Hayden v. R., [1998] 3 CTC 2919

Rip T.C.J.:

David D. Hayden and Peggy T. Hayden appeal income tax assessments in which the Minister of National Revenue (“Minister”) disallowed various rental losses claimed by the appellants in filing their income tax returns on the basis that the expenses were personal or living expenses, as defined by subsection 248(1) of the Income Tax Act (“Act”), and therefore not deductible in computing income for the year: paragraph 18(1)(h) of the Act. The Minister also disallowed an interest expense claimed by Peggy Hayden in computing her income for 1991 since the expenses were not incurred for the purpose of gaining income from a business or property: paragraph 18( 1 )(a) of the Act. David Hayden’s appeals are from assessments for 1988 and 1989 and Peggy Hayden’s appeals are from assessments for 1991, 1992 and 1993.

David Hayden and Peggy Hayden are husband and wife. Their appeals were heard on common evidence. They were not represented by counsel.

The amount of tax and interest in dispute by the appellants for each taxation year is under $12,000. I queried Mr. Hayden as to why, in the circumstances, he and his wife appealed under the general procedure of the Court rather that under the informal procedure. I explained some of the differences between the procedures. Mr. Hayden replied that he was “led to believe” they should proceed by way of general procedure. After the hearing of these appeals I instructed the Registrar to write the appellants to advise that if they wished to move their appeals to the informal procedure they should make the necessary election by April 30, 1998. They have made elections under Rule 16(1) of the Tax Court of Canada Rules (Informal Procedure) and the Crown consented. The informal procedure under the Act apply to the appeals at bar.

In 1981, while on a March school holiday skiing trip with their children at Mont Ste. Marie, Quebec, approximately 60 miles from Ottawa, Mr. and Mrs. Hayden visited a kiosk displaying expansion plans for the mountain promoted by its owner, Mont Ste. Marie Limited (“Limited”). They were impressed with the presentation. The Haydens returned to Toronto with promotional literature and made arrangements to acquire a unit in a condominium building Mont Ste. Marie that qualified as a multiple unit residential building (“MURB”) under the regulations to the Income Tax Act (“Act’) at the time. The total cost to the Haydens for the unit, including the cost of the unit, furniture and legal fees, was $96,000. Mr. Hayden borrowed $67,500 from the Canadian Imperial Bank of Commerce secured by a hypothec on the unit and payable over five years; the annual interest note on the loan was 17.075%. The property was hypothecated to the bank for $12,900 to secure other sums payable by the bank.

Mr. Hayden stated that the major enticement for the acquisition of the unit was its status as MURB. Another major enticement was that the property could be used by the family for a specific number of days in the year, at the time 77 days a year. Limited would rent out the unit during the balance of the year and the Haydens would derive rental income from the property. In other words Limited would operate the condominium building as a hotel, renting units on behalf of their absentee owners.

At all relevant times, the Haydens lived in Toronto and because of the travel time by automobile between Mont Ste. Marie and Toronto, approximately 7 hours, they did not anticipate using the property as often as owners of units who lived in Ottawa. Nevertheless they saw the acquisition as a “good deal”.

Mr. Hayden stated that when he acquired the property he realized it would not be a profitable investment; however, he looked at the anticipated growth at Mont Ste. Marie and saw “tremendous potential”. He said that he was willing to “suffer” for a few years realizing he would make money on any resale of the unit. He acknowledged that at the time he thought he could sell the unit at a profit in four or five years.

Mr. Hayden explained that each fall, around October 1st, he would determine what days he and the family wished to spend at Mont Ste. Marie; the balance of the days was available for rent.

Mr. Hayden testified that the family never used the unit to the maximum of the 77 nights. In 1982 they transferred the unused portion to Limited for rent and thus make additional income.

During the 1981-1982 and 1982-1983 winter seasons the Haydens used the property for about 16 nights. In the spring of 1983 Limited asked them to reduce the number of nights for personal use because, according to Mr. Hayden, business was good. Mr. Hayden, as a member of the condominium unit owners association, agreed to alter the arrangement between Limited and the owners of units so that the number of nights available for personal use would be 60 nights a year instead of the original 77 nights. (The Haydens had previously reduced their personal use.) During the 1984 to 1987 winter season the Haydens used the property approximately 35 to 45 nights a year. In 1987 Limited asked the owners to reduce their personal use of the property from 60 to 45 nights so as to give Limited a greater facility to rent the units and they all agreed.

The original agreement with Limited was for 10 years and expired in 1988. Limited and the owners association could not agree on any renewal. However Limited required units for rent. Mr. Hayden agreed with Limited to reduce his family’s personal use of the unit to 40 nights and make the balance of the time available for rent. At the time, according to Mr. Hayden, Limited and the Federal and Provincial Governments were investing some 20 million dollars into Mont Ste. Marie so he was very confident of the future.

