Jean Méthé v. Minister of National Revenue, [1986] 1 CTC 2493, 86 DTC 1360

Taylor, T.C.l.: This is an appeal heard in Montreal, Quebec, on february 25, 1986, against an income tax assessment for the year 1981, in which the Minister of National Revenue disallowed a major portion of a claim for a rental loss made by the appellant from a residential building. The essence of the point at issue before the Court was that Mr. Méthé had included in the rental statement he filed an amount of $65,425.13 for “repairs and maintenance”, whereas the Minister allowed only $25,000 of this as a current expense, the balance to be treated by the Minister as “capital”. Certain other minor factors entered into the hearing but it was clear that the determination of this point — the characterization of the $65,425.13 as capital or income, was the crux of the dispute and the Court indicated to the parties that this would be the sole focus of the decision. The hearing was conducted in the French language, but almost all the referenced jurisprudence was in English and after discussion with the parties, it was indicated that the decision would be made available to the parties in both languages.

In 1980, Mr. Méthé acquired an old building for $38,000, which over the course of approximately the next two years he renovated. The building had been constructed about 1925, and contained six apartments. He himself had lived there for many years, and four of the other apartments were also occupied by long-term tenants when he purchased the property. The one vacant apartment had only been that way a short period of time. The property was on a main corner in the City of Quebec and had three above- ground storeys, plus a half-basement. Except for one small corner of the foundation, it was structurally sound. Mr. Méthé had a general knowledge of construction, and had a good idea of what he would be required to do in the renovations. He employed a general contractor, and skilled workmen, as well as doing much of the simpler work himself. The building was simply not “patched up” or “plastered over” in order to provide a better looking property. It was a complete job. The outside of the building was in good condition, and was left virtually untouched. A detailed list of the type of renovations done totalling $144,640.80 (Exhibit A-2) was presented — but this covered the entire work which extended into the year 1982. The appellant did not provide separate information dividing this amount between 1981 and 1982. However other information provided in the appellant’s 1981 income tax return showed that about $106,615 had been incurred in the year 1981 (the $65,425.13 noted above and about $41,190 which the appellant reported in his 1981 tax return as on capital account). The gross rental revenue of the building before 1980 had been only a few thousand dollars ($2,240 for the four months it was owned by the appellant), but the rent increased dramatically so that by 1984, the gross revenue was over $21,000 per year. Mr. Méthé depended very much on his understanding of the Information Brochure regarding Rental Revenue provided by the Department of National Revenue, and in particular the following portion thereof:

Capital vs current expenses

Expenses you incur to restore your property to its original condition are considered “current expenses*'. For instance, if the roof leaks and you have it patched or replaced with the same quality of roofing material, this is a current expense.

But expenses you incur to improve your property beyond its original condition are regarded as “capital expenses.” For example, if the roof leaks and you replace it with one which is of better quality and greater durability than the old roof, this is considered a capital expense.

If, in fixing up your property, you incur both current and capital expenses, you must identify each expense and allocate it accordingly on your tax return. If only a small portion of the expenses are capital in nature, the Department will allow you to treat the entire amount as a current expense.

As he explained it, Mr. Méthé had determined that when he replaced items — e.g. doors, windows, floors, plumbing, etc. with other items of similar quality, that was a current expense. He had arrived at his total of some $41,190 “capital" (supra) by considering that the amounts of which this consisted were of “superior" quality or of great durability.

For record purposes I would provide the list of jurisprudence upon which counsel for the appellant made his very able and concise argument.

Weller v. M.N.R., 2 Tax A.B.C. 188; 50 D.T.C. 303;

Levinter v. M.N.R., 5 Tax A.B.C. 75; 51 D.T.C. 359;

Oakdale v. M.N.R., 10 Tax A.B.C. 326; 54 D.T.C. 229;

English Estate v. M.N.R., 14 Tax A.B.C. 225; 56 D.T.C. 18;

Rosenberg v. M.N.R., 27 Tax A.B.C. 348; 61 D.T.C. 546;

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

Dube v. M.N.R., [1979] C.T.C. 2241; 79 D.T.C. 10.

