Richard Collins v. Minister of National Revenue, [1992] 2 CTC 2753, 92 DTC 2227

Margeson, T.C.C.J.:—This appeal is from a reassessment of the appellant for the year 1986, by which the Minister of National Revenue disallowed the deductions claimed as rental losses on a property owned by the appellant in California, in the amount of $18,953.

The Minister allowed expenses for 1/6 of the year only, and disallowed the above-noted expenses for the remainder of the year.

Facts

The evidence presented before me established that the appellant was a professor of biomedical engineering and was employed at a University in California when an opportunity arose for him to obtain an appointment at the Technical University of Nova Scotia in Halifax, Nova Scotia, for the period from November 1, 1985 to June 30, 1990. This appointment was accepted and the appellant left California in December of 1985 en route to Halifax, Nova Scotia.

The subject property was owned by the appellant and from his viva voce evidence as well as from the documentary evidence submitted by him, the appellant sought to establish the fact that when he left California, he intended to rent the property at a profit. Exhibit A-1 was a letter from the real estate agent in California which had attached to it a copy of the advertisement in the local newspaper. The exhibit is referred to as a Lease/Option". The letter itself makes it clear that the real estate agent felt the property was overpriced and that no favourable response had been received to the Lease/Option" advertisement. Exhibit A-2 was a copy of the advertisement above referred to and Exhibit A-3 was a note from the real estate agent to the appellant and his wife indicating that renovations were going on to the property and were improving it but at the same time urging them to lower the price so that it could be sold.

The appellant testified that he deliberately set a price on the house that was well above the market price because it was his belief that in time the market would improve and the house could be sold at a reasonable profit. He stated further that they listed the property with an agent who had a great deal of experience and a large number of contacts and he believed that the agent might be able to rent it. It was his position that they set a price that was less attractive for purposes of sale and more attractive for purposes of rental.

Exhibit A-4 is a letter to the rental agent confirming the intention of the appellant to keep the property for rental until a better sale price could be realized, rather than reduce the selling price.

Exhibit A-5 was an income projection done by the accountant for the appellant which in the end result indicated a shortfall of $1,719.23. Exhibit A-6 was a letter from the agent confirming the rental listing for all of 1986.

The appellant testified that his interest was to hold the property and to obtain a maximum profit, that he did not know how long that would be but that he felt that he had a sure investment.

In cross-examination the appellant said that the real estate agent may have taken management fees but he did not know what they would be. He confirmed rental for November and December 1986 only for a total income of $3,027 Canadian, expenses of $22,744 and a net loss of $19,717. He confirmed that the Minister had allowed only $3,790.67 expenses and had revised the net loss to $763.67.

The respondent introduced Exhibit R-1, a letter to the real estate agent imploring him to continue trying to rent the property at a level which would allow the appellant to maintain the cost of the mortgage while waiting for the sales market to improve. Exhibit R-3 confirmed rental of the property from January 1, 1987 to March 1987 and sale of it in April of 1987. It was brought out that Exhibit R-4 made it clear that any tenant would have to vacate the property on one month's notice after a suitable sale was arranged.

The appellant was asked if he needed $2,000 per month from rental of the property to break even in 1986, he said that those were his holding costs at that time. He did not conclude when he would break even on rental and he did not conclude as to how long they would continue to rent the property. He was unable to say how much the mortgage payments were during the relevant period of time.

In re-direct the appellant agreed that the property had to be redecorated in order to rent it.

Appellant's position

The appellant took the position that he intended to rent the property through 1986 and that this position was supported by the Exhibit evidence. It was not necessary to liquidate the California property in order for him to buy a property in Halifax, the property was on the rental market and thus all expenses were business expenses and not personal expenses, in his opinion.

He further argued that profit was his principal motivation and that the property was located in one of California's fastest growing regions. He says that the expenses were not personal or living expenses. He says the Minister has allowed some of the expenses, the property was managed by someone thousands of miles away from the appellant and it is clear that the expenses were not personal.

Although not initially raised by the appellant, he took the position at the end of the hearing, that since the Minister had allowed him expenses for two months of the year, he could not now argue that for the other ten months of the year they were personal expenses. Further, he argued that the Minister could not take the position on the appeal that there was no reasonable expectation of profit, having allowed some expenses. His position is that it was not just a change of reasons for disallowing some of the expenses but the actions of the Minister were tantamount to a change of assessment or allowing the Minister to make two assessments in one year.

The appellant argued further that it was reasonable to expect the property to be rented at $2,000 per month, he was attempting to rent it at a profit and thus all his expenses should be allowed as they were made only for the purposes of obtaining a higher rental income. Further, he said that the Minister did not specify which expenses were not allowed but merely allowed the expenses for two months of the rental period and allowed the appellant to deduct 1/6 of the expenses from income. The appellant said that since he had the property for investment purposes until its value was enhanced, that shows that the expenses were not personal.

Finally, the appellant argues that it does not matter whether the intent was to make a capital profit or a business profit on the rental aspect of the property since the intention was to make a good investment and this should satisfy any requirements.

Respondent's position

The respondent takes the position that the expenses were personal or living expenses, that this was the appellant's personal residence until 1985 when he put it up for sale. He had problems selling it at his price and kept it for future sale. Just because he intended to rent it does not make it a business or make the expenses any less personal.

The respondent refers to Exhibit R-4 in support of the position that the appellant only intended to rent it for a short term. Further, the respondent says that Exhibit R-1 shows that he only hoped to maintain the holding payments while awaiting sale and did not really expect to have a rental profit. This was another way of saying we want to defray our personal costs of keeping the house until we can sell it at our price. The argument made is that the appellant was merely attempting to make a profit off his personal residence, that this is further shown by Exhibits A-1 and A-3 and just because the appellant moved out of the property does not make it any less a personal residence.

The respondent refers to James and Linda Menzies v. M.N.R., [1991] 1 C.T.C. 2346, 91 D.T.C. 222, in support of the position that there must be a change of use from a personal use to a business use to take it out of the personal category but in this case the main purpose in 1986 and 1987 was to keep it for sale, not to rent it as a business and therefore it was personal rather than business.

On the matter of reasonable expectation of profit counsel for the Minister refers to Matthew Epstein v. M.N.R., [1988] 1 C.T.C. 2152, 88 D.T.C. 1088, and says that it supports her proposition that she can argue that there was no reasonable expectation of profit, because in that case the Minister had allowed restricted farm losses and upon appeal the Court upheld the assessments even though it found no reasonable expectation of profit. She says the Minister changed his position at the time of the appeal and said there was no reasonable expectation of profit and accepted the burden of establishing the same and that is all that the Minister is doing in this case.

According to the respondent what is at issue in this case is not the assessment but the reasons for the assessment or the reasons for allowing part of the expenses and not allowing the remainder. The argument made is that the Minister has merely changed his reasons for disallowing part of the expenses and there is nothing wrong with that. There is no second assessment and there is no change of assessment since the tax payable is the same. He is merely confirming the assessment and giving extra reasons for disallowing the expenses.

The respondent argues that it is up to the Court to look at all of the facts and to decide whether the expenses are allowable or not allowable. She argues that if the Minister is not allowed at the appeal to advance the additional reasons for disallowing the claimed expenses that this is tantamount to estoppel against the Crown. The Minister accepts the burden of proof in the alternative argument of no reasonable expectation of profit in this case and says that providing there is sufficient evidence established by the Minister on that point then the argument is a valid one.

The respondent concludes that the evidence makes it clear that there was no reasonable expectation of profit by the appellant in this case and that one need only look at the amounts as referred to in Exhibit A-5 as projected rental income and the amounts of income and expenses shown in paragraph 6(f) of the reply, which were accepted by the appellant, to see that there was no reasonable expectation of profit. Even if the appellant was able to rent for $1,100 per month for the whole year he could not have shown a profit and that was before capital cost allowance. Further, the Minister argues that there were other expenses that were not claimed that would make the final picture even worse. The position taken by the Minister is that the appellant left it entirely up to the rental agency and did not even make any projections as to profitability and that the appeal should be dismissed.

Issues

It is clear that the Minister has allowed 1/6 of the expenses claimed in the year in question based upon the two months that the property was rented in that year. The argument raised is that by doing so he has admitted that there was a reasonable expectation of profit and further that he has admitted that the expenses claimed were not personal, but were business expenses.

The respondent disagrees with this contention and says that the Minister may have made a mistake in allowing any expenses, but so long as he does not attempt to disallow the expenses already allowed, he is free to make any argument as to why the expenses disallowed were properly disallowed.

In the reply the Minister acknowledges that he erred by not considering the $3,790.67 of expenses to be personal or living expenses. Further, in the reply the Minister submitted in the alternative that the entire 1986 expenses were personal or living expenses on the basis that the appellant had no reasonable expectation of profit from his 1986 rental activities.

It was pointed out to counsel for the respondent at the time of trial that this argument was not sound and the respondent agreed that the pleading was bad and that it should have been argued that the expenses were personal or living expenses and there was no reasonable expectation of profit. No effort was made to amend the pleading but that bad pleading in itself is not necessarily fatal to the respondent's position.

The respondent accepts the burden of proving that there was no reasonable expectation of profit but has not agreed to accept the burden of proving that the expenses were personal or living expenses. I am satisfied that if the respondent is entitled to argue either, that there was no reasonable expectation of profit, or that the expenses were personal or living expenses, then the burden is on the respondent on both issues because there was no evidence before me as to which of the expenses were allowed because they were not personal and which were disallowed because they were personal, and all of them were grouped together.