In 1989 the family used their unit for 36 nights and in 1990 for 30 nights. In 1991 the property was used by the Hay dens for only 10 nights. Mr. Hayden testified that the family business was in bankruptcy and he was unable to visit Mont Ste. Marie on any regular basis. The family vacationed at time at Mont Ste. Marie during the winter and in August. In most years the Haydens made use of the facility during the Christmas vacation.

In the meantime the value of the condominium units at Mont Ste. Marie was falling. Seven condominium units were put up for sale in 1992 at an asking price of $92,000 and none were sold. In 1992 Limited stopped operating the condominium building as a hotel. Two employees of Limited formed a rental company to represent the owners of the condominium units in renting out the units. The Haydens agreed to let these people rent their unit on their behalf. The Haydens reserved 10 nights for personal use of their unit. In 1993 the Haydens agreed to use the property for 15 nights.

By 1993, Mr. Hayden stated, the value of a condominium unit fell to less than $56,000. In 1993 eight units were sold at prices between $46,000 to $53,000.

By 1991 the Haydens were in a dilemma. The family business was in bankruptcy and Mr. Hayden could not sell the condominium unit without incurring a loss. To break even and “walk away” from the property, he would have to sell the unit, he calculated, for less than $60,000. Since a sale at that value was impossible the family continued to hold on to the property.

In 1994 the Haydens put the unit up for sale for $69,000. The real estate agent was authorized to accept $60,000. The agent had the property for nine months and had only three interested customers. In June 1995 the unit was listed with a new agent for $66,000 but during three months the agent had the listing, it was not shown to anyone.

Mr. Hayden said that there were “always rumours” that something would be happening at Mont Ste. Marie that would increase the value of the units. Mr. and Mrs. Hayden were reluctant to sell since they feared that once they sold the unit it would increase in value due to some unknown factor. As Mr. Hayden put it, “there were always rumours when we were on the verge of selling”. He was thus encouraged to hold on to the property. He acknowledged that he never tried to sell the unit for a profit, he only wanted to “break even”.

In the original arrangement with Limited, the Haydens were guaranteed rents of $3,200 a year for the 288 nights available for rent. Mr. Hayden, who gave most of the evidence for him and his wife, said that he knew what the expenses for the unit would be but he expected to break even once the occupancy rate reached 80% for the whole year. At no time did the hotel have an annual occupancy rate of 80%.

Prior to the purchase of the unit, Mr. Hayden acknowledged, he did not investigate occupancy of the other hotels or condominium units that were available for rent in the general area of Mont Ste. Marie, including the Gatineau and Laurentian Mountains. Mr. Hayden said that Mont Ste. Marie recently has been acquired by Intrawest Inc., a major ski developer and operator in North America, and he is now very optimistic that the unit will increase in value.

For the years 1988 to 1991 Mr. Hayden claimed all of the losses in his tax returns. The losses were claimed as to 50% each by Mr. and Mrs. Hayden for 1992 to 1996. Mrs. Hayden pleaded that sometime after 1990, Mr. Hayden transferred an undivided one-half interest in the condominium unit to her. Mrs. Hayden commenced in 1992 to claim 50% of the losses incurred on the operation of the unit. However there was no evidence that such a transfer ever took place. Mr. Hayden and Mrs. Hayden both conceded that while it was their intention to transfer the property there was no actual transfer. Mr. Hayden stated that he realized only recently no transfer of ownership interest had occurred when he contacted the notary who had charge of the records concerning the purchase and hypothecation of the unit.

The following are the gross rental incomes, and losses from the condominium unit claimed by Mr. or Mrs. Hayden, or both of them, in tax returns for the years 1988 to 1996:

Mr. Hayden attempted to reduce mortgage interest by substituting a second mortgage on his home for a mortgage on property he owned in Cobourg, Ontario. The proceeds from the loans secured by the mortgages had been used to finance the Mont Ste. Marie property.

In her 1991 tax return Mrs. Hayden deducted carrying charges and interest of $13,047. She was not sure what the money was used for. She testified that she understood that she personally guaranteed loans to the family business. In fact, the family home was mortgaged as security for a loan by a bank to the corporation owned by the Haydens, Hayden Galleries Inc. When Hayden Galleries Inc. entered into bankruptcy, Mrs. Hayden was called upon to honour her guarantee. Mr. Hayden testified that when Hayden Galleries Inc. went bankrupt in 1990 he and Mrs. Hayden lost money they invested in the business. In addition, the Haydens lost money as a result of personal guarantees they had to pay to the bank. Mr. Hayden explained that in order to pay the bank he and Mrs. Hayden had to borrow additional funds. The $13.047 was interest payable on money borrowed by Mrs. Hayden to pay her personal guarantees to the bank.

