Skrupski v. R., [1997] 3 C.T.C. 2765

McArthur T.C.J.:

1 These appeals are under the informal procedure concerning the Appellant's 1991, 1992 and 1993 taxation years. They involve the disallowance of expenses from a gravel mining operation and the rental of farm land for hay harvesting.

2 In 1987, the Appellant acquired 40 acres of land with a dilapidated house and support buildings known as Lot 10, from an estate and from his father. He paid $15,000.00 for 50% of the land and the remaining 50% was a gift from his father. He was further gifted from his father a one-fifth interest in abutting land, being 20 acres in Lot 9. Commencing in 1989 he used 400 square feet of the existing building on Lot 10 as his principal place of residence, living in substandard conditions until renovations were completed in and about 1993.

3 He had previous experience in the gravel extraction business, working with his father during the 1970s. In a professional manner, he arranged for test holes on both properties confirming the existence of substantial natural deposits of marketable gravel. During the relevant years he upgraded the existing home and support buildings. He also constructed four small storage sheds to house some of the equipment used in the extraction of gravel. In 1993, he purchased a used 50 ton-drag line, which he used to extract the gravel from a pit created in Lot 10. During the relevant years the only income reported from the sale of gravel obtained from Lot 9 was from a municipality.

4 The Appellant presented in evidence pictures of his drag line machine with its massive boom and 21/2cubic yard bucket. He purchased the 1963 machine for only $2,600.00. He disassembled it from the vendor's site, moved it to Lot 10, reassembled it and made it operational. The pictures also revealed impressive hills of gravel extracted by the Appellant, leaving a large water-filled hole. Sales of Lot 10 gravel were not recorded until 1994, 1995 and 1996.

5 Apart from the gravel operation the Appellant received a small amount of rental income from part of Lot 10 rented for farming purposes. He computed losses from the rental activity as follows:

		1991	1992	1993
Revenues:		Nil	$ 700.00	$ 400.00
Expenses:
	Property Tax	$ 55.12	$ 162.00	200.00
	Maintenance and Repairs	$2,067.52	Nil	Nil
	Interest	$1,007.50	$1,854.00	$1,482.41
	Insurance	$ 55.00	Nil	Nil
	Light, heat and water	$ 237.83	Nil	Nil
	Land Improvements	$ 75.00	$ 308.00	Nil
	Vehicle Expenses	$1,074.37	$ 60.00	Nil
Net Income Loss:	$4,572.34	$1,684.00	$1,282.41

He computed losses from the gravel pit activity as follows:

		1991	1992	1993
Revenues:		$1,057.65	$ 113.00	Nil
Expenses:
	Vehicle Expenses	$1,074.37	$1,681.00	$1,408.85
	Interest	$1,007.50
	Light, heat and water		$ 180.00	$ 300.00
	Office and Telephone	$ 104.30	$ 109.00	-
	Maintenance and Repairs	$ 500.30		$ 515.70
	Depreciation Allowance	$ 90.96
	Capital Cost Allowance	$1,005.49	$3,465.80	$2,539.05
	Land Improvement			$ 327.57
	Telephone			$ 120.00
	Snow Removal			$ 20.00
Net Income Loss:	$2,725.64	$5,322.80	$5,231.17

6 The position of the Minister of National Revenue is that the Appellant did not have a reasonable expectation of profit from the rental activity. The expenses totaling $4,572.34, $1,684.00 and $1,282.41, disallowed with respect to the rental activity, were not incurred for the purposes of gaining or producing income within the meaning of paragraph 18(1)(a).

7 Also expenses claimed for the gravel pit activity including vehicle, telephone, maintenance and repairs, light, heat and water, snow removal and land improvements were not incurred for the purpose of gaining and producing income from a business or property within the meaning of paragraph 18(1)(a).

8 The interest deducted is non-deductible pursuant to paragraph 21(c) of the Act. The snowblower and Jeep Cherokee were not acquired to gain or produce income.

9 The Minister further submits that the cost of the items are not deductible as capital costs of property within the meaning of paragraph 20(1)(a) of the Act.

10 The Appellant further submitted there was only one operation and therefore, all expenses should be combined and should not have been separated into rental activity and a gravel business. The entitlement to claim should be based on business use as it pertains to the entire operation of gravel mining. Income has been generated on the gravel operation and the cost of the vehicles was incurred to earn income.

11 The business use of a phone is conservative. Maintenance and repairs to equipment and buildings were necessary to commence operations and provide adequate storage for fuel, oil, cables, tools, et cetera. Building repairs and maintenance of buildings and equipment, as well as depreciation on storage sheds, is allowable. The truck (a Jeep Cherokee) was purchased at a cost of $23,241.00. One-half of this truck was listed on the depreciation schedule.

