Hubbert v. R., [1998] 3 CTC 2111, 98 DTC 1726

Sarchuk T.C.J.:

These are appeals by John Douglas Hubbert (the Appellant) from assessments of tax with respect to his 1989, 1991 and 1992 taxation years. In computing income for the 1989 taxation year, the Appellant failed to report the gain realized in the amount of $90,893 from the disposition of a property located at 5 Concorde Place, Unit 1601, North York, Ontario (the property). In computing income for the 1991 and 1992 taxation years, the Appellant deducted the amounts of $11,400 and $9,600, respectively, as carrying charges and claimed rental losses in the amounts of $2,092 and $1,377, respectively.

In reassessing the Appellant for the 1989 taxation year, the Minister of National Revenue (the Minister) treated the sale of the property as being on income account and included the gain realized in the Appellant’s income. With respect to 1991 and 1992, the amounts deducted as carrying charges and rental losses were disallowed by the Minister.

The Concorde Property Sale

In 1985, the Appellant, a mechanical engineer, was approached by Teron Developments to act as consulting engineer for the design of a residential condominium project. His company tendered a proposal and was awarded the contract. In 1986, just prior to the commencement of construction, the Appellant decided to purchase one of the units. The purchase price was $179,107 of which $159,107 was financed by way of a vendor take back mortgage.

The Appellant’s unit was to be ready for occupancy in December 1988. In September of that year, the project was substantially completed, the first occupants began to move in and it became apparent to the him that they were predominately of Asian origin. He says that following discussions with his wife, it was decided they did not want to live there as part of a “minority group”. As a result, he spoke to the developer’s sales manager and sought a release from his obligations under the Agreement of Purchase and Sale. When that was not forthcoming, he immediately retained a Chinese real estate agent recommended by the manager and listed his unit for sale. On January 3, 1989, the Appellant received and accepted an offer for the condominium with occupancy to be taken by the purchasers on April 1, 1989 (Exhibits A-2 and A-3). The sale price was $270,000 plus the accrued interest on the original deposit of $15,000.

The Appellant asserts that his sole purpose in acquiring the property was as a principal residence. It was, he said, a good area, close to the neighbourhood in which he grew up. It had features he sought such as a pool, spa and exercise facilities. As well, because of his relationship with the developer, he was able to buy a second parking stall and have both located side by side in a preferred location. He maintains that he did not have resale in his mind at the time of acquisition.

I am unable to accept the Appellant’s assertions. An examination of the Appellant’s personal and business circumstances at the time of acquisition discloses the following. He had been previously involved in new condominium projects and had contracts with at least three such large developers. He was aware of their practice with respect to “predevelopment” sales and understood the value of such a purchase in a rising real estate market. Indeed, he made reference to advice received from a Teron employee (Wyatt) to the effect that the predevelopment price available to him was a good deal and that “prices would probably go up”. It is also logical to infer that given his relationship with the developer, the Appellant was aware of how Teron’s sales had gone and what the market value of the units was in December 1988. Last, the Appellant knew that the high interest rates of the early 1980s had come down and agreed that the real estate market had “just started to go up about a year earlier”.

On the other hand, the reasons advanced by the Appellant for the eventual abandonment of his stated intention were not convincing. He testified that he was so certain that he did not want to live in this unit that he sought to extricate himself from his obligation to the developer. In cross-examination, the following exchange took place:

Q. Now, and you have suggested that you saw this as being a big problem?

A. I went to the sales manager for the Concorde Court property and asked him, this fellow’s name was Al Decastro, and asked him if there was a way to get out of this particular deal and let them sell it to somebody else.

Q. So you were willing to walk away from the unit and have them take it over?

A. Absolutely, absolutely.

Q. I would suggest that that is a little bit hard to believe, given the fact that you had an agreement to buy the unit for 170,000 and yet apparently its market price was 270,000, so you had $100,000 of profit there, yet you were willing to just let the developer take the unit and sell it for whatever they could get for it?

A. Absolutely, “Give me my money back and let me go”.

I find his assertions most difficult to accept. The Appellant’s explanation that he did not wish to burden himself with additional carrying costs! [1] of an empty unit is simply not credible given the nature of the market at that time. Furthermore, if he truly intended this unit to be his principal residence, one could expect to hear some testimony regarding any plans for his current residence, but there was not a tittle of evidence adduced in this regard. It also strikes me that if such an offer had been made to Teron Development, it is unlikely that the sales manager (who undoubtedly was aware that the market value of the unit was almost $100,000 more than the preconstruction price) would have rejected an opportunity to make an additional profit for his employer.