It is only when a taxpayer loses money from property and applies his or her losses to other income he or she earned or received in the year that the Minister questions the losses. The Minister queries whether the expenses of a property were maintained by the taxpayer for the use of the taxpayer and not maintained in connection with a business carried on for profit or with a reasonable expectation of profit. If the property was not maintained in connection with a business carried on for profit or with a reasonable expectation of profit then the Act, at subsection 248(1), provides that the expenses of that property are personal or living expenses; personal or living expenses are not deductible by a tax payable in computing income: paragraph 18(l)(/i).

In 1977 the Supreme Court of Canada [1] considered the question of what is required by a taxpayer to have a profit or reasonable expectation of profit from a venture so that the expenses of a property would not be categorized a personal or living expenses. Dickson, J. (as he then was) explained at page 5215:

Although originally disputed, it is now accepted that in order to have a “source of income” the taxpayer must have a profit or a reasonable expectation of profit. Source of income, thus, is an equivalent term to business: Dorfman v. M.N.R. [72 DTC 6131], [1972] C.T.C. 151. See also s. 139(1)(ae) of the Income Tax Act which includes as “personal and living expenses” and therefore not deductible for tax purposes, the expenses of properties maintained by the taxpayer for his own use and benefit, and not maintained in connection with a business carried on for profit or with a reasonable expectation of profit. If the taxpayer in operating his farm is merely indulging in a hobby, with no reasonable expectation of profit, he is disentitled to claim any deduction at all in respect of expenses incurred.

Mr. Justice Dickson went on to explain the meaning of the phrase “reasonable expectation of profit”:

There is a vast case literature on what reasonable expectation of profit means and it is by no means entirely consistent. In my view, whether a taxpayer has a reasonable expectation of profit is an objective determination to be made from all of the facts. The following criteria should be considered: the profit and loss experience in past years, the taxpayer’s training, the taxpayer’s intended course of action, the capability of the venture as capitalized to show a profit after charging capital cost allowance. The list is not intended to be exhaustive. The factors will differ with the nature and extent of the undertaking: The Queen v. Matthews (1974), 28 DTC 6193. One would not expect a farmer who purchased a productive going operation to suffer the same start-up losses as the man who begins a tree farm on raw land.

Recently the Federal Court of Appeal has considered anew in Tonn v. R.* [2] the relevancy of reasonable expectation of profit to the deductibility of losses. In Mastri v. R. [3] the Court held that where there is no personal element involved in the making of expenses “the judge should apply the reasonable expectation of profit test less assiduously than he or she might do if such a factor were present”. [4] Robertson, J.A. writing for the Court, confirmed that Tonn cautioned against “second guessing” the business decisions of a taxpayer [5] whose commercial venture turns out to be less profitable than anticipated. [6]

Soon after deciding Mastri, the Court of Appeal released its reasons in Watt v. R. [7] Décary, J.A., writing for the Court, stated that a fair reading of Tonn and Masm'allows the following conclusion [8] in considering whether a taxpayer had a reasonable expectation of profit from a venture:

a) that a personal element may coexist with a profit motive; b) that where a personal element exists, it will prompt the Court to apply the reasonable expectation of profit test more assiduously; and c) that where the personal element is “the dominant, motivating force”^ [9] the taxpayer’s burden may be considerably more onerous.

The facts still in the appeals at bar are that “the dominant, motivating force” in Mr. Hayden acquiring the unit at Mont Ste. Marie was two fold: to use losses from the unit in computing income and for the family to use the unit during holidays. He did not expect any income or profit from renting the unit. Indeed, Mr. Hayden relied solely on sales literature described by the vendor in arriving at his decision to purchase the unit; he did not make the effort to compare the economic viability of the proposed acquisition to similar properties near Mont Ste. Marie. He was - if I correctly appreciate his evidence and I believe I do - enthused with the prospect of having a vacation property that could at the same time help reduce his taxes. Mr. Hayden also hoped that at some future time, he could sell the unit at a profit.

I do not wish to “second guess” Mr. Hayden. He acquired the unit in an area he and his family found attractive. The purchase was financed by a mortgage (hypothec) on the unit and a mortgage on property owned by Mr. Hayden and his wife in Ontario. The mortgage interest was the greatest of expense incurred on the unit. As well, there was a personal element involved in the purchase of the unit. I cannot conclude there was any degree of commerciality in this venture to warrant a finding that there was a reasonable expectation of profit by Mr. Hayden when he acquired the unit.

There is no evidence that Mr. Hayden transferred any interest in the unit to Mrs. Hayden.

Finally, the interest incurred by Mrs. Hayden was not for the purpose of gaining or producing income from a property or business. She borrowed money (on which the interest was paid) for the purpose of honouring her personal guarantee to the lender of a loan to Hayden Galleries Inc. She was not in the business of making guarantees and did not earn any income from making the guarantee and the guarantee was not a venture in the nature of trade.

The appeals of Mr. and Mrs. Hayden are dismissed. Since these appeals are now subject to the informal procedure, there is no costs.

Appeal dismissed.