Gaston Bergeron and Diane Bergeron and Aurore Bergeron v. Minister of National Revenue, [1990] 2 CTC 2220, 90 DTC 1511

Lamarre Proulx, T.C.J.:— The appellant is appealing from a reassessment by the respondent for the 1984 taxation year.

This appeal raises two questions, namely the admissibility of a business investment loss under paragraph 39(1)(c) of the Income Tax Act ("the Act") and the nature of the expenses incurred to repair or renovate an apartment building.

The decision rendered on the second point will also apply to two other appeals, those of Aurore and Diane Bergeron, since by consent of the parties and with the Court's approval the evidence presented in this appeal will serve for the other two appeals.

Business Investment Loss: Facts

The appellant testified that in 1984 he was semi-retired. He was relatively young, in his early fifties, and was looking for an investment to make that would be a good one from the standpoint of both financial return and the nature of the business. The appellant considered various possibilities and was inclined toward the creation of a small business making and selling kitchen cupboards and renovating houses. What encouraged him in this direction was that some time earlier the appellant had the opportunity to have renovation work done at his business office and was greatly impressed by the quality of work done by a Mr. Leblanc. He subsequently discussed going into business together with him. The appellant would be responsible for creating a team of cupboard salesmen, and Mr. Leblanc would look after manufacture and be responsible for the renovation side of the business.

In early 1984 a corporation was created under Quebec laws known as “Rénovations ma maison Inc.” The appellant was the sole shareholder in the corporation. He subscribed $1,000 in ordinary shares and $4,000 in preferred shares. The business leased premises in the Montréal-Nord industrial park at $875 a month. As employees the business had Mr. Leblanc and a workman. In the first two months the appellant advanced $12,400 to the business. From the outset the appellant realized that he had not invested in a business that would bring him a good return. He did not know anything about kitchen cupboards or renovation, and even if he was well versed in the public relations of establishing and creating a sales team, he did not think he would ever be able to make the business pay.

On March 1, 1984 he transferred all his shares but one to Mr. Leblanc and forgave his debt of $12,400. The transfer of shares and assignment of the debt were made gratuitously.

The corporation's financial statements for April 30, 1984 show a net loss in the period ending on that date amounting to $15,807. In view of this loss, the fact that the advances had always been made by the appellant and that the capital was subscribed by the appellant alone, the shares according to the appellant's accountant were not worth anything. The appellant’s accountant also said that the debt could not be repaid for the same reasons and because of the obvious lack of liquidity.

The appellant took the advice of his accountant, who told him [Translation] “You had better make a certain loss and then get out of the business and do something else”. I again quote: [Translation] "He spent his days there and never received a cent of salary for all of that. There was a very little chance it would ever make money. Also, it would go on costing him money in the short run, at least for a couple years more".

I again quote:

[Translation]

. . . the problem is that Mr. Bergeron was in a position to say, “good, I’ll close up shop", and he would have been responsible, shall we say, for the rent and other expenses and accounts payable which he had to pay on the one hand, and on the other hand, Mr. Leblanc would be out of work, he would have nowhere to go. As far as the Régie is concerned, it takes capital of at least $5,000 to have a licence, and the company had already been formed, at that point Mr. Leblanc ran the risk of losing money in the short term if he did not make money, but at least he could be working. If Mr. Bergeron closed down the company, then, without having more money, Mr. Leblanc would be out on the street. As a result he told Mr. Leblanc; "Take a chance, try to work your way out of it.” Because that was the situation.

The only thing he wanted, he wanted to put in no more money and wanted to stop spending his days there. He said, listen, I am retired, I am losing money and I am wasting time here, I just want to get out, because it was a company that was not profitable at that time.

The argument raised by the Minister against this claim by the appellant for a business investment loss is that it is strange that the appellant did not have a promissory note signed and try to recover his debt later, as for example against the repair costs described below.

