Hall v. R., [1997] 1 CTC 2420 (Informal Procedure)

Teskey J.T.C.C.: — The Appellant, in her Notice of Appeal, wherein she appealed her assessments of income tax for the years 1991, 1992 and 1993, elected the informal procedure.

Issue

The Appellant in her Notice of Appeal stated that the issue to be decided was whether she had a reasonable expectation of profit from a basement apartment in her residence.

The Respondent in her Reply to the Notice of Appeal stated that the issues were:

a) whether the Appellant had a reasonable expectation of profit from the rental of the Property in the 1991, 1992 and 1993 taxation years;

b) whether the rental expenses were incurred by the Appellant for the purpose of gaining or producing income from a business or property; and

c) in the alternative, whether the disallowed rental expenses were reasonable in the circumstances.

The Minister of National Revenue (the “Minister”) in his Notice of Confirmation stated that:

The expenditures to the extent of $7,495.13, $9,210.00 and $6,906.39 in the 1991, 1992 and 1993 taxation years claimed as deductions from income as rental losses were not incurred by you for the purpose of gaining or producing income within the meaning of paragraph 18( l)(a) of the Act, but were personal or living expenses within the meaning of paragraph 18(1)(h) and subsection 248(1) of the Act.

Facts

Neither the Appellant nor the Respondent called any viva voce evidence.

It was admitted in the Reply that the Appellant, on December 27, 1990, purchased a bungalow located at 163 Belgiance Avenue, in Toronto, Ontario for the sum of $190,000 and that the purchase was financed with two mortgages totalling $170,000.

The following facts, reproduced in the Reply which were assumed by the Minister when he made his assessment of income tax, read:

a) from 1991 to 1993 the Appellant rented the basement apartment of the Property, allocating 52 per cent in 1991, and 50 per cent in 1992 and 1993 of the total expenses to the purported rental activity;

b) from 1991 to 1993 the Appellant reported rental income, expenses and losses from the propert as follows:

YEAR	INCOME	INTEREST		RENTAL PORTION	LOSS
			TOTAL
		EXPENSES	EXPENSES
1991	$5,674	$19,485	$25,198	52%-$13,169	$7,495
1992	$4,300	$22,152	$25,896	52%-$13,510	$9,210
1993	$4,475	$17,855	$22,762	50%-$11,381	$6,906

c) the rental income received by the Appellant in the 1991, 1992 and 1993 taxation year from the Property did not cover the interest expense;

d) the Appellant rented part of the Property to help defray the cost of maintaining her principal residence;

e) the Appellant had no reasonable expectation of profit from the rental of the Property during the 1991, 1992 and 1993 taxation years;

f) the rental expenses claimed were not made or incurred for the purpose of gaining or producing income from a business or property;

g) the rental expenses claimed were personal or living expenses of the Appellant.

Both counsel agreed that when the Respondent, as she did herein, pleads in the alternative that the onus of proof shifts to the Respondent in regards to the alternative. [1] As set out above, the Respondent pleaded to the Court in the alternative that the disallowed rental expenses were not reasonable in the circumstances and were prohibited by section 67 of the Income Tax Act (the “Act”).

Appellant’s position

The Appellant referred to the general limitation on deductions from income in paragraph 18( 1 )(a) of the Act which reads:

(1) In computing the income of a taxpayer from a business or property, no deduction shall be made in respect of

(a) an outlay or expense except to the extent that it was made or incurred by the taxpayer for the purpose of gaining or producing income from the business or property.

The Appellant then referred to the recent decision of the Federal Court of Appeal in Zonn v. R., [1996] 1 C.T.C. 205, 96 D.T.C. 6001, and in particular the prohibition of deductions that fit within the provisions of paragraph 18(1 )(h) which reads:

(h) personal or living expenses of the taxpayer, other than travelling expenses incurred by the taxpayer while away from home in the course of carrying on his business; ...

Subsection 248(1) defines personal or living expenses in part as:

“personal or living expenses” includes:

(a) the expenses of properties maintained by any person for the use or benefit of the taxpayer or any person connected with the taxpayer by blood relationship, marriage or adoption, and not maintained in connection with a business carried on for profit or with a reasonable expectation of profit,

Linden, J.A. said, at page 212 (D.T.C. 6005) in Tonn (supra):

Some legislative overlap is apparent here, when one compares paragraph 18(1 )(a) to paragraph 18( 1 )(h). Personal expenditures are impliedly excluded by the intention test of paragraph 18(1)(a), for they are external to the pursuit of profit; this makes paragraph 18(l)(h) somewhat redundant. Nevertheless, paragraph 18(l)(h) makes it abundantly clear that expenses incurred for personal purposes are not deductible. It differs, however, from paragraph 18(1)(a) in that its reference to “reasonable expectation of profit” contemplates an objective assessment of a business enterprise to determine whether any given expense was or was not of a personal nature. Such objectivity is not specifically mandated by either subsection 9(1) or paragraph 18(l)(a).

