Kay B. Whitmore v. Minister of National Revenue, [1990] 1 CTC 2145, 90 DTC 1018

Teskey, T.C.J.:—The appellant appeals his reassessments for 1983, 1984 and 1985.

Facts

The appellant, a businessman, purchased a 160-acre farm for $45,000 in the fall of 1966. He agrees that a fair breakdown of the purchase price is as follows:

Land — $41,000

Buildin —$ 4,000

The property was purchased with the intention of it being a rental property and not for recreational use.

The appellant was the sole director and shareholder of Baythmore Corporation Ltd. (Baythmore) which was in the management consulting business and was a personal service corporation. It had a good cash flow and earned the majority of the appellant's income at that time. His intention at the time of purchase was to hold title in his own name and to rent the property to Baythmore, which was to continue in the management consulting business as a personal service corporation to the appellant and to operate a beef farming operation on the farm property. The entire property was rented to Baythmore for the 1977 year at a rental of $2,400.

In 1978, the rent was substantially increased in anticipation of a steel barn being added. It was ordered in 1978 and erected in June of 1979 at a cost of $26,373.

The rental charged over the relevant times are as follows:

The cash profit or loss for those years is as follows:

The appellant’s calculation for payment of the purchase price of the property and the steel barn was based on the borrowing costs from the Toronto Dominion Bank at the time of purchase and at the time of ordering the steel barn. The rental payments would have paid in full the total investment in 13 years. A 13-year payback on a rental property is acceptable. The Court concludes from this that the rental was at least fair market if not in excess of fair market.

Unfortunately for the appellant, shortly after ordering the steel barn, interest rates started to creep up and rose to record heights thus throwing the operation of the property into a loss position. At the time of purchase the appellant was paying 10 per cent interest and by 1980—19.5 per cent and In 1981-24 per cent.

In spite of these increased rates of interest, at the end of 1982 the overall cash loss on the property was approximately $1,550 (i.e. taking his profit for 1977 and 1978 and deducting his 79-80-81 cash losses).

A second disaster fell upon the appellant to assist in sinking the profitability of the project in that the Income Tax Act (the 'Act") was amended in 1981 by introducing paragraph 18(1)(p) to take effect for taxation years commencing after November 12, 1981.

This amendment eliminated the benefit of the personal service corporation for the appellant in the year 1983. This is the reason the rent was drastically reduced in 1983 as the company simply did not have any money.

Faced with the double disaster of high interest rates and loss of income to Baythmore due to amendments to the Act, the appellant in 1982 realized he was in a very difficult situation. The property had gone from an income producing asset (upon which income tax was paid) to a losing asset. It was listed for sale in 1983, the farm operation ceased in the spring of 1984, no other tenant could be found and the property was finally sold in February 1985 for $58,500 gross, thus creating the terminal loss. Baythmore over the years 1977 through 1983 ran a farm business and did make a profit.

The appellant never lived on the property or used it for recreational purposes. After Baythmore vacated the property, the appellant tried unsuccessfully to rent the property and/or the farm to others. The appellant when asked about the lowering of the rent said:

Because of the raise in interest rates that affected both the corporation and myself. The corporation in those years could not pay any more rent.

and

Because the corporation could not afford to pay more rent.

and

Based on the idea that interest rates are going to go back down and that the years ahead are going to be very fruitful and very productive.

The appellant agreed with the statement:

Q. It was not able to pay so you charged it whatever it could afford?

A. That's right.

Respondent's Position

The respondent submits that this Court should;

(i) only look at the three years in question,

(ii) find that there was not a reasonable expectation of profit, since the rents

did not cover the appellant's expense in the years in question,

(iii) based on (i) and (ii) determine that the expenses were personal and were not proper deductions, and

(iv) determine that the terminal loss could not be written off due to subparagraph 40(2)(g)(iii) of the Act.

The respondent did not advance any argument under section 67 of the Act although pleaded and therefore the Court takes the position that this defence was abandoned at trial.

Appellant's Position

The appellant argues that the whole project in 1976 appeared to be a good viable business enterprise. The rents as established for the farm and new steel building would have paid off the appellant's total cost of the farm and steel building in a 13-year period. That two unforeseen outside extraneous events occurred due to no fault of his that upset the profit of the enterprise, namely the record breaking high interest rates and the amendment of the Act.

He says the enterprise obviously had a reasonable expectation of profit and invites the Court to look at years 1977 and 1978 when a profit was in fact made and income tax paid thereon.

