Nancy Murray, Paul Murray, Paul S. Zitir, Dr. Michael Piercell, Alexander-Leopold Strausz, Jerry Nickels, Dr. Robert Lan Hing Ming, Dr. Merrill E. Nesseth, Elfrieda Nickels, Charles McFarlane, Charles L. Beaudoin, Dr. M.J. Ziter, Joseph Piercell, Roxana S. Chow, Ernst D. Bondy and Ronald Neily v. Minister of National Revenue, [1991] 2 CTC 2308

Taylor, T.C.J.:—These are appeals heard on common evidence at London, Ontario on July 9 and 10, 1991 against income tax assessments, in which the Minister of National Revenue ("respondent") had disallowed a claim for an operational loss for the taxation year 1986, for each of the above. The amounts varied but the principle involved for each was exactly the same. The sole issue was whether the total rental loss at issue $874,283, and a further $54,334 amount of interest also claimed - $928,617 was deductible, (sometimes the $874,283 was rounded off "in the pleadings” to $875,000, so that the total amount at issue stood at $929,334, but that is not important). As an example I have used the appeal of Dr. Michael Piercell to provide background:

From the notice of appeal:

— The Appellant claimed an operating deficit of $27,880 in his 1986 income tax return.

— In 1979, the Appellant purchased from R.C. Pruefer Co. Ltd. (Riverside), an undivided interest in certain lands, buildings and equipment, in common with others, in a multiple residential project known as Windsor Westchester At The Lake, Windsor, Ontario, (the Westchester Project) under an Agreement between the Appellant and Riverside (the Purchase Agreement).

— Under the Purchase Agreement, Appellant agreed to make payments on account of the purchase price of his interest over a number of years pursuant to a Promissory Note (the Promissory Note).

— Under Article 4 of the Purchase Agreement, Riverside was appointed Manager of the Westchester Project for a period of 10 years at a compensation of 4% of the revenue flowing from the project.

— The primary financing for the project was a first mortgage in favour of The Mutual Life Assurance Company of Canada in the amount of $12,570,000 (the Mutual Life Mortgage).

— Due to the economic recession during the period of construction and rent up of the building, the rent up of the building was unduly slow resulting in substantial rental losses.

— The Westchester Project commenced repayment under The Mutual Life Mortgage in October of 1981.

— In or about 1982, the Appellant failed to make payments which were due and owing under his Promissory Note with Riverside.

— During the calendar years 1983, 1984 and 1985, Riverside did not have outside Accountants due to the economic recession.

— In or about the year 1984, The Mutual Life Assurance Company of Canada took possession of the Westchester Project under the terms of its mortgage.

— In or about the year 1986, discussions ensued between Riverside and the Appellant and his co-investors with a view to an Application to the City of Windsor for conversion of the Westchester Project into a condominium with a view to the ultimate sale of condominium units. In the same time frame, the Appellant settled with Riverside with respect to his indebtedness for arrears under the Promissory Note.

— In 1988 Riverside was successful in having the Westchester Project converted to a condominium and has thereafter commenced sales of condominium units.

— The cash required to carry on the operation of the Westchester Project for the calendar year 1983 exceed the cash available from operations by $874,283 as set out in a financial statement for the project subsequently prepared as at that date (the 1983 statement). Riverside did not deliver the 1983 statement to the Appellant because Appellant was in arrears in his Promissory Note and Appellant was not aware of, and did not claim for income tax purposes, any portion of the operating deficit for 1983. In fact, Riverside absorbed the full amount of the operating deficit as Manager and Agent for the Appellant pursuant to the management provisions of Paragraph [sic] 2.02 of the Purchase Agreement and did not charge the operating deficit to Appellant and other Purchasers.

— Riverside did not advise Appellant of nor seek to charge Appellant for any part of the 1983 operating deficit in either of the years 1984 and 1985.

— By way of the unaudited financial statement for the project for the year ending December 31, 1986, the newly appointed Accountants for Riverside re-allocated operating expenses by increasing the 1986 operating deficit and reducing the loan receivable or Riverside by $929,334 in accordance with generally accepted accounting principles. Particulars of the reallocation were set out in Note 3 and in the Accountants comments to the December 31, 1986, financial statement.

ISSUES TO BE DECIDED

— Whether the operating deficit in question should have been (claimed) by the Appellant in 1983 rather than in 1986 in computing the Appellant's profit or loss from the Westchester Project pursuant to Section 9(2) of the Act.

— Whether the interest element of the charge has no basis in the purchase in accordance with paragraph 18(1)(b) of the Act.