I think it can be said that it was in order to sever his connection with a small business that he had begun and in which he had also involved Mr. Leblanc that the appellant assigned everything without a promissory note. Further, there was in my opinion no reason for Mr. Leblanc to have agreed to give a promissory note. What interest would he have had in doing so? There was no obligation to accept an onerous transfer of shares or of the debt. Both were done to allow the appellant to get out of a business he had begun.

On the question of the shares, I feel that this was an application of subparagraph 39(1)(c)(ii) and that the appellant sustained a loss in accordance with that subparagraph.

As regards the debt, the claim was made pursuant to subparagraph 39(1)(c)(i). Here it is necessary to read paragraph 50(1)(a) of the Act:

50. (1) For the purposes of this subdivision, where

(a) a debt owing to a taxpayer at the end of a taxation year (other than a debt owing to him in respect of the disposition of personal-use property) is established by him to have become a bad debt in the year,

On reading this section it seems clear that one of the requirements of the section is for the taxpayer to have established that a debt was owed to him at the end of a taxation year. The rather vague evidence in this regard seems to indicate that the debt for the advances by the appellant to the company was in law and in fact transferred to Mr. Leblanc in March 1984. Among other oral evidence is, for example, this exchange between counsel for the appellant and the accountant:

[Translation]

Q. Do you know what happened with the sale of $12,400 which was indicated in the company's statements, advances owed to a director?

A. The $12,400 remained there, shall we say, for . . . during the year Mr. Leblanc took a little money for . . .

Q. I would like to know what happened between Mr. Bergeron and Mr. Leblanc regarding this $12,400.

A. It stayed on the books as an advance owed to a shareholder who was now Mr. Leblanc. At that time it was Mr. Leblanc . . . there was never any letter written stating that Mr. Leblanc or the corporation had to pay Mr. Bergeron $12,400.

Q. To your knowledge the entire agreement between the parties, since you participated in the negotiations . . .

A. Yes.

Q. Was that Mr. Bergeron transferred his shares without consideration to Mr. Leblanc, and also forgave Mr. Leblanc his debt of $12,400?

It thus appears that at the end of the 1984 taxation year no debt was owed to the appellant by the corporation. He was no longer the holder of this debt. Paragraph 50(1)(a) therefore, cannot be applied.

I accordingly conclude that the appellant can claim a business investment loss for the disposition of the shares but not for the director's advance.

Expenses Incurred to Renovate an Apartment Building

The second point at issue concerns the nature of the expenses incurred to renovate an apartment building. On June 27, 1984 the appellant purchased an apartment building for $80,000. The building had seven apartments, four with four and a half rooms and three with three and a half. In the purchase the appellant estimated the amount of repairs at about $25,000. The final cost was $109,121. At the time of the purchase the building was used as an apartment building. In order to repair it quickly, the new owner arranged for tenants to give up their apartments, which was done except for one tenant who left later.

The repairs began in July 1984 and ended in December 1984. The entire amount of $109,121 was not claimed as expenses deductible in calculating income. An amount of $26,469 was regarded by the appellant as capital expenditure. These expenses were as follows:

$10,119 for new kitchen cupboards;

$10,800 for a new electric heating system, for a new 400-ampere input and new washer-dryer inputs;

$3,250 for vinyl covering and for north-east side insulation;

$2,300 for improvement of land.

The following is a description of the repairs and costs, as determined by the contractor Renovations ma maison Inc.:

[Translation]

Detailed Costs of Repair

11,574 to 11,586 Hôtel de Ville, Montréal-Nord

	Materials	Labour
Outside bricks
Decayed areas — remove old bricks and relay.
Remove 3 old chimneys.
Redo brick joints.	150	3,650
Roofs
Repair part of metal roof, southwest side	140	660
Repair gravel roof over bedrooms 11,582 and
11,584, northwest side	Subcontract, total cost		1,000
Repair fire break and paint aluminum	275	1,025
Balconies
Repair 14 balconies — change plywood and/or
boards.
Replace steel posts.
Weld wrought iron, replace missing rods.
Sand and paint with rustproofing.
Replace decayed steps.	4,000	7,500
Windows
Removal, repair, scouring.
Replace counterweight cords.
Replace broken fittings, paint with primer and
final coat all interior and exterior windows.
Purchase and instal 123 panes and 24 screens.
Redo joints with silicone.	950	8,600
Doors
Repair doors and screen doors.
Adjust and replace handles where necessary.
Scour and paint. Instal weather stripping.	220	780