He submits to the Court the hypothetical example of a businessman acquiring an eight suite apartment building in Elliott Lake just before the mine closed. He operates the same profitably for a period of time then, due to the mine closing, seven apartments became vacant, thus throwing the operation of the property from one of profitability into a loss and thereafter no reasonable expectation of profit. He argues he is in the same position and that in 1983 he tried to extricate himself from the problem but was unable to do so until early 1985.

Analysis

During argument, this Court was referred to several authorities, namely:

Scott v. M.N.R., [1984] C.T.C. 3040; 85 D.T.C. 1;

Skarja v. M.N.R., [1985] 2 C.T.C. 2104; 85 D.T.C. 477;

Saleem v. M.N.R., [1984] C.T.C. 2660; 84 D.T.C. 1579;

Trojanowski v. M.N.R., [1984] C.T.C. 2841; 84 D.T.C. 1705; Sandoz v. M.N.R., [1981] C.T.C. 2116; 81 D.T.C. 181.

All these cases dealt with a property scheme that never showed a profit, thus the Court had to decide if there had been a reasonable expectation of profit. In this case there was an actual profit for just the two years.

After the conclusion of all argument, it was agreed that the respondent would have an opportunity to submit written argument on the following point with the appellant having the right to submit a written reply.

— Assuming the Court found that at the time of the purchase of the property that there was a reasonable expectation of profit and it was only due to external forces beyond the appellant's control profit disappears and becomes an impossibility. What is the legal consequence?

The respondent had until September 30 to serve and file his argument and the appellant had five days to reply. I now have received the arguments on this point.

The Court finds that the appellant at the time of purchase had a reasonable expectation of profit from the rental of the property and in fact the property did produce taxable profit during the first two years and that it was only due to external forces beyond the appellant's control that the profit disappeared.

This Court was referred to Hibberd v. M.N.R., [1983] C.T.C. 2017; 83 D.T.C. 14. The appellant Hibberd never did make a profit but had a reasonable expectation of profit, which expectation was lost through external forces beyond his control. Mr. Hibberd admitted that his family preferred living on the farm property rather than in the city. The Court said in the right-hand column on page 2021 (D.T.C. 17):

The fact that there may have been a reasonable expectation of profit at one time cannot justify endless deduction of losses if circumstances have changed so that there is now no expectation that a profit will ever be realized.

The Board went on and categorized the expenses as personal and living expenses.

This Court is not satisfied that the principle enunciated in Hibberd, supra, applies to a business adventure that produces a profit then, through external forces, loses its profitability. Particularly in this case, if the interest rates had dropped back to their original level profit undoubtedly would have been obtained once again. The Court is satisfied that, on the facts of this case, the appellant’s timing in discontinuing the operation and selling the property was reasonable.

The Court was also referred to:

Laurence v. M.N.R., [1987] 1 C.T.C. 2234; 87 D.T.C. 173;

Shiewitz v. M.N.R., [1979] C.T.C. 2291; 79 D.T.C. 340;

Warden v. M.N.R., [1981] C.T.C. 2379; 81 D.T.C. 322;

Magee v. The Queen, [1987] 2 C.T.C. 17; 87 D.T.C. 5282;

Croutch v. M.N.R., [1986] 2 C.T.C. 246; 86 D.T.C. 6453.

These cases all deal with situations where a profit was never realized and therefore is of no help in this instance.

The respondent argued that to allow the appeal would be contrary to the principles laid down by the Supreme Court of Canada in Moldowan v. The Queen, [1978] 1 S.C.R. 480; [1977] C.T.C. 310; 77 D.T.C. 5213. There the sole issue before the Court was whether the farming business carried on by Moldowan was his chief source of income or whether it, in combination with another source, was his chief source of income. That is, was he entitled to deduct for tax purposes the entire amount of farming losses or was he restricted to the limited loss of $5,000 a year. The Minister therein had allowed the limited farm losses thereby conceding that there was a reasonable expectation of profit. Moldowan, as in this case, did have a small profit for two successive years.

Under all the circumstances of this case and having in mind all the principles laid down by Moldowan the Court is satisfied that the appellant's property was a viable rental operation that showed a profit and his decision to discontinue the operation and sell the property as well as the timing of the decision was reasonable.

Therefore the appeal is allowed, with costs, and the matter is referred back to the Minister for reconsideration and reassessment on the basis that the expenses were business expenses which could be written off against income and the appellant is allowed his terminal capital loss.

Appeal allowed.