GROUNDS FOR APPEAL

— The Appellant did not become liable for, nor was the Appellant aware of, any portion of the reallocation of operating expenses until the Appellant was made aware of the same by the financial statements dated December 31, 1986, which were delivered on or about April 25, 1987. It was only at the time of delivery of the 1986 financial statements that the costs in question were charged to the Appellant and became the liability of the Appellant. The Appellant claimed the costs as soon as they were charged to him.

— At the time that Riverside paid the operating costs, including the substantial mortgage interest, Riverside was liable for the same as Guarantor of the mortgage and as the party who ordered the other services which formed part of the operating costs.

— The operating deficit in question was an operating deficit of the Appellant from a business or property in the year 1986 in all of the circumstances.

— The operating deficit and the accumulated interest which are the subject matter of these Assessments, was only charged to the Westchester Project by Riverside in 1986 and in accordance with established jurisprudence relating to the calculation of profit and loss, this expense should only become deductible to the Appellant in that year.

From the reply to notice of appeal:

(Judge’s note:—The respondent took issue with much of the background material provided by the appellant in the notice of appeal above, but these points do not warrant review unless they impact directly on the result of this trial, in which case this will be noted below.)

— the Westchester At The Lake Project (the "Project") sustained rental losses in the amount of $874,283 in the 1983 taxation year and states that the Appellant did not demand information regarding the income or losses realized by him as an investor in the Project in the 1983 taxation year

— the Respondent denies that the Appellant was indebted to R.C. Pruefer Company Ltd. for arrears of interest

— the Appellant did not claim his proportionate share of the 1983 operating loss in his 1983 income tax return;

— the Appellant did not claim his proportionate share of the 1983 loss until the 1986 financial statements were prepared.

— The Respondent relies, inter alia, upon sections 3 and 111, subsections 9(2) and 152(4) and paragraphs[sic] 20(1)(c) of the Income Tax Act, R.S.C. 1952, c. 148, as amended (the "Act").

— The Respondent respectfully submits that pursuant to section 3 and subsection 9(2) of the Income Tax Act, rental losses realized by the Appellant in the 1983 taxation year were required to be deducted in the year incurred and were not available for carry over pursuant to section 111 of the Income Tax Act.

— The Respondent respectfully submits that the deduction of interest expense has properly been denied on the basis that the amount claimed did not represent an amount paid in the 1986 taxation year or payable in the 1986 taxation year pursuant to a legal obligation to pay interest either on borrowed money used for the purpose of earning income from a business or property or on an amount payable for property acquired for the purpose of gaining or producing income therefrom or for the purpose of gaining or producing income from a business pursuant to paragraph 20(1)(c) of the Income Tax Act.

Evidence

This was a Multiple Urban Residential Building (MURB) project in its original form, the total plan was for some 300 rental units, a recreation area, parking etc. Testimony and evidence come from Mr. Docherty, the President of Riverside; from Mr. Horn, a financial analyst, who was an investor in the project, although not an appellant in this matter; and from Mr. Menzies, a chartered accountant, who prepared the journal entries and financial statements presented at the trial in support of the assertion that the amount at issue reflected a 1986 rather than a 1983 loss. Mr. Menzies was not the accountant responsible for the original fiscal years 1983, 1984 and 1985 financial statements. His basic role, as it related to these appeals was in the adjustments he regarded as warranted to show the amount at issue as a 1986 rather than a 1983 charge, when he was preparingthe 1986 financial statements in about April 1987.

While the testimony of Mr. Docherty and Mr. Horn was illuminating and interesting it had little direct bearing on the critical issue before the Court. (As indicated earlier, none of the appellants in these appeals actually testified, and that in itself left their situations on very precarious ground. However, it was agreed between counsel that the Court should hear Mr. Horn and accept his testimony as representative of that which would be given by any of the appellants.) Only the testimony of Mr. Menzies had any real relationship to the problem as I see it. As well as I could follow his rationale for the assertions of 1986 rather than 1983, it was founded on three propositions:

First. Since those investors who had not made their agreed upon instalments in 1983 (or in 1984 or 1985) finally in 1986 "came back into the fold”, or made arrangements (which were not detailed at the trial) to bring their arrears up to date, they then (in 1986) effectively accepted the amounts at issue as their responsibility. They were not entitled to them before that time because they had not met their obligations to the project, and costs incurred had been carried on by Riverside in the interim, according to Mr. Menzies. (Riverside had not claimed these 1983 losses, other than perhaps any small part of the losses represented by Riverside's own proportionate retained share of the project.)

Second. During the year 1986, Mr. Docherty had succeeded in having another one of his similar rental building projects converted to a condominium, the investors therefore had confidence that he could do the same with this project, and became supportive again.

Third. The “accounting recommendations" of the Institute of Chartered Accountants to which Mr. Menzies attempted to adhere, in his mind dictated the accounting treatment he accorded the amount at issue, and substantiated his view that 1986 was the proper year in these circumstances.

