Rossi v. R., [1997] 2 CTC 2033

Taylor T.CJ.:

This is an appeal heard in Toronto, Ontario on December 2, 1996, against assessments for the years 1991, 1992 and 1993, disallowing claims for “rental losses” in the amounts of $3,255.00, $4,424.00, $3,419.00 respectively.

The Notice of Appeal read:

At the time of purchase, our projected revenues would have covered the operating expenses, albeit by a slim margin.

Our projected increases in rental income of approximately 5% per annum would have realized a net profit.

At the time of purchase, our intention was to sell the property in three years, realizing a capital gain.

As a result of unforeseen economic circumstances, we were forced to lower the amount of rent charged; it became more difficult to find suitable tenants we were forced to hold the property for a longer period of time than we had anticipated.

It is our position, that our expectation at the time of purchase, that profit was not unreasonable and does indeed fall within the meaning of Section 18(1) of the Canadian Income Tax Act.

In the Reply to Notice of Appeal, the Respondent stated:

(a) in June 1989, the Appellant, his sister and his brother-in-law purchased 659 Main Street East in Hamilton, Ontario (the “Property”);

(b) in the 1991, 1992 and 1993 taxation years, the Appellant reported rental income, expenses and losses as per Schedules “A”, attached;

(c) in the 1989 and 1990 taxation years, the Appellant claimed rental losses total of $6,684.00 and $3,988.00, respectively of which his 50% share was $1,671.00 and $1,994.00;

(d) the rent charged was not sufficient to offset the fixed operating expenses (mortgage interest and property taxes) of the Property;

(e) the Appellant did not have a reasonable expectation of profit from renting the Property during the 1991, 1992 and 1993 taxation years;

(f) the rental expenses were personal or living expenses of the Appellant.

6. The issue is whether the Appellant had a reasonable expectation of profit from renting the Property in the 1991, 1992 and 1993 taxation years.

7. He (the Respondent) relies on sections 9 and 67, subsection 248(1) and paragraphs 18(l)(a) and 18(l)(h), of the Income Tax Act (the “Act”) as amended for the 1991, 1992 and 1993 taxation years.

The Appellant reviewed the history of his entry into the “real estate rental” field, the location and condition of the property, the difficulties with rentals and evictions, as well as the damages done, the change in economic conditions, and the final decision to sell in 1993, which sale did not materialize for two or three years, during which losses continued. The Notice of Appeal itself set out that the Appellant’s intention and belief was he could make a profit - and I assume that by “operating expenses” he means to include interest costs. He had difficulty at the trial to set out the basis upon which such an original hope (for profit) had been founded, other than com- paritive rents and the experience of friends. He agreed that if losses were generated, he and his partners would be expected to provide additional contributions, which they did. His best information on the “business” prospects of the operation was that starting rents had been about $1,350.00 per month

- and were “sufficient to make the monthly mortgage payments”. Other costs had not been expected to be excessive. He stressed the impact of the “unexpected economic circumstances” which at least aggravated the difficulty of getting the operation going properly. He also did note the hope for a “capital gain”, but he did not stress that aspect too much. In fact, in the end the venture showed a loss on disposition as I understand it.

Counsel for the Respondent referred to the signal case of Moldowan v. R., (sub nom. Moldowan v. Minister of National Revenue) [1978] 1 S.C.R. 480, [1977] C.T.C. 310, 77 D.T.C. 5213 and Tonn v. R., [1996] 1 C.T.C. 205, 96 D.T.C. 6001 (F.C.A.). It was her view that the facts and the Appellant’s testimony demonstrated that their had not been “a reasonable expectation of profit” i.e. a source of income as highlighted in Moldowan (supra) and referenced in Tonn (supra). She agreed that the “personal element”, as that arises in Tonn (supra) particularly for any personal occupancy of the building or part of it did not exist here. Further it had been purchased as an investment - but did not deserve the appellation “commercial venture”, again, since there was no demonstrated “reasonable expectation of profit”. Her comment that these “rental losses” claimed were “personal expenses” nevertheless, was questioned by the Court, and she provided the standard explanation that since they were not “business” (by her definition) they were indeed “personal” by virtue of section 18(l)(h) of the Act. Counsel particularly referred to a quotation from Tonn (supra) to be found at page 225 (D.T.C. 6013) thereof as the critical position for the Court to take in this case:

Though I do not support the use in the Nichol case of the word “patently”; I otherwise agree that the Moldowan test should be applied sparingly where a taxpayer’s “business judgment” is involved, where no personal element is in evidence, and where the extent of the deductions claimed are not on their face questionable. However, 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.

Counsel for the Respondent did not bring into issue the taxpayer’s “business judgment” except in the most oblique way, and no effort was made by the Respondent to argue that deductions claimed were “questionable” - at least as I understand that term has been used in Tonn (supra). In Tonn (supra) the very fact that the costs immediately exceeded revenue did not appear to the learned Justics to be “questionable” in the circumstances.

Analysis

The documents, testimony and evidence from the Appellant left considerable doubt in my mind that from the start he felt assured that a profit could be generated from the operation. Paragraph 5(c) of the Reply to Notice of Appeal, shows clearly that losses started immediately, even in the two years before those years under appeal (the reference to this Appellant’s share of the losses in 1989 (50%) should be $3,342.00 rather than $1,671.00 apparently but that is not material). Counsel for the Respondent concentrated on this lack of support for this as a “rental operation”, as evidenced by the record of losses sustained. The identification by the Respondent of the expenses which produced the alleged “rental losses” at issue, as “personal expenses”, is not too different from the comment in the judgment in Tonn v. R., (sub nom. Tonn v. Canada) [1995] 2 C.T.C. 2979 (D), 96 D.T.C. 1806 at page D.T.C. 1807 at the Tax Court level of the appeal:

[...] The simple fact is there are only two categories in which Revenue Canada has available to put expenses that are spent by taxpayers and that is first, some form of business or investment, or second, personal or living. Personal or living means absolutely nothing specific in that section, it just means the category that Revenue Canada does not consider to have been demonstrated to have been a business.

