Chartrand v. R., [1997] 3 C.T.C. 2810

Garon T.C.J.:

1 These are appeals from income tax assessments for the 1991, 1992 and 1993 taxation years in the case of the Appellant Larry Chartrand and appeals from the income tax assessments for the taxation years 1992 and 1993 in the case of the Appellant Lorraine Chartrand. By the reassessments, the Minister of National Revenue disallowed rental losses claimed by both Appellants in the years in issue.

2 These appeals were heard on common evidence.

3 The Appellant Larry Chartrand was the only one to testify on behalf of the Appellants. The Respondent did not call any witnesses.

4 The Appellants are husband and wife. The Appellant Larry Chartrand, who is presently 40 years of age, had a grade 12 education and, as he put it, “plus a couple of credits in University”. In addition, he took the “Manitoba Real Estate Course” and passed the required exams.

5 The Appellant has been involved in business for the past 18 years. Prior to that, the Appellant Larry Chartrand worked for three or four employers holding labour and office jobs. The Appellant Larry Chartrand has been in the labelling business with his brother-in-law through a corporation by the name of Labels Unlimited Inc., in the City of Winnipeg, for about 11 years. Each owns a 50 percent interest in the capital stock of that corporation. The Appellant Larry Chartrand is the general manager of this firm which employs about 38 persons. The latter firm is “the number two out of half a dozen” in the Province of Manitoba. It has been a successful business; in fact, it has one of the finest reputations in western Canada, according to the evidence.

6 The Appellant has also been engaged with others in running a label manufacturing plant, a printing shop, in Kelowna, B.C. The Kelowna firm has about 11 employees and is also doing well. A new firm called Systematic, in which the Appellant and others are involved, has also been established out of Kelowna. It was described by the Appellant Larry Chartrand as “a new upstart Company” and it presently has three employees.

7 The Appellant Larry Chartrand was also involved in the rental business. He put his own house for rent when he was posted by the Army to another location. The rent covered the mortgage and other expenses. He also bought, with his brother-in-law, a “fourplex”. Within a year, they bought a “fiveplex” and finally the Appellant Larry Chartrand acquired, on his own, an 11-suite apartment block.

8 The Appellant has been in the real estate business seven or eight years prior to the acquisition of the Pembina property to which reference will be made later. Over that period, the Appellant Larry Chartrand was, in most cases, successful in making a profit from his ventures; in some cases he broke even.

9 Through his experience, he learned that in the case of real estate, location is a paramount factor. During the year 1990, the Appellant became interested, with an individual by the name of Richard Banack, in setting up an aquarium business to be operated in the City of Winnipeg. Mr. Banack was knowledgeable in assembling aquariums and filtration systems. He had done some work for the Appellants in putting up a custom-built aquarium at the Appellants' residence.

10 The Appellant Larry Chartrand and Mr. Banack prepared a plan for a very viable aquarium store specializing solely in salt water and fresh water fish. Incidentally, the Appellants had very good referrals from others about Mr. Banack. The latter had a very good reputation and was, at the time, operating a business from a very modest and secluded location in a rundown area of Winnipeg. Mr. Banack was experienced in the aquarium business, but did not have sufficient financial resources to make the investment necessary to start up a new enterprise. The Appellant Larry Chartrand was to provide the necessary financial resources.

11 In November 1990, the Appellant Larry Chartrand arranged for the incorporation of a Company called Winnipeg Aquarium Company Inc., the “Company”. On or about December 1990 the Company purchased a free-standing building on Pembina Highway, the “Pembina property”, for $228,000.00 to house the aquarium business. The building, according to the Appellant Larry Chartrand was ideally located. Pembina Highway is the second largest thoroughfare in Winnipeg; it is the main route to certain suburbs of Winnipeg.

12 The Appellant Larry Chartrand considered it was more economical to own the building rather than rent it. The building has 3,250 square feet of usable space and parking on the property beside the building could accommodate five or six cars. Parking was also available on the front and side streets.

13 The acquisition of the Pembina property was financed by the assumption of a mortgage held by Royal Trust Corporation of Canada, (the “Royal Trust”), in the amount of $205,469.00 and a cash payment of $22,901.47, including the deposit in the amount of $2,500.00. The required financing for the cash portion of the payment came from the Appellant Larry Chartrand.

14 In embarking on the aquarium venture, the Appellant Larry Chartrand and Mr. Banack entered into an agreement which had been drafted by the Appellant Larry Chartrand. This agreement, dated December 17, 1990, which was filed with the Court, reads as follows:

Let it be known that Larry Chartrand and Richard Banack both agree with the following and that this is to be considered a legal agreement.