Analysis

In my view, none of these reasons is either viable or valid, and I would comment as follows:

First. The fact that none of the appellants had claimed a proportionate share of the loss in the 1983 year, does not alter the basic situation that the loss was one for that year,—not any other year which might appear to be more advantageous or appropriate. Simply put, the individual taxpayers who are now appellants in this matter were specifically responsible—on the self reporting system under which Revenue Canada operates—to declare all their income and determine therefrom the taxable income for that year, (in this case 1983). One important element of that kind of declaration is the inclusion therein of any claimable losses for that year. The operating loss of $874,283 was incurred by the investors, not by some intangible body called "Westchester", nor was it affected by which party or parties contributed funds to provide for the dollar payments related to the operating loss. (Whether the investors (appellants) actually even paid for their instalments on the project was not brought forward as an issue, and I make no comment on the question of their possible disentitlement to deductions on completely different grounds than simply the proper year—1983 or 1986.) The loss is not affected by the fact that Mr. Docherty, for his own purposes, was reluctant to provide details of the loss to the investors for that year. Nor can it be altered because the individual investors exerted varying degrees of effort—with attendant varying degrees of success—in finding out the operating results of the project. Also, it should be noted that none of the appellants attempted legal action to secure the needed information, although there was testimony from Mr. Horn that legal advice had been received by them to the effect that they should not proceed that way— presumably to avoid the prospect of other liabilities. None of that is of consequence—there is simply no basis whatsoever for not recording and reporting a 1983 loss under these circumstances, and then attempting to hike it forward to a point in time more suitable to the aims of these taxpayers.

A clear reminder of the required configuration of financial reporting is found in Consolidated Textiles Ltd. v. M.N.R. [1947] C.T.C. 63; 47 D.T.C. 958 at 69 (D.T.C. 960), which appears to me to have survived in essence in subsequent jurisprudence, also noted by counsel for the respondent*:

In my opinion, section 6(a) excludes the deduction of disbursements or expenses that were not laid out or expended in or during the taxation year in respect of which the assessment is made. This is, I think, wholly in accord with the general scheme of the Act, dealing as it does with each taxation year from the point of view of the incoming receipts and outgoing expenditures of such year and by the deduction of the latter from the former with a view to reaching the net profit or gain or gratuity directly or indirectly received in or during such year as the taxable income of such year.

Second. The reasons for which the investors felt more secure in supporting the project in 1986 rather than 1983—whether condominization or whatever— are quite irrelevant to the contentions in these appeals. The issue is to determine when the operating loss involved was sustained and would be deductible for income tax purposes.

Pendray Farms Ltd. and Fortuna Farms Ltd. v. The Queen, [1980] C.T.C. 1009; 80 D.T.C. 6062 (F.C.T.D.); The Queen v. Nomad Sand and Gravel Ltd., [1991] 1 C.T.C. 60; 91 D.T.C. 5032 (F.C.A.)

Third. This is perhaps the most interesting reason advanced, at least it has an ingenuity not evident in the above "first" and second" arguments. Transporting the operating loss of fiscal 1983 to fiscal 1986, the intended result of the adjustments, journal entries and financial statements for 1986 prepared by Mr. Menzies, transcends any comprehension I have of the purpose and rationale for accounting records and reports. The operating loss of $874,283 which was sustained by Riverside, and therefore because of the structure of this venture available to the investors of Riverside for taxation purposes, was not simply a mathematical result at the end of a page. The amount of $874,283. represented the fact that the expenses properly allocable to the year 1983 exceeded the comparable by that amount. Simply put, to move this amount from 1983 to 1986, would be to assert that these excess expenses did not occur in 1983. Indeed Mr. Menzies, showing some concern about this aspect of his efforts, prepared, (simply for purposes of illustration at this trial) a revised set of financial statements for the year 1983 to show the $874,283 as an increase in the amount due from Riverside to the Project Westchester, rather than as a reduction of the Developers Equity in the project, which latter placement would be where such a loss would normally appear, and indeed where it did appear in the original statements. He did not merely eliminate the operational loss, by leaving out or "deferring" some of the expenses. In effect, the view that Mr. Menzies espoused was to merely "park" the $874,283 in the R.C. Pruefer— Riverside account with the project in 1983—a kind of "suspense" account, and leave it there until 1986 at which time the circumstances between Riverside and the investors in Westchester had been clarified and re-arranged as noted earlier. In this way, he contended that the reduction of the "Developers Equity" would have been avoided in 1983, and only brought into the picture in 1986 when they paid or made arrangements to pay the instalment arrears on their purchase of theindividual interests. Unfortunately for Mr. Menzies' logic, the fact that the investors did not live up to their commitments to Riverside in 1983, has no bearing at all on the operating loss of the project for that year, or of the entitlement of the investors to the taxation results of the loss—also in that year. In his financial statements for the year 1986, Mr. Menzies made the following comments:

Management has informed us that a reallocation of operating expenses has been made during the year increasing the net loss and reducing the loan receivable of R.C. Pruefer Co. Ltd. by $929,334. (see note 3). Generally accepted accounting principles require this adjustment to be recorded retroactively—if an error has been made; however, this adjustment has been made in the current year as a change in estimate.

