Green v. R., [1997] 1 CTC 2668 (Informal Procedure)

Sarchuk J.T.C.C.: — The appeals of David Green (the Appellant) are from reassessments of income tax made in respect of his 1991 and 1992 taxation years. Pursuant to the provisions of subsection 18(1) of the Tax Court of Canada Act he has elected to have the informal procedure apply.

In computing income for those years the Appellant claimed rental losses from a property in the amounts of $8,553.25 and $10,190.28. In assessing the Appellant, the Minister of National Revenue (the Minister) disallowed the deduction of the losses on the basis that there was no reasonable expectation of profit from this venture and that in any event, certain of the expenses were unreasonable within the meaning of section 67 of the Income Tax Act (the Act).

The following facts are not in dispute. In 1988, the Appellant purchased a one-bedroom condominium located at North Miami Beach, Florida, (the property) for $33,000.00(US) ($41,020.00(Cdn.)). The full amount of the purchase price was financed by way of a mortgage placed on the Appellant’s principal residence. The property was rented on a short term basis, i.e. for the high season which usually ran from late December to the end of March. In the years 1989 to 1993 inclusive, the Appellant reported rental income, expenses (before capital cost allowance) and losses from the property as follows:

No figures are available for 1994 but it would appear from the Appellant’s testimony that they were similar to the income and expenses in 1993. The property was listed for sale in 1991 and was sold in 1995 at a profit of $10,000.00 (US).

Appellant's Testimony:

The Appellant is a salesman who over the years had been employed by a number of companies. In 1988 he turned 50 and was giving some thought toward a retirement plan. The following year, he secured a sales position with Rockwell International which provided him with a substantially larger income than that earned in previous years. These increased earnings provided him with added funds for investment and he began to consider a number of ventures which might provide a source of retirement income for him and his wife. To that end, he spoke to friends and acquaintances, including lawyers and accountants and concluded that the best approach was to purchase property which in due course, would produce income and be self-sustaining. Accordingly, he set out to purchase property which met the following criteria: it was located in upscale neighbourhoods to assure quality tenants; its operation would be predictable from a financial standpoint; and the time involvement would be minimal. In October, 1988 he purchased the property and retained a realtor to find tenants.

The purchase of the property followed discussions with a close friend who apparently owned units in the same building, and was one of the primary sources of information regarding rental rates and expenses. The Appellant says he anticipated rent in the range of $600.00 (US) per month for tenants leasing on a yearly basis and $1,000.00 to $1,100.00 (US) per month for the high season. He says the projected annual rentals on either basis together with the estimates made regarding expenses satisfied him that the purchase of the property was feasible and within his financial capabilities. The Appellant maintained that his projections with respect to income and expenses for the Florida property were well-founded and that unforeseen circumstances, particularly the loss of the Rockwell position in 1991, as well as the “recession and collapse of the real estate market” made the property difficult to sell. [2]

Pursuant to his “investment plan” the Etobicoke condominium, which was yet to be constructed, was purchased for $190,000.00 (Cdn.), by way of a 25% cash down payment with the balance of some $152,000.00 financed by way of first and second mortgages arranged by the builder. He was certain that the projected rental income was sufficient to carry the investment as structured and that no losses should be incurred. The unit was leased at all times from first occupancy in 1991 until its sale in 1996? [3] Substantial losses were incurred in all years.

To finance both properties, the Appellant obtained a mortgage on his principal residence which had appreciated substantially since its acquisition and could provide the necessary capital. He produced a “cash flow statement” [4] to demonstrate that his new position at Rockwell would provide sufficient disposable cash to enable him to pay down the bulk of the mortgage within five to seven years thereby making both properties profitable since the major expense, interest, would no longer be payable.

The Appellant relied on the decision of the Federal Court of Appeal in Tonn v. R. [5] and argued that he was being penalized by the Minister in circumstances where the purpose of the acquisition was commercial and this solely because he had made an error in judgment on the issue of financing and other expenses. This error, he said, coupled with the reduction in cash flow when Rockwell terminated his employment, undercut his plans and frustrated the otherwise reasonable projections for profitability. He contends that a determination by way of ministerial hindsight that a reasonable expectation of profit did not exist was wrong and not permissible.

Conclusion

The testimony of the Appellant as a whole was disquieting. It was generally facile and unconvincing, particularly with respect to the inquiries made in Florida and with regard to the discussions with his “friend” whose name he said he would not divulge. He alleges that written analyses were made with respect to costs, rentals and other factors prior to the acquisition but they were not produced. While he was able to file a number of other documents with respect to the acquisition and rental of the property, the Appellant says the analyses are no longer available. The Appellant also argued that the property was not acquired for use as a vacation property or for personal use, alleging that only “minimal use of a week or two each year was made” but that “the bulk of this time was in painting and decorating and making arrangements with the real estate agent”. His testimony regarding the “working trips” he and his wife took to Florida and with respect to the expenses incurred for that purpose was equally unconvincing.

The calculations the Appellant made in his “cash-flow statement" are difficult to follow and in any event do not support his repeated assertions that the additional Rockwell income was dedicated to paying down the mortgage. I note that although the Appellant, in 1989, 1990 and 1991, did earn substantially higher income, he failed to make a single additional payment towards the mortgage. His explanation for this lapse was, like much of the rest of his testimony, not particularly convincing.

I am satisfied that the acquisition of the property in Florida involved a personal element and accordingly, the “reasonable expectation of profit” test established by the Supreme Court in Moldowan v. R., (sub nom. Moldowan v. The Queen), [6] is applicable. While it is inappropriate for the Minister or the Court to substitute its business judgment for that of a taxpayer, it is the responsibility of such taxpayer to demonstrate that there are sufficient of the indicia of commerciality to justify the conclusion that there is a real commercial enterprise being conducted.’ [7] The evidence adduced by the Appellant regarding his arrangements fails to provide such indicia. I note first that

the substantial expenses and losses in comparison to the gross revenues are inconsistent with a genuine commercial operation. Although the Appellant has claimed that his losses stem from an error in judgment, in my view, nature and type of expenses claimed, the overestimate of the availability of tenants and the potential for rental, the disproportion between the resulting losses and the volume of business generated and the absence of any capital being committed all suggest that the “judgment” was so patently unreasonable as to entitle this Court to conclude that no real business was being conducted.

Furthermore, the circumstances strongly suggest a personal motivation existed. In such case, where the expectation of profit was so unreasonable, the taxpayer is generally called upon to justify objectively that the operation was in fact a business. This the Appellant has failed to do.

The appeals are dismissed.

Appeal dismissed.