Further, in light of the above, I am satisfied that in this case if the Minister is not able to advance the argument that there was no reasonable expectation of profit (because the Minister had already agreed that there was by allowing some of the expenses), then likewise the respondent would be unable to advance the argument that the disallowed expenses were personal or living expenses (having already allowed some of those expenses and not having separated the allowed expenses from the disallowed expenses either in the pleadings or by the evidence).

The primary question therefore is whether or not the respondent is free to advance either argument as referred to above? If the answer to that question is yes, then I must further consider whether or not the evidence establishes that the disallowed expenses were either personal or living expenses or if there was a reasonable expectation of profit.

At the conclusion of the trial the Court invited counsel for the respondent and the agent for the appellant to make further submissions and to refer to authorities in support of their respective positions. The appellant referred to Canada v. McLeod, [1990] 1 C.T.C. 433, 90 D.T.C. 6281, arguing that that case stood for the proposition that the Crown could not change the basis for its assessment. This case can be readily distinguished on the facts from the case at bar since the Minister was in reality seeking to appeal his own reassessment, the result of which would be to allow him to claim that less tax was owing than Originally but on a completely different basis, and this is something that the courts have customarily rejected.

Further, I cannot accept the appellant's argument that the Minister is in effect reversing his own decision or appealing his own decision as in McLeod, Supra.

The respondent refers to a number of cases including The Queen v. Bowater Mersey Paper Company Ltd., [1987] 2 C.T.C. 159, 87 D.T.C. 5382 (F.C.A.), in support of the position that what is involved in an appeal by the taxpayer is the“ result” or the amount of tax, interest and penalties payable and not the errors made by the Minister, and the result may be justified under the Income Tax Act in various ways, or under various sections of the Act, irrespective of the fact that the Minister in making the calculation of the" result”, relied upon a particular provision based upon an erroneous opinion of the facts, so long as the“ result” is not too high.

The cases of Vineland Quarries and Crushed Stone v. M.N.R., [1970] C.T.C. 12, 70 D.T.C. 6043 (Ex. Ct.) and M.N.R. v. Minden, [1962] C.T.C. 7962, D.T.C. 1044 (Ex. Ct.), are cited by the respondent in support of the contention that an appeal from an assessment of tax is an appeal against the amount of tax, and if the Minister's reasons for making the assessment are erroneous the Court may, for correct reasons, either maintain the assessment or direct that a lesser amount be assessed.

Analysis and decision

The basic principle is set out in Johnston v. M.N.R., [1948] S.C.R. 486, [1948] C.T.C. 195, 3 D.T.C. 1182, which makes it clear that the burden of proof is on the taxpayer to show that the assessment is wrong. However, in M.N.R. v. Pillsbury Holdings Ltd., [1964] C.T.C. 294, 64 D.T.C. 5184, (Ex. Ct.), Cattanach, J., at page 5188, makes it clear that the Minister may rely upon facts other than those found or assumed when the assessment was made, providing he meets the burden of establishing them. This conclusion is accepted as settled by Christie, A.C.J.T.C., in Finley Baggs v. M.N.R., [1990] 1 C.T.C. 2391, 90 D.T.C. 1296, at page 2393 (D.T.C. 1297), where other authorities are also listed in support of this position. In Smythe v. M.N.R., [1967] C.T.C. 498, 67 D.T.C. 5334 at page 510 (D.T.C. 5341), Gibson, J., of the Exchequer Court of Canada, said:

I am of opinion that the respondent is not bound by the assumptions made by the assessor or the reasons stated in the Notices of Assessment or Reassessment and is not restricted to relying on the reasons stated or the section or sections of the Income Tax Act referred to, purporting to be the basis for the assessment or reassessment for income tax, but is entitled to allege in his pleadings in this Court other facts and to plead any other alternative or additional section or sections of the Income Tax Act as the basis for asking this Court to confirm or otherwise adjudicate upon any assessment or re-assessment for income tax, but in so far as the latter procedure is adopted by the respondent, the onus of proof is on him.

If the Minister makes a new allegation of fact which is substantially different from the assumptions made at the time of the assessment, that is sufficient to shift the burden of proof to the Minister on that point, as held by Garon, T.C.C.J., in Maroist v. M.N.R., [1990] 1 C.T.C. 2521, 90 D.T.C. 1524, at pages 2525-26 (D.T.C. 1527). However, a mere error by the Minister, causing no prejudice to the taxpayer, may not shift the burden of proof to the Minister, as in The Queen v. Mattabi Mines Ltd., [1989] 2 C.T.C. 94, 89 D.T.C. 5357, at page 111 (D.T.C. 5365).

