and (b) of the reply as aforenoted.

Mr. Salamon's testimony substantiated the factual allegations relied upon by the minister as outlined in the reply to the notice of appeal, paragraphs 5(a), (b), (c), (d), (e), (f), (h), (i) and (j). He took direct issue with those allegations in subparagraphs (g), (k), (I) and (q) of that paragraph.

The farm land and house were purchased in 1980 with mortgage debt financing to the approximate extent of $125,000. In 1985 the appellant and his wife separated. The farm was then valued at $230,000 and the mortgage, then at under $100,000, was increased to around $150,000 so he could pay out his wife and keep the property. It is reasonable to infer that all or part of the $70,000 paid to the wife represented her interest in the farm land and house, and therefore it is reasonable to conclude that the refinancing was directly linked to the appellant's acquisition and purchase of that interest. The evidence was that some business activity had commenced on the property in 1984 or 1985 and that, since its acquisition in 1980, the appellant had actively sought ways to put it back into production. No previous farm experience was enjoyed by the appellant or by his former wife or by his current wife.

Early in the 1980s forestry and farm officials were consulted, and sufficient feed crops were grown by a tenant entitling the appellant to a reduction of property tax by way of the Ontario farm tax rebate program.

In 1980 a forestry management program was entered into with the Ontario Ministry of Natural Resources granting a licence to the latter to enter, to plant nursery stock and to improve woodland on the forest in accordance with its management program. Thereafter the appellant cut and sold wood to customers who had wood burning fireplaces or furnaces. Advertising was minimal and was done very informally. Between 1988 and 1992 the gross income receipts from wood sales ranged from a high of $763.50 to a low of $275. The appellant said no large amounts could be enjoyed from this source because of the forest management agreement and its restrictions.

Back in 1986 following his domestic separation, the appellant rented one- half of the house to a woman and her son to help meet his expenses. In 1986 he rented a log cabin near the house for $300 annually which continues to this day. He had claimed losses arising from these two rental activities for 1985, 1986 and 1987 as well as for 1988, 1989 and 1990 now under review.

Before 1985 the appellant had taken formal courses in beekeeping. He said he was aware of the risks associated with this activity and that at least ten hives were needed in order to produce a profit from the sale of honey. By 1988 he had three hives producing 300 pounds of honey which he sold at $2.20 a pound for $607 that year. The three hive inventory remained constant during 1989 and 1990 because of winter-kill calling for replacement. Annual honey sales revenues averaged $600. In 1991, he had four hives, two of which were destroyed because of disease. He acknowledged his awareness of these risks of the business. In 1992 he had four hives which produced 230 pounds of honey and 88 packages of honey comb, all of which sold for a total of $850. He said the risk of disease had been lessened due to new medicines on the market, that he was getting better at this activity, and that by 1995 he anticipated having the requisite ten hives on hand producing 1,000 pounds of honey from which he expects to derive, if all is sold, some $3,000. The Court was not enlightened as to any projected increased operational costs associated with the acquisition, maintenance and harvesting of ten hives and its attendant sales activity. Mr. Salamon stated that he expected at the outset that his beekeeping operation would take three to five to seven years to make a profit and that losses had been experienced and claimed from its outset.

There was no question that the activities thus far triggered net losses because of the interest payable under the mortgage debt. In other words, the appellant commenced and continued these operations until 1991, some six continuous years, under the yoke of severe undercapitalization. Mr. Salamon's summary of actual events for the period 1988 to 1992 inclusive, with projections 1993 to 1995 inclusive (Exhibit A-8) markedly point out the direct and onerous impact of this debt load.

The appellant began paying down the mortgage principal in 1992 from $140,700 of the previous year to $112,000. He projected that further debt reductions, being down to $100,000 for 1993, $97,000 for 1994 and $93,000 for 1995 together with increased wood and honey sales, would result in a break even basis by 1994 and a profit in 1995. This projection included no adjustments for contingencies. Mr. Salamon opined that these products could easily be sold in their entirety at his price. Even with increased activity and sales, his projections estimated other expenses (excluding interest and taxes) to remain the same.

It seems reasonably clear that there could be no reasonable expectation of any profit ensuing during 1988 to 1990 inclusive from the wood and honey sales without significant debt reduction which did not commence until two years later. No evidence was tendered as to why this was not done sooner. A cursory examination of the tax returns filed for the subject years (Exhibits A-5 to 7 inclusive) indicate business/investment activities being directed elsewhere. In any event, no reasons were advanced of circumstances precluding mortgage pay down sooner than 1992 if that was indeed the appellant's original plan.

For the reasons given, the appeals fail with respect to the part-time farming operation of wood sales and beekeeping.

With respect to the appellant's home rental operation, he made inquiries of the Ontario bed and breakfast association in 1988 as to running a type of bed and breakfast operation therefrom, hoping to draw customers attending the various and numerous festival and show activities in the Guelph area. The house was five to seven miles from downtown Guelph and only a few minutes drive from the university.

A yellow flyer was produced in 1988 (Exhibit A-12) and posted on bulletin boards in his school, the university and around the city. Very little broad-based advertising was accomplished in 1988 as his rental receipts confirm. The $380 income for that year represented $300 from the cabin and $80 from bedroom rentals. A loss of $3,000 therefrom is being claimed which was comprised essentially of $1,800 mortgage interest, $840 in utilities and $700 for taxes and other.

The following years, in response to concerted broad-based advertising placed in the Ontario bed and breakfast accommodation publications, revenue was gained in the amounts of $1,102 for 1989, $1,031 for 1990 and $1,880 for 1991. Mortgage interest expenses also factored heavily in the net losses which ensued which were $2,700 for 1989, $3,000 for 1990 and $2,260 for 1991. Obviously higher volume rentals would attract higher expenses for utilities, food and general maintenance.

In 1992 with the mortgage pay down as afo red escribed, but for the water system repair, the loss would have been very modest. The income for that year of $3,460 well exceeded interest expense for the first time. One hundred and fifty one guest nights were logged for that year. The prior years obtained revenue from 63 guest night rentals in 1989, 48 in 1990 and 73 in 1991.

I agree with Mr. Salamon that his 60 per cent personal and 40 per cent rental allocation was reasonable and that it takes time to acquire and maintain customers of this nature after concerted efforts had been expended to advertise and to push to get people in. While the rental accomplishments may have been marginal during 1989 and 1990, the 1991 and 1992 actual and projected to 1995 illustrates, fairly and reasonably in my view, the planned growth assisted by stable utility and maintenance costs with a reducing interest debt. The guest night number is expected to stabilize at around 100 which is required to keep Mr. Salamon's projections on track.

Given all of the circumstances, I am satisfied that the appellant has shown, on the balance of probabilities, his bed and breakfast or rental income plan had started up in 1989 and that for that year and for 1990 the overall plan as conceived, financed and developed, encompassed a reasonable expectation of profit within a reasonable time.

Conclusion

In summary then, the appeal for the appellant’s 1988 taxation year is dismissed. The appeals for each of his 1989 and 1990 taxation years are allowed, without costs, for purposes of the matter being referred back to the Minister of National Revenue for reconsideration and reassessment on the basis that the appellant is allowed losses in the amounts of $2,705.39 for 1989 and $3,019.32 for 1990 arising out of his house rental operation located on RR #1, Puslinch, Ontario.

Appeal allowed in part.