12 In 1992 a good deal of repairs and construction were done on outbuildings and storage sheds. The cost of $3,194.00 for the outbuildings was used exclusively for business purposes. The further cost of $11,730.00 was incurred in 1993 for other buildings and also a portion of the residence. Of this amount, only $1,250.00 was allocated to business use of the outbuildings, and the remaining $10,480.00 was not claimed since there was a personal use component of that amount. A snowblower was also required for use in and around the site and storage buildings, as repairs and maintenance are carried out in the off-season.

13 Interest on the property used for the business should be deductible, as the property is used for the purposes of earning income. The deductible portion of the interest expense is 75% of the total interest paid.

14 The principal place of residence was built in 1932, had 832 square feet and contained no running water or sewer. There is only, in essence, one operation, and the income from hay sales was only incidental to the maintenance of the site.

15 The expenses generated in the maintenance and the carrying costs of the site are part of the costs of the quarry and gravel operation and are deductible. The interest paid was paid pursuant to a legal obligation to pay interest. The start-up costs have taken place over a very short period of time, namely three years. Of significant note is that no person from Revenue Canada has taken the effort or the initiative to survey this site and the operation in order to determine the scope in the operation and the result of the intensive development of the quarry.

Analysis:

16 Neither of the parties referred to case law, both agreeing that the decision depended upon an interpretation of the facts.

17 The Appellant presently works for the Manitoba Correctional Services. In 1989 he was unemployed and acquired land with the assistance of his father and the bank. He had previous experience in the extraction and sale of gravel. He satisfied himself that the land contained natural commercial gravel. He moved into 400 square feet of the house being the first or lower level of the log cabin on the premises, and began modestly to establish a gravel business.

18 I accept that the expenditures were made for the purpose of gaining or producing income. The motivation was to create a business. There was a personal element, in that he slowly renovated the dwelling, residing there on his own until 1993, and then with a spouse.

19 The further element is that his long term intentions included stocking the ponds left after the gravel extraction, with fish and commercially exploiting this secondary venture.

20 In the decision of Tonn v. R. (1995), 96 D.T.C. 6001 (Fed. C.A.), The Federal Court of Appeal noted that a taxpayer should be given a reasonable period of time to make an investment a profitable one and it is inappropriate to second-guess the taxpayer's business judgment.

21 In the years following 1993, the Appellant's business is showing more income and less expenses. The Appellant worked seemingly hard with minimal expenditures and with generous assistance from his father and siblings. With the benefit of hindsight, his investment may turn out to be imprudent, particularly in view of all the time and effort he and his family have extended. Nonetheless, it was made in good faith with a commercial intent.

22 I accept the Appellant's submissions that the farm rental activity is incidental to the gravel business and should not be treated separately. All income and expenses should be combined. I agree with the Respondent's argument that some of the expenses may be unreasonable. I cannot accept that all the expenses in excess of those allowed by the Minister were unreasonable.

23 In Tonn supra, the Court stated that the Minister, in most cases, should refer to Section 67 in challenging the reasonableness of a taxpayer's transaction. This section provides that an expense may be deducted only to the extent that it is reasonable in the circumstances. As stated, the Appellant is entitled to a reasonable start-up period. In the present circumstances, I believe four to five years is a reasonable period.

24 While I have no yardstick to measure the reasonableness of the expenditures, the evidence of the Appellant was credible. He has taken extraordinary efforts to market gravel from his property, and his expenses in doing so cannot be, for the most part, ignored.

25 Each case must be determined on its own facts, and in this case it is a matter of degree. It is difficult to escape the inference that there was more personal element involved in the expenses than volunteered by the Appellant, but less so than determined by the Minister. The Appellant did not satisfy the Court that his use of his Jeep Cherokee for business purposes was as much as claimed. The gravel business and the farm rentals did not operate in the winter.

26 In conclusion, all of the income and expenses as reflected in the Reply to the Notice of Appeal for the rental and gravel operations are allowed, with the exceptions of the vehicle expenses which are reduced to reflect an allocation of 25% for business purposes and 75% for personal use.

27 In the same manner, the amount of depreciation or capital cost allowance for the Jeep Cherokee is reduced to permit capital cost allowance on 25% of the value. No expenses or capital cost allowance depreciation is allowed for the snowblower. All other claims as submitted by the Appellant are allowed.

28 Therefore, the appeals are allowed, and the assessments for the 1991, 1992, and 1993 taxation years are referred back to the Minister for reconsideration and reassessment in accordance with these reasons and without costs.