He particularly stressed the point that the reason the repairs had been so extensive is that they had been long delayed, but that the jurisprudence indicated that the nature and not the cost of the expense was the important factor. By far the greater part of the disputed expenses did not increase the value of the building in the view of counsel, they really only brought it up to a proper level for both appearance and usefulness. Counsel reflected on the various assumptions of fact provided by the Minister in the Reply to Notice of Appeal, and indicated that several of them had been shown by the appellant at the hearing to be either incorrect or irrelevant. It was counsel’s conclusion that the appellant had established that the criteria for “capital” expenditures exhibited by the jurisprudence noted above were not present in the instant case, and therefore the Minister’s assumptions had been overturned. It was not the burden of the appellant to prove that the expenses at issue were deductible, only to show that they should not be classed as capital, according to counsel.

Conversely counsel for the Minister pointed out that it was the responsibility of the appellant to show that the disputed expenses should bc termed as current, rather than capital, and that the efforts of Mr. Méthé had fallen short of that. The Court did not have a basis upon which to determine which specific item (if any) of the disputed expenses, properly could be considered as “current”. The Minister's assessment, according to counsel, should stand and the disputed amount was not “lost” to the appellant, its deductibility on capital account would merely be spread out over many years as opposed to claiming it in one year.

First, the Court will take the responsibility for limiting the issue, in a sense, to one of principle, as opposed to one of detailed accounting for the various and sundry items contained in the totals shown above. It is clear that the Minister allowed a “blanket” amount of $25,000 as current expenses for the year 1981, out of the total of some $106,000 applicable to that year, and I do not regard it as the Court's function to re-examine all data, and reassess penny by penny. Whether the $25,000 was an exactly appropriate amount or not, even a most detailed examination of each individual receipt or voucher might not determine — and in matters of this kind, it may well be that some discretion must be left to the Minister (See Stephen Coleman v. M.N.R., [1984] C.T.C. 2725; 84 D.T.C. 1637 and Audrey B. Wager v. M.N.R., [1985] 1 C.T.C. 2208; 85 D.T.C. 222). l have no doubt that the expenditures incurred in the repairs and renovations of the building needed to be done, and were done economically and conscientiously by the appellant, with no motive other than to provide a good substantial rental property for his tenants and himself. There is no suggestion at all that he was extravagant, or that he undertook a task beyond his capability or resources, and is now seeking some external “post facto” relief. Mr. Méthé, in my view, believes that he tried to follow the guidelines available to him in apportioning the great cost of this exercise, and that he is entitled to the “first year” loss which resulted. As a matter of interest, Mr. Méthé's other income in 1981 was about $43,000, and accordingly with the “rental loss” which resulted from this substantial “repair and maintenance’ charge at issue, he ended up with a very large negative net taxable income — hardly a result which would have been pre-planned. Leaving that aside, however, Mr. Méthé’s problem at the hearing is indeed — as counsel for the respondent asserted — to prove to the Court that the expenses incurred do not have characteristics identifiable with capital expenditures and that they should be classified as on Current account.

The hearing has clearly shown that the building was in need of great rehabilitation — hence the $144,640 spent on it. And there could hardly be any question that some part of that was the result of neglect or delay in earlier years — a maintenance situation. I would also agree that merely doing the direly needed maintenance on this building, whatever that might have cost, could have been a completely uneconomical, perhaps impossible, task. However the simple and salient fact is that Mr. Méthé purchased an old building for $38,000 — which was still habitable, in fact inhabited regularly and continuously and then proceeded to spend some $144,000 additionally on it. Initially he did characterize some $41,190 spent during 1981 as on capital account. But in my view, when Mr. Méthé finally finished his work by the year 1982, he did not have the same old building at all that he started with. He had virtually a new building, at least certainly a quite different building. Nothing could more demonstrate that fact, than the revenue results increasing rapidly to some $21,000. I cannot take responsibility for whatever perception of his task Mr. Méthé gained from his reading of the relevant Information Brochure (supra). I can only point out that the replacement of one item (a door, a window, a floor, etc.) which normally “might be repairs’, when done within the context of an entire renovation project may very readily lead into the capital expenditure world as contrasted with the current expenditure environment. I would quote from page 2210 (D.T.C. 224) of Wager (supra):

