Tom M. McLaughlin v. Her Majesty the Queen, [1992] 1 CTC 2001

Bowman, T.C.C J.:—I shall now proceed to render judgment in the case of Tom M. McLaughlin versus The Queen, Court Number 91-1438(IT).

This is an appeal from a reassessment for the appellant's 1987 taxation year. It raises a question of the allocation between revenue and capital expenditures, a matter that has been litigated in this country and in the United Kingdom with, I should think, greater frequency than almost any other issue in the field of income tax. I do not propose to review the authorities at length. That has been done in higher courts on a number of occasions. What remains for me to do is to apply the principles to the facts before me in this case and arrive at what I hope will be a fair and reasonable resolution based on the principles enunciated in those authorities.

In 1987 the appellant and his wife bought a century old house at 4 Margaret Street, Waterdown, for $113,000. It was occupied by the then owner. The appellant considered renting it in its then condition but decided that in that condition it would not attract the type of tenant or command the rent that he wanted and that it was not practical to rent it while work was being done. The house was obviously habitable but it needed work and accordingly the appellant embarked on a project of repair and renovation that lasted until the late fall of 1987 at which time it was rented in December for $1,500 per month—an amount which could not have been obtained had the work not been done. That tenancy did not work out and subsequently the appellant had to rent the house for a lesser amount. The appellant, a retired high school teacher, is experienced in the field of rental properties. He owned or had interests in several other rental properties.

The work involved putting in a new kitchen, drywalls, light fixtures, fixing up bathrooms, painting, wallpapering, replacing the wood trim, replacing or installing baseboard heating, straightening the floor, and general repair work.

The appellant submitted detailed lists of the expenses. The Minister accepted that the expenses, totalling $60,835.69, had been incurred but refused to accept that any portion of it was attributable to current revenue expense for repairs and took the position the entire expense was on capital account.

The appellant in filing his return of income consulted with his accountant and endeavoured as best he could to arrive at a fair and reasonable and conservative allocation between expenditures that resulted in a permanent and enduring benefit and those that were merely repairs that would restore the house to its original state. In this he sought guidance from the Departments Interpretation Bulletin IT-128R. He filed his return on the basis that of the $60,835.69 spent, $19,420.19 was of a revenue nature and the balance was capital. His accountant testified as to the method used—he took all expenses of less than $150, totalled them along with miscellaneous fixtures and other small items, to arrive at that portion of the cost of building materials that he considered to be of a revenue nature. He then allocated the labour costs in the same proportion. Paint and wallpaper were allocated entirely to revenue. Labour for electrical work, as well as the cost of new windows and a fireplace, were all capitalized. The method was not precisely as scientific as it might have been but it was, in my opinion, reasonable. It would be unreasonable to expect in the circumstances for the taxpayer to count nails.

A similar question arose in an entirely different context in Sherritt Gordon Mines v. M.N.R., [1968] C.T.C. 262, 68 D.T.C. 5180, where the question was the allocation of bond interest and commitment fees to particular projects. It was argued by counsel for the Minister, at page 280 (D.T.C. 5191), that:

The percentage allocation made by Sherritt was notional, retroactive and hypothetical and based on total cumulative monthly investment from all sources and not on any particular attribution to source. The allocation of commitment fee follows the allocation of interest, i.e., it is in the same proportion, and does not take into account the difference between interest and commitment fee, the former being based on the amount of capital borrowed and the latter on the amount that had not been borrowed.

Mr. Justice Kerr of the Exchequer Court had this to say about that argument, at page 291 (D.T.C. 5197) :

I think that in the circumstances of Sherritt's business it was proper for the company to make the retroactive attribution and allocation of bond interest and commitment fee payments on the basis of judgment and opinion and the records of the company, as Sherritt did, and although the fit may not be perfect the attribution and allocation so made was fair and reasonable and adequate and acceptable for income tax purposes . . . .

The premise of the Minister's assessment is that where a habitable house is fixed up so that it is improved so that an enhanced rent is achieved all expenditures are on capital account. I find the premise of the assessment to be wholly unreasonable and indeed arbitrary. No basis for this extraordinary conclusion was given to the appellant or his representative at the objection level and the rather stark statement of defence puts forward no factual assumptions supporting the conclusion that the appellant was required to rebut in accordance with the decision of the Exchequer Court in M.N.R. v. Pillsbury Holdings, [1964] C.T.C. 294, 64 D.T.C. 5184.