Richard has lent Winnipeg Aquarium Company Inc. $5000.00 that is to be repaid by the company as soon as possible. No interest will be charged. In the event of the company going bankrupt or closing it's [sic] doors, the $5000.00 loan shall be considered unpayable until all other debts have been paid first.

At present, Larry owns 100% of Winnipeg Aquarium Co. Inc. As soon as possible Richard will acquire 50% of the company shares at no cost. This will take place when there is no more risk of creditors filing statements of claim against Richard or Something's Fishy or R. & D. Development Corp. and or suing same.

Larry will not be an employee of the company, but will have a say in the day-to-day operations of the company. At the time the company shows reasonable profit, Larry shall become an employee and receive a salary acceptable to both Larry and Richard. Richard shall be an employee of the company and will receive $2000.00 per month only after the company has paid all other expenses. Richard shall receive a minimum salary of $500.00 per month during slow times. The salary Richard does not receive, shall not and cannot be accumulated and demanded by Richard as backpay [sic] in the future.

Company profits deemed expendable by both Larry and Richard shall be divided50/50between Larry and Richard.

15 As far as the management of the Company was concerned, Mr. Richard Banack made all the day-to-day decisions; the Appellant Larry Chartrand made all the financial decisions. With respect to the important decisions made by the Company, the Appellant Larry Chartrand carried much more weight than Mr. Banack, but the latter had an input in such decisions.

16 Mr. Banack's sole investment in the Company was by way of a $5,000.00 loan. The other capital, which turned out to be very substantial, was provided by the Appellant Larry Chartrand.

17 During 1991, the first year of operation, the business did not go as the Appellants had expected. The Appellant Larry Chartrand was not depressed about it, although not overly happy. During that year, the Company had sales of approximately $146,000.00 and a gross profit of approximately $53,500.00. Offsetting operating costs resulted in the Company having a loss for the year ending December 31, 1991 of $77,233.00.

18 Towards the end of 1991, the Appellant Larry Chartrand decided to cause the Company to transfer the Pembina property to himself and the Appellant Lorraine Chartrand. It had the corresponding effect of removing the Royal Trust mortgage from the Company's liabilities as well. The Appellant believed that the Company had to downsize. He had spoken to Mr. Banack about this and explained to him that he thought that he should have “full control of the property”. Mr. Banack agreed to this.

19 On January 1, 1992, the Company sold the building to the two Appellants for $1.00 and other valuable consideration. The mortgage was assumed by the two Appellants with the consent of Royal Trust.

20 Mr. Banack had not been a guarantor of the mortgage debt at the time of the acquisition by the Company of the Pembina property. He was not even asked because it would not have been fair, according to the Appellant Larry Chartrand having regard to the former's financial situation.

21 The property in question was leased by the Appellants to the Company for $37,200.00 per year, or $3,100.00 per month. No lease document was executed at the time. The rent to be paid by the Company to the Appellants was to cover all expenses and allow a small profit for the Appellants in the range of $500.00 per month.

22 In the first months of 1992, the business of the Company went reasonably well, but this was not good enough, in the circumstances. A decision had to be made. The Company had to pay the rent to the Appellants or, alternatively, the Company had to pay the employees and purchase more goods to put on the shelves. Mr. Banack and the Appellants decided to look after the employees and rejuvenate the stock in the store. There were, at the time, five employees, some on a part-time basis.

23 Later on during 1992, the Company's situation deteriorated. Mr. Banack began working without being remunerated because he believed so strongly in the success of the Company.

24 Signs were put up indicating that the building was available for rent. For this purpose, the Appellant Larry Chartrand retained the services of a realtor and efforts were made with a view to renting the property.

25 Towards the end of 1992, the Appellant found someone interested in renting the building and carrying on a business as a pet store, expanding the variety of animals that he was going to sell. It turned out that the individual bought the property in April 1993, with a mortgage back to the Appellants as vendors. The inventory and the shelving units were included in the transaction with the individual in question. The transaction was closed on May 1, 1993. The Company's aquarium business ceased to exist at that time.

26 Six months later, the Appellants took back the property on account of the default on the part of the purchaser in making the required payments. The Appellant Larry Chartrand contacted again his realtor with a view to having somebody interested in buying or renting the property, as he was rather desperate at the time. He was in debt, as he had, to use his expression, “poured everything he had into” the aquarium business. Drastic measures had to be taken. Several months later he accepted an offer to purchase from the owner of an in-ground swimming pool and hot tub installation business. Six months later the purchaser moved out and left the Appellants “holding the bag”.

27 Once again the Appellants were in possession of the building. This time the realtor came reasonably quickly with an offer to lease for five years from a national firm that seemed reasonably strong. The latter firm was operating a chain of bicycle stores. In actual fact, in 1995 the building was leased for the period in question to this firm.