Woodwork

Repair woodwork — scour door and window

frames, sand and repaint with varathane. Redo

joints with silicone. 110 1,390

Walls and ceilings

Repair plaster and/or gyps.

Draw joints. 4,000 11,000

Floors

Sand wood and varathane. Subcontract, total cost 837 Linoleum and/or carpet. 1,465 560 Tiles. 1,995 1,000

Bathrooms (5)

Repair and/or replace washstands, toilets and

baths, and various pipes where necessary.

Remove old tiles and instal new tiles. 3,000 12,000

Electricity

Replace two-strand wire found to be dangerous

where necessary. 410 2,290

Painting

Interior: 7 apartments

4 X 4 / and 3 xX 3 /

one primer and two final coats. 1,170 6,800

Exterior: all woodwork, doors, balconies,

wrought iron, two coats. 230 1,600

Land

Repair cement sidewalks.

Replace sidewalk tiles and broken patios. 365 395

Cleaning and levelling. Subcontract, total cost 610

Cleaning Basement

Remove old linoleum, carpets, containers 2,475

Total 18,480 61,725 2,447 Grand total 82,652

Figures rounded to nearest dollar.

Renovation and/or Capitalization

Materials Labour

New kitchen cupboards 8,019 2,100

New electric heating system.

New 400 amp. input.

New washer-dryer inputs.	Subcontract, total cost 10,800
Recovering vinyl, reinsulating northeast side.	Subcontract, total cost		3,250
Improvements to land.		2,300
Total	8,019	4,400	14,050
Grand total			26,469
The cases cited by the parties are as follows:

— M.N.R. v. Vancouver Tug Boat Company Ltd., [1957] Ex. C.R. 160; [1957] C.T.C. 178; 57 D.T.C. 1126;

— Thompson Construction (Chemong) Ltd. v. M.N.R., [1957] Ex. C.R. 96; [1957] C.T.C. 155; 57 D.T.C. 1114;

— M.N.R. v. Haddon Hall Realty Inc., [1962] S.C.R. 109; [1961] C.T.C. 509; 62 D.T.C. 1001;

— Canada Steamship Lines Ltd. v. M.N.R., [1966] Ex. C.R. 972; [1966] C.T.C. 255; 66 D.T.C. 5205;

— M.N.R. v. Algoma Central Railway, [1968] S.C.R. 447; [1968] C.T.C. 161; 68 D.T.C. 5096;

— Dubé et al. v. M.N.R., [1979] C.T.C. 2241; 79 D.T.C. 10;

— Shabro Investments Ltd. v. The Queen, [1979] C.T.C. 125; 79 D.T.C. 5104;

— Healey v. M.N.R., [1984] C.T.C. 2004; 84 D.T.C. 1017;

— S, Coleman v. M.N.R., [1984] C.T.C. 2725 ; 84 D.T.C. 1637;

— Johns-Manville Canada Inc. v. The Queen, [1985] 2 S.C.R. 46; [1985] 2 C.T.C. 111; 85 D.T.C. 5373;

— A.B. Wager v. M.N.R., [1985] 1 C.T.C. 2208; 85 D.T.C. 222;

— J. Méthé v. M.N.R., [1986] 1 C.T.C. 2493; 86 D.T.C. 1360;

— Quebec (Sous-ministre du revenu) v. Goyer, [1987] R.D.F.Q. 159;

— Gold Bar Developments Ltd. v. The Queen (1987), 9 F.C. 303; [1987] 1 C.T.C. 262; 87 D.T.C. 5152;

— Damon Developments Ltd. v. M.N.R., [1988] 1 C.T.C. 2266; 88 D.T.C 1128.