While there are many areas of the Tonn (supra) judgment from the Federal Court of Appeal which are still being examined and reviewed, it seems to me that the learned Justices at least put this particular stark perspective - “if not business, it is personal” into question, although according to Counsel in this matter it appears to arise out of Moldowan (supra).

I understand Counsel putting it forward since it is based on the onus of responsibility on the taxpayer - Appellant. Simply put, Counsel suggests - if the taxpayer claims a “business” loss (rental loss in this case) then it is for the taxpayer at the appeal stage to demonstrate the inherent elements of a business structure, particularly a “reasonable expectation of profit”. Failing that, it may be assumed by the courts that the expenditures at issue were made for some “personal use or benefit”. I have expressed some reservations in Joseph v. R., [1996] 2 C.T.C. 2388 (T.C.C.) about departing too abruptly from this maxim (which I repeat it is asserted arises from Moldowan (supra)). Nevertheless it is the wisdom in Tonn (supra) that must be taken into account in this matter by this Court, and I fail to see how Counsel for the Respondent can simply allocate the phrase “personal expenses” to the losses claimed here, and thereby skirt what appears to be an essential feature of the Tonn (supra) decision. Leaving aside any other merits of Counsel’s argument, the contention of the Appellant in this particular case that he is entitled to the rental losses claimed, cannot be set aside merely on the grounds that the expenses were “personal. The phrase “for the use or benefit of the taxpayer” has not been demonstrated to exist of this matter - I fail to see what possible use or even benefit he attained. In fact, if this Appellant’s basic premise (that he expected a profit - or at least not a loss) is to be given any weight, then he has been disadvantaged by further required contributions. If it is not to be a prerequisite for a taxpayer to demonstrate the “source of income”, as may be read into Tonn (supra) then it is equally the case that the Respondent cannot simply inpute a “personal element” where none exists or can be shown. Where a “personal element” (primarily use or occupancy by the taxpayer) does exist, I have no hesitation in regarding this as a formidable obstacle to be overcome by the Appellant, Sardinha v. R. (November 29, 1996), Doc. 96-860(IT)I (T.C.C.), and I have always done so.

I will not review all of the factual aspects of this case as it can be compared to Tonn (supra), but simply state that the similarities are striking, while I note the two differences - that the years 1989 and 1990 have not been reassessed (they are probably in the statute-barred category), and the value of those claimed losses remains with the taxpayer; and second that in this appeal, the prospect of “capital gain” was raised directly. This Appellant did not raise the issue of so-called “start-up costs” and I need not deal with it, except to again make reference to comments on that point in Sardinha (supra). The Appellant feels entitled to the same treatment accorded the Appellants in Tonn (supra) and I relate that to a particular phrase in Zonn (supra) at page 229 (D.T.C. 6015):

The evidence clearly showed that the taxpayers engaged themselves in a business enterprise and their expectations of profit were not unreasonable in the circumstances.

While not precisely worded as “a reasonable expectation of profit” by the learned Justices, I must assume that the above expression sufficiently satisfied the same purpose for them, in Tonn (supra) and should have some application here.

Turning then to the “capital gain” hope raised by the Appellant in the Notice of Appeal, I would only add that in Tonn (supra) the learned Justices did not find that kind of expectation, when the taxpayers regarded real estate as a good investment, to be unwarranted, or decisive against the appeal. Counsel for the Respondent did not press this aspect of the case strenuously, and I comment no further on that point here.

While perhaps regarded by the Respondent as of dubious merit, this appeal appears to me to fit into the parameters outlined in Tonn (supra). Even though in other circumstances I have expressed my own reservations and cautions about the absolute applicability of Tonn (supra). Certainly, it is quite clear from Tonn (supra) that merely sustaining losses should not be the decisive factor in the determination. The basic proposition of the Appellant that there was a reasonable expectation of profit has not been seriously diminished; the Appellant’s position in the matter is not tainted by any “personal element”; and the potential “capital gain” contention has not been shown to have a negative bearing on the appeal.

The appeal is allowed.

Appeal allowed.

Revenue (1995), 90 F.T.R. 97n and I note that Justice Linden, who wrote the Tonn (supra) judgment, commented in Coad (supra) as follows:

In applying Moldowan, it is not whether profit is earned, but whether it could reasonably be earned. As long as the business has a reasonable chance of earning profit in the year or in the near future, the interest is deductible, whether or not there actually was a profit earned in a given taxation year. That is the lesson of the Tonn case, which only seeks to restate and clarify the application of the principle of Moldowan. Thus, where as here, if no profit is possible in the year or in the near future, no deduction can be allowed (at least as long as Moldowan continues to govern cases such as these).

Whether I might have viewed this appeal somewhat differently, had Counsel for the Respondent brought Coad (supra) to my attention, giving me a reasonable opportunity to re-examine Tonn (supra), I do not know. However I will certainly be taking Coad (supra) into consideration in future cases, and I recognize Justice Linden’s clarification of the use of Moldowan (supra).