The Appellant then submitted that as a matter of law the Minister cannot allow any expenses unless there is a business. Thus the Minister is contradicting himself when he allowed some expenses and then pleads there was no reasonable expectation of profit or that they were not made or incurred for the purposes of gaining or producing income from a business or property.

The Appellant also submitted that reasonableness of expenses applies not only to the quantum but to the allocation thereof.

The Appellant’s position being that since the Minister allowed some expenses, namely up to the amount of the rental received, he must have acknowledged that there was a reasonable expectation of profit and that the expenses allowed were made for the purpose of gaining or producing income from property, and since the burden of proof on the question of reasonableness has shifted to the Respondent, and since there was no evidence adduced at the trial on the question of the reasonableness of the expenses, the appeal should be allowed.

Respondent’s Position

The Respondent submitted that no expenses were allowed and that the Minister used the simple mathematical expediency of deducting the excess expenses over the alleged income. He argued that there was no source of income within the wording of section 3 of the Act and since there was no source, there was no income. Thus, since there was no income, there were no expenses allowed.

Appellant's Reply to Respondent's Argument

The Minister has to include the rents as income because it is income from property.

Analysis

It is trite law to say that the Minister cannot tie my hands on a point of law by agreeing to a legal principle that in my opinion is in error. My authorities for this proposition is President Thorson’s decision in Goldman v. Minister of National Revenue, [1951] C.T.C. 241, 51 D.T.C. 519, were he said at page 248 (D.T.C. 523):

Once the facts have been established, the responsibility for determining the validity of the assessment as a matter of law is solely that of the court. It must decide the question according to the applicable law regardless of the submissions of the parties. [2]

and my colleague Bowman J.’s decision in L.I.U.N.A. Local 527 Members’ Training Trust Fund v. R., (sub nom. L.ILU.N.A. Local 527 Members' Training Trust Fund v. Canada) [1992] 2 C.T.C. 2410, 92 D.T.C. 2365, he said at page 2415 (D.T.C. 2369):

Parties cannot, however, make a judicial admission on a point of law, because “the Court may not be bound by error in an admission by the parties as to the law...

The legal principle that the Respondent agreed to herein is too broad an interpretation of the Federal Court-Trial Division decision of Tobias supra. Cattanach J. in Tobias was dealing with an assessment that was predicated on “the assumption that the project (therein) was one of a commercial nature”. The alternative position in Tobias was that to the exact contrary that the project was not of a commercial nature.

Herein, the Minister was dealing with a set of consistent facts and states that his assessment is correct for several different reasons.

The third issue raised as the alternative in the Reply is based on the same (undisputed) facts. I am satisfied that Tobias (supra) is only authority for the proposition that the onus shifts to the Respondent when he pleads in the alternative a complete contradiction of the original pleaded facts. [3] This is not the case herein and I am satisfied that the onus did not shift to the Respondent since the issues were already set forth in the Reply and a determination of the issues all rely on the same assumed facts.

The Appellant in her Notice of Appeal, as noted above, stated that the issue to be decided is whether she had a reasonable expectation of profit from the basement apartment. With both parties herein pleading that reasonable expectation of profit was an issue before the Court, the Appellant should not at trial disown that issue, without asking for an amendment to her Notice of Appeal. Herein, the Notice of Appeal was professionally prepared by her solicitor who is associated with a large law firm. Nevertheless, I expressly reject the Appellant’s proposition that the Minister in law by his assessment found that there was a reasonable expectation of profit.

While the word “assessment” can bear the construction, as being both the process by which tax is assessed or the product of the assessment, Hugessen, J.A. in Consumers’ Gas Co. v. R., (sub nom. Consumers’ Gas Co. Ltd. v. The Queen), (sub nom. R. v. Consumers’ Gas Co.) [1987] 1 C.T.C. 79, 87 D.T.C. 5008 held that the word “assessment” is in the second sense only.

The ultimate decision that I have to make is a question of whether the assessment of tax is correct. Herein the onus is on the Appellant to prove on a balance of probabilities that it is incorrect. [4]

As the Appellant called no evidence, the facts assumed by the Minister in making his assessment of tax stands.

Even if the Appellant’s position had been correct that the onus shifted to the Respondent, I would still have dismissed the appeal. Based on the facts assumed by the Minister in subparagraphs (a), (b) and (c) as reproduced above, it was open to me to find and I do so find, that expenses in the range of 2.3 to 3.1 times the income are not reasonable in the circumstances.

The position taken by the Respondent at trial that there was “no income” as there was no source is accepted.

The rental received in each year is revenue. Subsection 9(1) of the Act reads:

1. Subject to this part, a taxpayer’s income for a taxation year from a business or property is his profit therefrom for the year.

