30 May 2007 External T.I. 2006-0211371E5 - Bed and breakfast - application of ss 18(12)

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.

Principal Issues: Given that there are several tax court decisions in which the TCC ruled that subsection 18(12) did not apply in bed and breakfast type operations, will the CRA reconsider its current position to the contrary.

Position: No.

Reasons: There is nothing in the words of subsection 18(12) that support the position that it does not apply to bed and breakfast operations. Nonetheless, the CRA abides by the Tax Court of Canada's decision in Sudbrack, the only decision on this issue heard under the general procedures. Accordingly, the CRA recognizes that an exception to the application of subsection 18(12) occurs in situations that fall within the same fact pattern as Sudbrack.

XXXXXXXXXX 							2006-021137
J. Gibbons, CGA
May 30, 2007

Dear XXXXXXXXXX:

Re: Subsection 18(12) of the Income Tax Act and Bed and Breakfast Operations

We are writing in response to your letter dated September 18, 2006, concerning the application of subsection 18(12) of the Income Tax Act (the "Act") to bed and breakfast (B&B) operations. You are writing on behalf of "XXXXXXXXXX", a non-profit organization that supports and promotes the XXXXXXXXXX tourism industry. In particular, reference is made in your letter to two informal decisions of the Tax Court of Canada (the "TCC"), Rudiak (2000 DTC 3901) and Moczulski (2003 DTC 3982), in which subsection 18(12) of the Act was held not to apply to the subject B&B type operations.

As you know, it is the position of the Canada Revenue Agency (the "CRA") that subsection 18(12) of the Act generally applies to B&B businesses - where the latter term is understood to mean the short-term rental of rooms by a taxpayer in his or her home. The CRA recognizes that an exception occurs in situations that fall within the same fact pattern as that in Sudbrack (2000 DTC 2521), a decision heard under the general procedures of the TCC, in which that Court ruled that subsection 18(12) of the Act did not apply

In Sudbrack, the taxpayer's renovated and expanded house was referred to as an "inn". This inn had five guest rooms with ensuite baths, three dining rooms, and a large newly-renovated kitchen that made up 17% of the entire area of the inn. The family living quarters, consisting of a bedroom, living area, bathroom and two attic bedrooms for the taxpayer's daughters, were quite distinct from the inn operation and made up 15% of the total area of the inn. The TCC concluded that the separate living quarters of the family constituted a self-contained domestic establishment. As an alternative, the TCC opined that if the inn as a whole was the "work space", that work space was "the individual's principal place of business". Accordingly, the Court ruled that subsection 18(12) did not apply, however the taxpayers' interest expense was restricted to 85% of the total interest expense in order to carve out the 15% personal portion.

In Rudiak, the TCC accepted the taxpayer's argument that his situation was sufficiently similar to Sudbrack. In Moczulski, the other case referred to in your letter, the TCC's conclusion therein that the deduction limitation in subsection 18(12) of the Act was not intended to apply to B&B operations overlooks Parliament's views as set out in the 1987 Tax Reform White Paper. The White Paper indicates that the then new subsection 18(12) of the Act should apply to, among other situations, "a person who lives in the building in which he or she operates ... a bed and breakfast business". Further, we do not agree that the words of that provision support the exclusion of B&B operations.

Notwithstanding the above, it should be noted that section 18.28 of the Tax Court of Canada Act provides that informal decisions of the TCC, such as those in Rudiak and Moczulski, shall not be treated as a precedent for any other case.

Finally, in regard to your argument that subsection 18(12) of the Act should only apply to restrict the deduction of rent or capital cost allowance, we are of the view that the reference in paragraph 18(12)(a) of the Act to "any part of a self-contained domestic establishment" refers back to the preceding words "of an otherwise deductible amount" which in turn refers back to the words "in computing an individual's income from a business." Accordingly, we are of the view that the reference to various types of expenses in ¶4 of IT-514, "Work Space in Home Expenses" accurately reflects the legislation.

We trust that the above information is helpful.

Yours truly,

Renée Shields
for Director
Business and Partnerships Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch