Francois Fiore and Gino Fiore v. Her Majesty the Queen, [1993] 1 CTC 2289

St-Onge, T.C.C.J.:—The appeals of François Fiore and Gino Fiore were heard on common evidence on the twenty-ninth (29th) of April nineteen hundred and ninety-two (1992) in the city of Montréal, province of Quebec.

The point for determination was whether the expenses for renovations to the buildings located at 1158/1168, Dorion Street, and 189/197, René-Lévesque Boulevard, Montréal, were capital outlays. Paragraph 4 of the notices of appeal:

The expenses of $285,339 and $41,039 claimed for renovations, maintenance and repairs should therefore be considered entirely by the Department as current operating expenses, and thus entirely deductible in the current year, and not as capitalizable outlays, as the Department claims.

[Translation]

The respondent claimed that the said expenses were in the nature of capital, taking for granted the following facts (paragraph 4 of the replies to the notices of appeal):

In reassessing, the Minister took the following facts in particular for granted:

(a) during the year 1984, the appellant purchased a building located at 1158/1168, Dorion Street, and 189/197, René-Lévesque Boulevard East, Montréal, jointly with another person;

(b) during the 1988 taxation year, certain expenses were incurred by the appellant in proportion to his share;

(c) the appellant received a grant from the City of Montréal to restore the said building;

(d) the appellant thus restored the building extensively according to the plans approved and the program established by the City of Montréal;

(e) the renovations made to the building, which amounted to $326,648, had the effect of creating lasting benefits for the said building;

(f) furthermore, the scope and nature of the renovations considerably increased the value of the building;

(g) the expenses incurred by the appellant constituted a major renovation of

the building, so that the said expenses were considered as capital outlays.

[Translation]

At the hearing, solicitor for the respondent filed a list of expenses, without figures, but which indicated expenses that could be considered as follows:

(1) capital outlays within the meaning of paragraph 18(1)(b);

(2) current expenses within the meaning of paragraph 18(1)(a);

(3) capital outlays within the meaning of subsection 18(3.1);

(4) expenses deductible under paragraph 20(1)(aa);

(5) capital or current expenses according to the evidence.

So that this case would not last a number of days, the Court asked the parties to withdraw and to try to determine the cost of the current expenses and they arrived at the following result:

(1) current expenses of $100,000;

(2) capital outlays within the meaning of subsection 18(3.1) for a total of $41,309, for the following expenses: property taxes, interest, insurance, security officers, land surveyor and legal expenses, during the renovation;

(3) landscaping expenses of $1,000 deductible under paragraph 20(1)(aa);

(4) capital outlays according to the evidence;

(a) clearing of basement openings and installation of window frames, $1,000;

(b) opening of floors, $750.

The two appellants, heard as witnesses, determined that the cost of the items considered by the respondent as of a capital nature was in the following amounts:

The first column of this list is entitled "Capital outlays within the meaning of paragraph 18(1)(b)" [Translation]:

— installation at main entrance of a door consisting of metallic tubes (2.3): $800;

— installation of a metal stairway (3.3): $5,400;

— construction of storage spaces (3.5): $1,500;

— stripping and demolition of secondary buildings and chimneys (5.1 to 5.3 and 5.5): $5,000;

— structural work (6.1 to 6.3): $25,000;

— floors (7.2 to 7.6): $20,000;

— installation of furring on walls (8.2): $1,000;

— alterations to rooms and changes to passageways (8.3 and 8.4): $9,000;

— electrical work (9.1 to 9.10): $15,000;

— plumbing work (10.1 to 10.6): $20,000;

— sound insulation (11.1 and 11.2): $10,000;

— insulation (12.1 to 12.4): $5,000;

— coatings (13.1): $32,000;

— replacement of all baseboards, quarter round and casings (14.1) and

installation of shelves and hanger rods in closets (14.3): $6,400;

— construction of cabinets for kitchens and washer-dryers (15.1 and 15.2): $16,000;

— installation of tiles and medicine cabinets (16.1 and 16.2): $3,000;

— installation of a fence and patio (18.1): $4,500.

The appellants explained that the first two items were not for installation, but rather for repairs to a door and a stairway. Following discussion with the parties, the Court reached the conclusion, with the agreement of the parties, that the amount in dispute was $174,150.

And the point in issue is to determine whether this amount is a capital outlay or a current expense. The appellant François explained that the eight apartments and a business in the buildings in question were all rented before the renovation work at $200 to $250 a month.

That they had received a grant of $128,000 and that the work had cost $326,648.

That, after the renovation, the apartments were rented, the rents were from $500 to $650 a month and that the valuations and annual rental income of the buildings had varied as follows:

In 1983, valuation $111,800, annual rental income, $20,000;

In 1986, valuation $480,000, annual rental income $61,800.

In 1986, if the buildings had been sold as condominiums, the valuation was $600,000; on May 2, 1988, their market value was $645,000.

No apartment was rented during the renovations, and the appellants acquired the buildings in 1984 for the sum of $107,000. Since the renovations, the current expenses have been very low.

The appellant François argued that four important items should be taken into consideration in determining the nature of the expenses:

(1) the normal capital value;

(2) the market value;

(3) the replacement cost;

(4) a depreciation of five to ten per cent on the buildings, despite the renovation work.

He referred the Court to Sous-ministre du Revenu du Québec v. Denis Goyer, [1987] R.J.Q. 988, 10 Q.A.C. 70, a decision of the provincial Court of Appeal at page 992 (Q.A.C. 75):

Maintenance and repairs are what is done in order to preserve the capital asset. It is, generally speaking, of little importance whether one replaces a few planks on a porch or a few pieces of piping each year — which would undeniably represent maintenance expenses — or, having allowed the asset to deteriorate, one is forced to make major and lasting repairs. Unless one creates a new capital asset, increases the normal capital value of the asset or replaces an asset that has disappeared with another, these are repairs and maintenance tending to return the asset precisely to its normal value.

[Translation.]

By virtue of this judgment, the appellant argued that, in order to determine the nature of the disputed expenses, one must consider the normal capital value, not the market value of the buildings, and that, according to the evidence, the said value of the said buildings was less than the normal capital value, even though the market value was high or higher.

He closed by saying that the disputed repairs were made in order to preserve an asset which the appellants had virtually made into a new building, but that they did not exceed the normal capital value.

Solicitor for the respondent commented on two judgments:

(1) Jean Matté v. M.N.R. (unreported), (T.C.C.), May 6, 1986;

(2) Bergeron v. M.N.R., [1990] 2 C.T.C. 2220, 90 D.T.C. 1505 (T.C.C.), October 23, 1989.

In the first case, it was decided that the appellant owned a virtually new building and that the disputed expenses pertaining thereto could therefore very well be considered capital outlays and not current expenses.

In the second judgment, at page 2228 (D.T.C. 1517):

The principles I draw from these cases are the following:

— income-related expenses include repairs the purpose of which is to make the part or the property repaired suitable for normal use again;

— capital expenses include work the purpose of which is to replace an asset by a new one and work which involves such a degree of improvement to an asset that it becomes a new one. This asset must have significant value compared to the rest of the property or be an asset in itself; work to change the use of premises or a room or to add new premises or a new room is usually capital in nature; the same is true of a change in the heating system;

— although the factor of recent purchase is not significant when there is no . change of use, the increase in value of the real property over the purchase price, as a result of the repairs, is an indication that the cost or part of the cost of the expenses is in the nature of the purchase price of property;

— expenses must also be reasonable in the circumstances (section 67 of the Act): the question is whether they were reasonably incurred to derive income or to increase the value of the property, and in what proportion; future profits can be taken into account if the expenses in question reduce subsequent expenses and also I suppose the unforeseen scale of the costs.

In 1984, the state of the buildings under appeal had sustained a considerable capital loss since they required very substantial expenses, that is a grant of $128,000, plus $326,648 in expenses for a total of $458,648.

If one adds to that amount the acquisition cost, $41,309, the buildings thus cost the handsome sum of $602,957.

Of the amount of $326,648, some $152,498 were allowed as deductible expenses. The appellants claimed that the $174,150 represented current expenses because the value of the said buildings was less than the normal capital value.

In the Court's view, the normal capital value of the buildings in 1984 was the total amount spent to make the building virtually new, that is $602,957.

Consequently, the Court cannot accept the appellant François' reasoning that the normal capital value should be considered in the instant case. Referring to Goyer, cited by the appellant, the Court notes that the capital outlays were those that were made:

(a) in order to generate either new income or greater income;

(b) or an appreciation of the building, which, in the near or distant future, is likely to provide the owners with a capital gain (whether that gain is realized or not, page 4 of the judgment).

In Goyer, the expenses were incurred to replace aluminum windows, all the plumbing and the balconies of an income property, whereas, in the instant case, the amount of $152,498 was allocated as a current expense, and the other, disallowed expenses were much more in the nature of capital than those mentioned in Goyer (see the list of capital outlays with the indicated amounts. From reading this list, one observes that they resulted in such a degree of improvement in the asset that it became a new asset), and Bergeron. (Future profits may also be taken into account, if the expenses in question reduce subsequent expenses.)

Consequently, by virtue of the tests stated in the cases cited and the factual evidence, which shows:

(1) that the amount of $152,498 was already allowed as current expenses;

(2) that, according to the very testimony of the appellant Francois, the total renovation expenses virtually resulted in a new building;

(3) that the very nature of the disputed expenses much more resembles that of construction expenses than current operating expenses;

(4) the future profits since the expenses in question reduced subsequent expenses;

(5) that the buildings in question have undergone considerable appreciation likely to result in a capital gain;

(6) that the total expenses claimed as current expenses in 1984 were out of all proportion to the declared rental income, something that is a nonsense and contrary to every principle of taxation and accounting.

For all these reasons, the disputed expenses of $174,150 are disallowed, the appeals are upheld in part for the other expenses not disputed or allowed, and the matter is referred back to the Minister for reassessment in accordance with the judgment of this Court.

Appeal dismissed.