On balance, I am unable to accept the Appellant’s stated intention with respect to the property in issue. As was observed in Racine v. Minister of National Revenue,? [2]

...Generally speaking, a decision that such a motivation exists will have to be based on inferences flowing from circumstances surrounding the transaction rather than on direct evidence of what the purchaser had in mind.

The inferences which can be drawn from the evidence before me all point to the conclusion that the primary, if not the sole, intention of the Appellant in purchasing the property was for resale at a profit.

Had I concluded otherwise and found that the gain realized upon the disposition of the property was on capital account, I would have in any event found that the capital gain in the amount of $90,893 was properly included in the computation of the Appellant’s income for his 1989 taxation year. Subsection 110.6(6) of the Income Tax Act (the Act) provides in part:

110.6(6)

Failure to report capital gain. Notwithstanding subsections (2)(2.1) and (3), where an individual has a capital gain for a taxation year from the disposition of a capital property and knowingly or under circumstances amounting to gross negligence

(b) fails to report the capital gain in his return of income for the year required to be filed pursuant to section 150,

no amount may be deducted under this section in respect of the capital gain in computing his taxable income for that or any subsequent taxation year and the burden of establishing the facts justifying the denial of such amount under this section is on the Minister.

I am satisfied that the Minister has met the onus.

The Appellant testified that he had no idea why the capital gain had been “left off the tax return”. He testified that he had discussions with his accountant, Alan Noss (Noss), with respect to this transaction when “they were preparing the return”. He was not certain what documents, if any, he gave them but did recall that: “I told him I sold the thing and I made some money and he said: ‘How much did you make, was it under $100,000? and I said: Yes, and then he said: ‘Well then, don’t worry about, it’s capital gains’”. The Appellant also testified that at best, he made a very cursory examination of his return before he signed it and that he “really didn’t go over it”.

The Respondent adduced evidence from Allan Noss, a chartered accountant, and Frank Scolaro, a certified general accountant, both of whom acted for the Appellant at the relevant time. Scolaro has been responsible for preparing the Appellant’s tax returns since 1970. Both testified that they had no recollection of any discussion with respect to the sale of the condominium. Both also testified that no advice was given to Hubbert to the effect that it was not necessary to report it. Noss further testified that had he been aware of the sale of this property “I would have told him there was a paper trail and he would be stupid ... and would have advised him that he would blow the election”. Scolaro maintained that he did not and would never counsel a client not to report income.

Hubbert cross-examined both witnesses and suggested that their evidence was untruthful and that they were motivated to lie because he had terminated their services in 1992 for excessive billing. Both denied the allegations.

I have considered the testimony of Noss and Scolaro, their relationship with the Appellant, their attitude, the manner in which they testified, as well as the probability of the facts they have sworn to and have concluded that where there is a conflict, I accept their testimony over that of the Appellant. The Appellant’s allegations of bias are, in my view, unfounded.

On the general issue of the Appellant’s credibility, two further points should be made. First, I have substantial reservations regarding the testimony given by him with respect to the acquisition and disposition of the condominium unit. Second, in cross-examination, the Appellant conceded that to obtain some tax relief with respect to another matter, certain trust agreements were back-dated and signed by him. He explained that the numbered companies which owned the strip malls “were losing money” and that he and his partner back-dated a trust agreement in an attempt to “recoup some of the losses personally because we were bleeding to death”. Although the Appellant maintains that he acted on the basis of professional advice, I am satisfied that he was aware that the steps being taken were, to say the least, questionable.

The issue is whether the Appellant knowingly or under circumstances amounting to gross negligence failed to report the capital gain in issue. I am satisfied that the Appellant did not advise his accountants with respect to the gain. On the evidence, it is reasonable to infer that he did not intend to disclose this gain and that his assertion that he did so on the advice of his accountants was designed simply to conceal that fact. This taxpayer is well- educated, has a great deal of business acumen, and is reasonably knowledgeable with respect to tax matters. This was not just a question of failing to exercise the care of a reasonable man to review his tax returns before signing them. Rather, the failure to report the capital gain was deliberate.

The Respondent also took the position that if the gain realized by the Appellant on the disposition of the property had been on capital account, it would not be subject to the rules respecting a principal residence as described in section 40 of the Act. I agree, since the evidence quite clearly established that the property was never his principal residence as defined in subsection 54(g) of the Act.

Deduction of Carrying Charges

In 1989, the Appellant and an associate purchased two commercial properties in Sault Ste. Marie (strip malls). The Appellant incorporated two companies, 761112 Ontario Limited and 746535 Ontario Limited (the companies), to purchase and hold his interest in these properties. Both properties were encumbered by mortgages obtained by the respective companies and in each instance, the Appellant acted as guarantor.