A substantial portion of the work that was done was, on the evidence, repairs to put the house back to its original state—not to effect a lasting permanent structural improvement. Painting and wallpapering, repairs of floors, replacement of drywall, replacing of fixtures is essentially repair. While I do not regard Interpretation Bulletins as having any particular probative value beyond showing how the Department of National Revenue interprets and administers the Income Tax Act, it is significant that paragraph 4(b) of Interpretation Bulletin IT-128R contains this statement:

Maintenance or Betterment—Where an expenditure made in respect of a property serves only to restore it to its original condition, that fact is one indication that the expenditure is of a current nature. This is often the case where a floor or a roof is replaced. Where, however, the result of the expenditure is to materially improve the property beyond its original condition, such as where a new floor or a new roof clearly is of better quality and greater durability than the replaced one, then the expenditure is regarded as capital in nature. Whether or not the market value of the property is increased as a result of the expenditure is not a major factor in reaching a decision. In the event that the expenditure includes both current and capital elements and these can be identified, an appropriate allocation of the expenditure is necessary. Where only a minor part of the expenditure is of a capital nature, the Department is prepared to treat the whole as being of a current nature.

The statement is consistent with my understanding of the decided cases, of which the leading cases on this point are Shabro Investments Ltd. v. The Queen, [1979] C.T.C. 125, 79 D.T.C. 5104, and Gold Bar Developments Ltd. v. The Queen, [1987] 1 C.T.C. 262, 87 D.T.C. 5152. Had the principles in those cases been applied here, the appellant might well have been entitled to deduct even more than he claimed.

Even in the decision of Jean Methe v. M.N.R., [1986] 1 C.T.C. 2493, 86 D.T.C. 1360, the Court allowed a portion of the expenditures of a total renovation to be deducted. The figures in that case are significant. The building cost $38,000; $145,000 was spent on the renovations and repair work; $65,000 was deducted currently; the Court allowed only $25,000. Virtually a new building was constructed. That is not the case here.

The only "assumption" that was pleaded was that the entire amount spent was on capital account. This is the case that the appellant was required to meet. No further factual basis for the assessment was pleaded. The appellant on the evidence has amply demonstrated that the premise of the assessment is erroneous.

In Johns-Manville Canada Ltd. v. The Queen, [1985] 2 C.T.C. 111, 85 D.T.C. 5373, an entirely different question relating to income or capital expenditures was discussed. While I do not propose to review the authorities discussed in that case in detail, there are two or three that merit some mention. At page 118 (D.T.C. 5378), Mr. Justice Estey referred to Sun Newspapers v. Federal Commissioner of Taxation (1938), 61 C.L.R. 337, and quoted from Chief Justice Dixon of the High Court of Australia where he said:

. . . the expenditure is to be considered of a revenue nature if its purpose brings it within the very wide class of things which in the aggregate form the constant demand which must be answered out of the returns of a trade or its circulating capital and that actual recurrence of the specific thing need not take place or be expected as likely.

He also cites Commissioner of Taxes v. Nchanga Consolidated Copper Mines Ltd., a decision of the Privy Council, [1964] A.C. 948, where Viscount Radcliffe stated:

Nevertheless, it has to be remembered that all these phrases, as, for instance, "enduring benefit" or "capital structure" are essentially descriptive rather than definitive, and, as each new case arises for adjudication and it is sought to reason by analogy from its facts to those of one previously decided, a court's primary duty is to inquire how far a description that was both relevant and significant in one set of circumstances is either significant or relevant in those which are presently before it.

At page 162 (D.T.C. 5377), Mr. Justice Estey cited M.N.R. v. Algoma Central, [1968] S.C.R. 447, [1968] C.T.C. 161, 68 D.T.C. 5096, where Mr. Justice Fauteux, as he then was, stated at 162 (D.T.C. 5097):

Parliament did not define the expressions "outlay . . . of capital" or "payment on account of capital". There being no statutory criterion, the application or nonapplication of these expressions to any particular expenditures must depend upon the facts of the particular case. We do not think that any single test applies in making that determination . . .

The Supreme Court of Canada in the Algoma Central case at page 162 (D.T.C. 5097) cited the Privy Council in B.P. Australia Ltd. v. Commissioner of Taxation of the Commonwealth of Australia, [1966] A.C. 224, where Lord Pearce said at pages 264-65:

The solution to the problem is not to be found by any rigid test or description. It

has to be derived from many aspects of the whole set of circumstances some of which may point in one direction, some in the other. One consideration may point so clearly that it dominates other and vaguer indications in the contrary direction. It is a commonsense appreciation of all the guiding features which must provide the ultimate answer.

In my opinion, had the Minister applied common sense in making the assessment here the appellant would not be before the Court.

I should like in closing to commend counsel for the Minister for his extremely fair and reasonable handling of this case. It is in accordance with the high standards the Court has come to expect of the representatives of the Attorney General of Canada.

The appeal will be allowed and the reassessment for the appellant's 1987 taxation year will be referred back to the Minister of National Revenue for reconsideration and reassessment on the basis that of the amount of $60,836 expended by the appellant on the repair and renovation of the house at 4 Margaret Street, $19,420 is to be deducted as an expenditure on revenue account. Thank you.

Appeal allowed.