There are several cases which at first blush may appear to take a contrary position to that referred to above, but on closer inspection of the facts in those cases, they would appear to be distinguishable. In the case of Estate of Harry Inman v. M.N.R. (1969), Tax A.B.C. 189, 69 D.T.C. 180, the Minister was seeking to appeal from his own assessment, and further the relevant statutory provision was subsection 22(1) of the Estate Tax Act which did not give the Minister any right of appeal.

Likewise the case of Klie v. M.N.R., [1979] C.T.C. 2262, 79 D.T.C. 254, appears to be a situation where the Minister was attempting to alter the legal basis of the assessment by seeking to amend his reply, which according to the Court was in effect an attempt to reassess.

In neither Klie, supra, or Inman, supra, did the Court consider subsection 152(3) of the Income Tax Act, which provides:

Liability for the tax under this Part is not affected by an incorrect or incomplete assessment or by the fact that no assessment has been made.

This provision was highlighted in Belle-Isle v. M.N.R. (1963), 31 Tax A.B.C. 420, 63 D.T.C. 347, at page 434 (D.T.C. 349), where the Tax Appeal Board found that:

. . .liability for tax is not affected by an incorrect or incomplete assessment. Hence, if the transaction entered into by the appellant attracted tax, it did not escape such tax because the Minister availed himself of one section of the Act rather than another section.

In applying the reasoning in the above noted cases to the factual situation before this Court, I am satisfied that the answer to the primary question is "yes" and the Minister is free to argue on the appeal that there was no reasonable expectation of profit and that the expenses were personal or living expenses.

Further, as indicated above, I am satisfied that the facts of this case bring in to play the rule as set out in Pillsbury Holdings Ltd., supra, and the Minister must meet the burden of establishing that there was no reasonable expectation of profit or that the expenses were personal or living expenses.

The question of estoppel against the Crown was raised by the respondent arguing that it does not lie against the Crown. Certainly in order for estoppel to apply it would have to meet the three tests set out in Western Smallware & Stationery Co. Ltd. v. M.N.R., [1972] C.T.C. 7, 72 D.T.C. 6036, and I am satisfied that none of these criteria have been met here.

It may be that to say there can be no estoppel against the Crown is to state the proposition too broadly in light of the decision of the Exchequer Court in Gibbon v. The Queen, [1977] C.T.C. 334, 77 D.T.C. 5193 at page 339 (D.T.C. 5196), which seems to make a clear distinction between an erroneous decision on questions of fact which has nevertheless induced the beneficiary of the decision to act on it, and a failure to apply the law, and in the latter case no decision by a servant or officer of the Crown can bind it. However, estoppel is clearly inapplicable in the case before me.

On the question of whether or not the respondent has met the burden of proof cast upon it to establish that there was no reasonable expectation of profit, I am satisfied that it has done so. It is clear from Moldowan v. The Queen, [1978] 1 S.C.R. 480, [1977] C.T.C. 310, 77 D.T.C. 5213, that in order to have a source of income “the taxpayer must have a profit or a reasonable expectation of profit". "Source of income” is an equivalent term to "business".

The only possible business that the appellant could have had in this case is a rental business. He was certainly not in the business of selling properties. One need only look at Exhibit A-5 to see that there was no way that the appellant could hope to make a profit even if the property was rented for twelve months of the year.

One must add to that fact the viva voce evidence of the appellant himself that there were other expenses involved that were not claimed and that capital cost allowance was not even considered. It is reasonable to deduce from all of the facts proven in this case that the appellant was not sure of the total amount of holding payments, did not know how long the house would be rented and required a clause in any rental agreement that the tenant would accept short notice, thus making the rental option less attractive.

The appellants position that it was reasonable to expect that the property would rent for $2,000 per month has not been established and the position taken by the appellant that because he was attempting to rent it at a profit all the expenses incurred would automatically be business and thus allowable expenses, is untenable. Further, the position taken by the appellant that because he intended from the beginning to make a profit on the sale of the property ultimately and that all of his actions were predicated upon that desire, does not satisfy me that there was any reasonable expectation of profit from this venture.

I am satisfied further that the evidence established that the expenses claimed were not deductible because they were personal or living expenses. I accept the argument of the respondent that these expenditures were made for no other purpose than to maintain the property until it could be sold at a higher price and thus give the appellant a profit.

It is true that the appellant did not require the property to be sold in order for him to obtain a new residence in Halifax but that does not make the venture any more a business and it does not change the expenses from personal to business nor is that task accomplished by the fact that the property was on the rental market. These are only factors that must be considered in the whole picture.

The evidence further satisfies me that there was no change from a personal use to a business use of this property and the expenses are therefore not deductible.

For these reasons, the appeal is dismissed.

Appeal dismissed.