28 Initially the Appellants made no profit in renting this building to the firm in question. At the present time, it is a break-even situation for the Appellants and they expect a profit of about $500.00 per month next year.

29 In the long run, the Appellant Larry Chartrand believes that the subject property is a good investment. It is a “nice building”, so he said. According to the Appellant Larry Chartrand, the present plan of the Appellants is to keep the building as, in his view, real estate is normally a good investment in the long run.

30 Upon being asked by his counsel as to why the Appellant Larry Chartrand did not terminate the lease arrangement with the Winnipeg Aquarium Company Inc. sooner, in other words, before the Company's business was wound up in May 1993, he replied as follows:

Well, although I realized that things weren't going as well as they should be, I still had a glimmer of hope and I was being pressured by my partner to keep it open and give him another chance. I've always believed in people and all my business dealings do involve partners and most of them are50/50and they all work. And I felt that, you know, he had a stake in it too, as well, even though it was costing me on the financial side. But it was worth a little bit of time to give him a bit of a chance. And I really felt strongly that he could still do it. So, you know, I guess I gave in, or whatever.

31 The Appellant Larry Chartrand also asserted that he never experienced rental losses in relation to the other business ventures that he had.

32 In cross-examination, it came out that the monthly payments of principal and interest to be made under the mortgage with Royal Trust at the time of the assumption agreement dated January 1, 1992, were in the amount of $2,115.00, and that the realty taxes for that year amounted to $5,648.25.

33 Finally, as part of the financial impact suffered by the Appellant Larry Chartrand, as a result of some of the transactions referred to above, it is worth noting that he claimed in his 1993 income tax return in computing his income the deduction of an allowable business investment loss in respect of a substantial loss which he sustained as a result of the financial arrangements he had made with the Company. The Minister of National Revenue allowed the deduction of a certain amount in respect of such a loss and there is no dispute about the tax treatment of this particular loss.

34 The question in issue is whether the Appellants, at the time they acquired from the Company, the Pembina property in January 1992, had a reasonable expectation that a profit would be made, in the reasonably near future, from the rental of the subject property.

35 First of all, I do not regard the transfer of the property by the Company to the Appellants as unsound or illogical from a business standpoint. The Appellant Larry Chartrand had injected, personally, considerable sums of money into the Company. Also, in view of the difficult situation of the Company, some rationalization of the division of the assets between the Company and the Appellants does not appear to me to be unrealistic. I also accept the explanation given by the Appellant Larry Chartrand that the removal of the property in question from the Company's assets would facilitate matters for Mr. Banack if he were to acquire a 50 percent interest in the capital stock of the Company, as he intended to do, when he was a party to the agreement dated December 17, 1990, with the Appellant Larry Chartrand.

36 Be that as it may, the question here is not whether the Appellant Larry Chartrand acted in the best interests of the Company when he caused the latter to transfer to the Appellants, the Pembina property, which was encumbered by the Royal Trust mortgage.

37 I am satisfied that the intention of the Appellants when they acquired the property in issue was to derive a profit from its rental. They knew that the rental operation could not be profitable in the short run, but could become so in the reasonably near future.

38 In coming to this conclusion, I am not only relying on the evidence of the Appellant Larry Chartrand, which I accept entirely, but on the brutal fact that the Appellant Larry Chartrand continued, at least for a period of a few months in 1992, in injecting cash into the business of the Company, and in causing the Company to acquire additional goods in order to enable it to carry on the business in question. The fact, also, that Mr. Banack accepted to work for the Company without being paid for his services in 1992 indicates that there was hope, at least early in 1992, that the Company could become profitable.

39 If the Company had discontinued its operations just a few days or a few weeks after January 1, 1992, I might have come to a different conclusion. As noted earlier, the Company ceased to carry on the aquarium business, as disclosed by the evidence, more than a year later, that is, in May 1993. I find that the Appellants realistically hoped early in 1992 that the Company's business could become profitable. If this had materialized the Company would then have been able to make the required rental payments, which payments would, in turn, have brought a profit to the Appellants. The profitability of the rental operation for the Appellants in 1992 was intimately linked with and dependent upon the results of the Company's trading activities at that time.

40 On the evidence, it is clear that the Appellants' operation in renting out the subject property was not a hobby or an undertaking of a personal nature. The venture, was of a purely commercial character.

41 I am therefore of the opinion that the Appellants had a reasonable expectation of profit from the rental of the subject property when they acquired it on January 1, 1992.

42 In analysing the evidence in this case, I had in mind the principles laid down by The Supreme Court of Canada in Moldowan v. R. and by The Federal Court of Appeal in Tonn v. R..

43 For these reasons, the appeals are allowed, with costs, and the assessments are referred back to the Minister of National Revenue for reconsideration and reassessment on the basis that the Appellants are entitled to the deduction of the subject rental losses.