During the year management directed a reallocation of the following operating expenses to the project and reduced the loan of R.C. Pruefer Co. Ltd.:

Mr. Menzies explained that he could not consider the change from 1983 to 1986 a "Prior Period Adjustment" and I agree with him. His contention was that he could not so classify it because of the constraints imposed on him as a professional chartered accountant by section 3600 of the Accounting Recommendations of the Canadian Institute of Chartered Accountants (C.I.C.A.). My view is that there was simply no prior period that required or warranted adjustment irrespective of the above section 3600,—there was nothing at all wrong with the way the 1983 financial statements had been prepared in the first place, at least as this item would be affected. Mr. Menzies also referred in the same way to section 1506 of the same C.I.C.A. rules, noting that he could not label the adjustment as a "Correction of an error in prior period financial statements". As I have said above there was no error to correct. Finally Mr. Menzies found some form of solace, although I confess I am unable to discern it, in making the transfer from 1983 to 1986 and relying on a different part of section 1506 of the C.I.C.A. rules entitled "Change in an Accounting Estimate”. Caution should be exercised in the use of Generally Accepted Accounting Principles (G.A.A.P.) as support for a conclusion related to taxation, when it appears to conflict with the result obtained by the straightforward application of generally accepted taxation principles arising out of the Act and the relevant jurisprudence. In this vein I would refer to Zeiben v. M.N.R., [1991] 2 C.T.C. 2008; 91 D.T.C. 886 at page 2021 (D.T.C. 895):

In summary I am far from convinced that there is anything inherently improper with the agreement of sale at issue (Exhibit R-1); nor am I satisfied if it should require revision that alterations to it are warranted solely on the basis of GAAP.

Summary

In the end analysis, the view of Mr. Menzies seemed to me to be that if he could find some support in the C.I.C.A. accounting recommendations, then the medium would validate the message. I am not aware that such emphasis and reliance is placed on the accounting recommendations even by the Institute (C.I.C.A.) itself. There is no doubt that such general rules are very useful, and have been developed over a long period of time by trained individuals dedicated to providing a reasonable set of guidelines and parameters to accountants. But the accounting record does not make the transaction or event, it is the transaction or event that brings about the requirement—if any, for the accounting entry. In this instance there was nothing but the interest in a much—desired result (showing the 1983 loss as a 1986 event) that dictated the search for some illusory support in the C.I.C.A. rules for accounting.

I have concentrated these comments on the “operating loss of $874,283”, since that was the vital point in my view. Not to lose sight of the "interest expense $54,334", I would only note that the same general observations would apply with a further substantial point. It was on the basis of these appeals that Riverside "picked up” the 1983 losses of $874,283 in that year, and then allowed them to be charged back to the individual investors (appellants) in 1986. Whether that happened or not, I have decided above that it could have no bearing on the issue before the Court. Consequently, “interest” charged by Riverside to the investors allegedly on these late or deficient instalment payments would have no relevance to these appeals. That would be a matter between Riverside and the investors if it should arise at all. The matching of revenues and expenses is a basic principle of accounting rules and regulations, even for the preparation of financial statements, let alone for income tax purposes. That principle should be moderated only when support may be seen within the narrow confines of relevant case law and I would give the following as some possible examples:

Associated Investors of Canada Ltd. v. The Queen, [1967] C.T.C. 138; 67 D.T.C. 5096; M.N.R. v. Tower Investment Inc., [1972] C.T.C. 182; 72 D.T.C. 6161; Tobias v. The Queen, [1978] C.T.C. 113; 78 D.T.C. 6028; Oxford Shopping Centres Ltd. v. The Queen, [1980] C.T.C. 7; 79 D.T.C. 5458.

In these appeals, I see no support for any departure from the matching principle, or distortion of the normal operating results, at either the elementary level of accounting, or the further result of tax impact. While a taxpayer is entitled to arrange his affairs in a manner most advantageous and beneficial to him, I am not aware that the relevant jurisprudence provides the same flexibility in arranging the record keeping and reporting of his affairs.

The appeals are dismissed.

Appeals dismissed.