I find it necessary to consider the decisions of the Courts in order to arrive at the principles that will assist me in determining the nature of the repair expenses at issue in the instant case.

In Vancouver Tug Boat Company Ltd. and Thompson Construction (Che- mong) Ltd., supra, the Exchequer Court of Canada held that the replacement of a boat engine and of the engine for a power shovel were capital expenses. In the case of the power shovel, the old engine had a market value even when separated from the shovel. The new engine by itself also had a market value. The purchase of the new engine was thus the purchase of a new capital asset. In the case of the boat engine, this could have been repaired for half the cost of buying the new engine. This was no longer the repair of ordinary wear and tear, but the acquisition of a new asset. In the latter case, the judge was influenced by the purchase price, which was four times the annual cost of repairs to the boat.

Haddon Hall Realty Inc., supra, is a judgment of the Supreme Court of Canada. It concerned an apartment building in Montreal. The taxpayer had incurred expenses to replace stoves, refrigerators and window blinds. Here again, as these were not repairs but replacements, the Court held that they were capital outlays.

In Canada Steamship Lines Ltd., supra, the Exchequer Court of Canada held that the replacement of the floors and walls in a cargo hold was the repair of floors and walls damaged by use and was not the acquisition of a new asset. The same was not true for the replacement of boilers. Speaking of the repairs, Jackett, J. made the following qualification at page 256 (D.T.C. 5207) of his judgment:

(I exclude, of course, a possible replacement by something so different in kind from the thing replaced that it constitutes a change in the character—an upgrading—of the thing upon which the money is expended instead of being a mere repair.)

In Dubé et al. v. M.N.R., supra, the chairman of the Tax Review Board had to decide a case which was very similar to the instant case, as regards the description of repairs.

I quote Mr. Cardin at page 2243 (D.T.C. 12):

[Translation]

The evidence indicates that there are six different kinds of major repairs on the two buildings which the appellants regard as current expenses: repairs on certain parts of the roofs; the restoration of five or six rows of bricks in the upper part of the two buildings; the removal of two poles from the front of the Dubé building and one pole from the front of the Central building; the demolition of two brick chimneys; and the painting of brick vaults on the Dubé building. Aside from this work, the expenses include the restoration of a wood walkway; replacement of window sills; painting of all openings; and restoration of a part of the sidewalk in front of one of the buildings.

It is worth reading the reasons which led him to regard the aforementioned repairs as ones the costs of which are deductible in calculating income (pages 2246-47 (D.T.C. 15)):

[Translation]

It should be noted that the Supreme Court of Canada and Exchequer Court cases cited involved not only the replacement of part of a capital asset, the part replaced was a Capital asset of a substantial value in itself. That is not true in the instant case. I find it hard to compare the repair of part of a roof by adding a layer of tar to it, using the same gravel, with the replacement of engines, elevators or boilers in any unit. It is also not easy to compare the repair of six rows of bricks on a building, removal of posts which had become dangerous and demolition of chimneys that were no longer used with the replacement of about a hundred refrigerators and stoves which have a capital value in themselves.

The work done during the taxation years and made necessary by use and by weathering, though more extensive and costly, is of the same nature as the annual maintenance and repair work. The purpose of repairing the roof is to keep an already existing capital asset in good condition. In my view the cost of these repairs cannot change their nature.

However, one point made by Mr. Cardin places the taxpayer's position in jeopardy (page 2247 (D.T.C. 15)):

If one now compares costs, which is the third test, it is apparent that the expenses for repair work in the taxation years were considerably higher than the cost of repair work in the preceding years; however, not only are they of the same nature as the earlier expenses, they are reasonable if one considers an amount of $25,000 in repairs on buildings 25 years old, and the assessed value of which, known to be well below the market value, is about $500,000.