. . . Therefore, as I see it, the nature of an individual expenditure itself may not, be, in circumstances such as this case, the sole criterion upon which the distinction is made. Clearly a replaced “door” can be a repair, but it also can be a capital expenditure in circumstances where the general overview of that accomplished by all the repairs is a total reconstruction or rehabilitation of the structure. The Minister, in assessing, is entitled to take an overview of the entire expenditure program, and it may almost be necessary, on some occasions, that the breakdown oe done somewhat arbitrarily between "current" and "capital". I am not aware of jurisprudence which would mandate for the Minister a course of accepting any or all individual items of expenditures as "current" rather than viewing some of those expenditures as on the same continuum as the original capital asset purchase, leading toward 4 completion of that capital expenditure program.

In the instant appeal, Mr. Méthé, at least in part may have brought the building up to modern standards, and to current residential requirements and demands, from the viewpoint of appearance, utility and safety. That is not simply doing ordinary repairs and maintenance resulting from day to day usage, no matter for how long repairs had been delayed. Perhaps he could not (under today’s circumstances) replace “piece for piece the building, and even if he could have done so, it would have been a completely uneconomical thing to do, resulting in little or no hope of adequately increasing rental revenue. Clearly for some of the expenditure Mr. Méthé was governed by zoning, building and construction requirements, which he was required to meet. In effect, once having taken on the task, a major part of its progress was out of his hands. Certainly his intention — and a laudable one at that — whether voluntarily or under some duress, was to transform the building from a poor investment property into a good one. And that he did. But in the course of so doing he did much more than mere repairs and maintenance. However one might have described the asset he acquired for $38,000, it is evident that now he has a property of some durability and of an enduring nature, with a recognizable revenueearning potential, indeed perhaps even a substantial resale value.

There is a second aspect to this situation which might stand comments. Whether during its history before 1980, this building had been "depreciated” for income tax purposes, was not discussed at the hearing, but as a rental property it was eligible for such treatment. The "capital cost allowance” charge permitted for income tax purposes, is not merely some intangible accounting concept designed for the reduction of income tax. It does have a relationship to obsolescence and deterioration. The "reserve for depreciation” which arises from the charge again is not merely an illusion — It is real, and in broad terms may be described as a liability. Without any attempt to put too strict technical definitions upon this "reserve”, it can at least be regarded as foreseeing the prospect of eventual replacement of the capital asset to which it is related. There is no requirement that the “depreciation reserve” be physically represented by some form of cash or tangible "reserve fund”, and that situation may play some part in the uncertainty with which this taxpayer views: the renovation task he undertook. Had such a "cash reserve fund” relating to prior depreciation charges been in existence at the time of his purchase of the building, it would have been, at least, the subject of discussion between vendor and purchaser. That such a “cash reserve fund” did not exist, but rather only the concept of the "depreciation reserve” does not minimize the Minister’s proper interest in the eventual renovation, in fact, restoration, of the asset involved. Certainly I do not advocate the return to some form of “depreciation reserve fund” method of dealing with the situation, but it might be noted that a very similar kind of procedure is now mandated in most “condominium” situations, for major repairs and replacements, and one can assume that the physical retention of funds dedicated for specific purposes does have the effect of maintaining for all interested parties — particularly the owners — the real nature and impact of obsolescence and deterioration, whether or not related to or affected by delay in regular repairs and maintenance.

In summary, I am satisfied that the 1925 building at issue could not simply be “repaired” up to the standards either desired by Mr. Méthé, or demanded by contemporary use. The Minister has allowed a “repairs and maintenance” expenditure of $25,000 on a building acquired for $38,000, and I have not been persuaded that an adjustment beyond that is warranted.

The appeal is dismissed.

Appeal dismissed.