The Appellant testified that at the time of acquisition, both properties were fully rented with well-established tenants. Shortly thereafter, a downturn in the economy led to closures of several businesses creating vacancies. Although tenants had been lost, the Appellant felt that they “could wait it out”. At some point of time, the companies were either in default or were about to default on their payments of principal and interest and the bank invoked its right against the Appellant under the guarantees. He then utilized a personal line of credit at the Royal Bank to obtain the funds required by the companies. According to the Appellant, the amounts claimed as carrying charges, $11,400 and $9,600, reflected the interest on the amounts so borrowed against his line of credit. It was the Appellant’s recollection that the funds so borrowed were advanced to the two companies to enable them to make the necessary payments. None of the relevant documents were produced by the Appellant.

It is the Minister’s position that the amounts claimed by the Appellant as carrying charges/interest expense were not incurred or, if incurred, were not incurred for the purpose of gaining or producing income from a business or property.

The issue in this case is whether the payments made by the Appellant were deductible pursuant to subparagraph 20(1 )(c)(i) of the Act. The relevant portions of that provision read:

20(1)

Notwithstanding paragraphs 18(1)(a), (b) and (h), in computing a taxpayer’s income for a taxation year from a business or property, there may be deducted such of the following amounts as are wholly applicable to that source or such part of the following amounts as may reasonably be regarded as applicable thereto:

(c) an amount paid in the year or payable in respect of the year (depending upon the method regularly followed by the taxpayer in computing his income), pursuant to a legal obligation to pay interest on

(i) borrowed money used for the purpose of earning income from a business or property (other than borrowed money used to acquire property the income from which would be exempt or to acquire a life insurance policy),

As I understood the Appellant, the reason the funds were borrowed was to preserve what he hoped would become income-producing assets for the companies and ultimately, for him. He did not dispute that the payments reflected his liability for the companies’ indebtedness which arose out of his guarantees of the mortgages.

I should first observe that the evidence adduced as to the actual quantum of the interest which related directly to the monies borrowed was most unsatisfactory. The Appellant claimed $11,400 and $9,600 in the years in issue. However, documents he tendered prepared by the Royal Bank indicate that substantially smaller amounts were paid by him as interest on his line of credit. [3] His explanations, a bald statement that the Bank was wrong, was neither surprising nor acceptable.

In 74712 Alberta Ltd. v. Minister of National Revenue,^ [4] the corporate taxpayer attempted to deduct interest paid on a loan obtained by it to enable it to meet its guarantee of a bank loan owing by its parent corporation. The taxpayer’s appeal was dismissed. The headnote thereto summarized the ratio decidendi as follows:

Because interest payments are usually made to increase the capital holdings of taxpayers, the interest payment deduction allowed by subparagraph 20(l)(c)(i) of the Act has been strictly applied by the Courts. In this case, therefore, the trial judge did not err in denying the deduction being sought, either because the preservation of income-producing assets was the true purpose of the loan, or because its true purpose could be traced back to the reason for which the guaranty had originally been given (which was not to obtain a credit facility as the taxpayer had argued). The trial judge was correct in concluding that the true purpose for the taxpayer’s loan was to enable it to honour its guaranty, and not to be used directly for the purpose of earning income from business or property. Hence, the trial judge made no palpable and overriding error.

I see nothing in the evidence adduced to distinguish the Appellant’s situation from that of 74712 Alberta Ltd..

Rental Losses

From 1989 to 1992, the Appellant reported rental income, expenses and losses as follows:

These rental losses were claimed in respect of a condominium located at 20,000 Gulf Blvd., Unit 503, Florida (the property). This property was owned 50% by the Appellant and 50% by his spouse. It is not disputed that it was also used by them as a vacation property.

The Minister’s position was that the expenses were not incurred for the purpose of gaining or producing income from a business or property, in that the Appellant had no reasonable expectation of profit in the years in question. The Appellant’s testimony consisted of a brief history of the acquisition, use of, and ultimate disposition of the property to a holding company, as well as an assertion that the property had produced a net profit in taxation year 1993. No supporting documents were tendered. Although this testimony was lacking in detail and substance, Counsel for the Respondent chose not to cross-examine the Appellant. The only other evidence available to the Court was the reported rental incomes, expenses and losses previously referred to. I do note that the net loss in 1989 was in excess of $15,000 and had been reduced to $2,754 by 1992. How this was achieved is not known. Nonetheless, albeit not without some misgivings, I have concluded that the Appellant has made out his case and the losses as claimed will be allowed.

The appeal for the 1989 taxation year is dismissed, with costs to the Respondent, and the rental losses claimed by the Appellant for the 1991 and 1992 taxation years are allowed.

Appeals allowed in part.