In Shabro Investments Ltd. the Chief Justice of the Federal Court of Appeal held at page 130 (D.T.C. 5108) that the replacement of flooring resting on the ground of a building by other flooring supported by steel beams or piles sunk into the ground “was a single operation whereby an improvement was made to the building that was essentially different in kind from a repair to the building as it originally was". This rule was adopted by Jerome, A.C.J. of the Federal Court in Gold Bar Developments Ltd. at page 264 (D.T.C. 5153):

I think it is more helpful to emphasize the purpose of the outlay by the taxpayer. What was in the mind of the taxpayer in formulating the decision to spend this money at this time? Was it to improve the capital asset, to make it different, to make it better? That kind of decision involves a very important elective component—a choice or option which is not present in the genuine repair crisis.

In all these decisions, the cases are ones in which the business was being operated. They are not, as in the instant case, situations involving a recent purchase.

The judgment of the English Court of Appeal (hearing civil cases) in Odeon Associated Theatres Ltd. v. Jones (Inspector of Taxes), [1972] 1 All E.R. 681, is useful in considering this situation. It involved a purchase of cinemas which had had no repair work done on them for many years. Despite this fact, the repair expenses were regarded as income-related. The cinemas were operated as cinemas before and after their purchase. Halsbury's Laws of England, 4th ed., vol. 23, comments on this judgment in chap. 322 as follows:

. . . the cost of deferred repairs to a newly-acquired cinema was held to be of a revenue nature since the expenditure was not required to make the asset commercially viable.

The head note in this case was as follows:

Held — (i) The money expended by the taxpayer company on the deferred repairs was laid out wholly and exclusively for the purposes of the taxpayer company's trade. ..

(ii) The expenditure was not capital expenditure . . . for the following reasons—

(a) the expenditure was by nature revenue and not capital expenditure and would have been deductible as such if the original owner of the cinema had remained the owner and had incurred it;

(b) as the commissioners had held that it was in accordance with established principles of sound commercial practice to charge the disputed items to revenue expenditure and not capital and as those principles in no way conflicted with any statute the court would, in the absence of any rule of law to the contrary, adopt and apply those principles in deciding the case;

(c) owing to the inability of the vendors, in common with all other owners, lawfully to execute the repairs in the period before acquisition, the purchase price of the cinema had in no way been affected by its disrepair at the date of acquisition;

(d) the cinema was a profit-earning asset at the date of its acquisition in spite of its disrepair and remained so for several years thereafter although no money was spent (or could be spent) on deferred repairs during some of those years;

(e) it had not been established that the taxpayer company had been put to any greater expense in the way of repairs and redecoration by reason of the deferred repairs than would have been the case if there had been no deferred repairs.

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 [1] and also I suppose the unforeseen scale of the costs.

In light of what I believe to be the principles applicable in the case of repairs and in light of the evidence, I consider that the expenses claimed for the work described by the contractor, except for the categories described, are expenses relating to work for the purpose of returning the apartment building to its regular use. I am inclined to think that the expenses for bathrooms are of a capital nature as their purpose was "to make it different, to make it better".

According to the municipal assessment made immediately after the repairs, the value of the building increased by $28,000. An amount very close to that of the repair expense was assigned to capital by the appellant. I thus do not feel I need to concern myself further with this aspect in my decision regarding the expenses at issue.

Were these expenses reasonable in the circumstances? Initially the appellant believed that renovating the building would cost him $25,000. The total cost to him was $110,000 (including the amount mentioned in the preceding paragraph) for a building bought at a cost of $80,000 with a gross rental income of not more than $30,000. However, as this argument was not raised in an alternative plea by the respondent and I have found that, with the exception of those mentioned above, the expenses were expenses which could be charged against income, I consider that I do not have to, and in fact cannot, without supporting evidence in this regard, determine the proportion reasonably attributable to income and so the part to be allocated to capital.

The appeal is allowed without costs in accordance with my above-stated conclusions and the assessment is referred back to the respondent for reconsideration and reassessment in accordance with these conclusions.

Appeal allowed in part.