Thus although the Appellant had revenue in the taxation years in question, she had no income as a result of subsection 9(1). Paragraph 3(a) of the Act taxes income and reads:

The income of a taxpayer for a taxation year for the purposes of this Part is his income for the year determined by the following rules:

(a) determine the aggregate of amounts each of which is the taxpayer’s income for the year (other than a taxable capital gain from the disposition of a property) form a source inside or outside Canada, including, without restricting the generality of the foregoing, his income for the year from each office, employment, business and property;

The reasons of Linden, J.A. in Tonn (supra) are most helpful and in particular wherein he said at pages 209-10 (D.T.C. 6004):

This case is the latest in a procession of similar cases using the reasonable expectation of profit test to assess whether a claimed business loss is an allowable deduction from other income. The jurisprudence, though substantial, is sometimes confusing. Cases like the present involve difficult factual and legal considerations. Not the least of these difficulties is that, for circumstances like the present, no fewer than five possible tests for expense deductibility - four of a statutory and one of a common law origin...

The scheme adopted by the Income Tax Act taxes income according to source. Various revenue-generating activities are defined by the Act as distinct income sources, and computation rules specific to those sources are set out accordingly. Four such sources are contemplated: income from employment, business, property and capital gains income...

The deduction rules for the property and business income sources are found substantially in sections 9 and 18 through 21. Four of these provisions are relevant to assessing the expenses presently before us, with each furnishing its own test for deductibility: they are subsection 9(1), paragraph 18(l)(a), paragraph 18(1 )(h), and subparagraph 20(l)(c)(i).

And at page 212 (D.T.C. 6005):

In other words, the expense must have been incurred within a business framework, bearing some relation to the income earning process...

And at page 214 (D.T.C. 6006):

In addition to these overlapping legislative provisions, each of which outlines a deductibility test applicable to the present circumstances, one must also consider the common law Moldowan test, which requires a “reasonable expectation of profit”.

And at page 216 (D.T.C. 6007), wherein he referred to a decision of Dickson J. Dorfman v. Minister of National Revenue, [1972] C.T.C. 151, 72 D.T.C. 6131 (F.C.T.D.):

I cannot accept the interpretation put by counsel for the Minister in this case on the words “source of income”: that there must be net income before there can be a source. In my view the words are used in the sense of a business, employment, or property from which a net profit might reasonably be expected to come.

And at pages 216-17 (D.T.C. 6008):

...A taxpayer’s intention to produce profit normally has to be reasonable before a Court will accept it. There is some difference of meaning and interrelationship between subjective and objective, however, lacobucci, J. attested to this in Symes where he stated the following concerning business intention within paragraph 18(l)(a):

As in other areas of law where purpose or intention behind actions is to be ascertained, it must not be supposed that in responding to this question, courts will by [sic] guided only by a taxpayer’s statements, ex post facto or otherwise, as to the subjective purpose of a particular expenditure. Courts will, instead, look for objective manifestations of purpose, and purpose is ultimately a question of fact to be decided with due regard for all of the circumstances.

And at pages 218-20 (D.T.C. 6009):

Whatever the particular circumstances, transactions contrary to the purposes of the Act are generally those where the underlying aim is inappropriate tax avoidance. The attempt to deduct the costs of what are essentially hobby or personal expenses as a business expense is one good example. As common sense might suggest, the Act’s fundamental purposes are not easily construed as contemplating such tax avoidance. It is, I believe, in this spirit that Dickson, J. penned the Moldowan test.

It seems to me that for most cases where the department desires to challenge the reasonableness of a taxpayer’s transactions, they need simply refer to section 67. This section provides that an expense may be deducted only to the extent that it is reasonable in the circumstances. They need not resort to the more heavy-handed Moldowan test. In fact, in many cases, resorting to section 67 may well be more appropriate...

The Moldowan test, therefore is a useful tool by which the taxinappropriateness of an activity may be reasonably inferred when other, more direct form of evidence are lacking.

And at page 224 (D.T.C. 6012):

The primary use of Moldowan as an objective test, therefore, is the prevention of inappropriate reductions in tax;

And lastly at page 225 (D.T.C. 6013):

.. where circumstances suggest that a personal or other-than- business motivation existed, or where the expectation of profit was so unreasonable as to raise a suspicion, the taxpayer will be called upon to justify objectively that the operation was in fact a business. Suspicious circumstances, therefore, will more often lead to closer scrutiny than those that are in no way suspect.

and after discussing the relevant factors to be considered, he went to say at page 226:

These quotations suggest that the list of relevant factors is growing and that it may continue to grow. What this indicates is that a detailed look at the business in the context of its operations is what is required, and that reasonableness is to be assessed on the basis of all the relevant factors, both the already listed ones and any new ones that may be helpful.

For these reasons, the appeal is dismissed.

Appeal dismissed.