1 September 1994 Internal T.I. 9413847 - DEDUCTIBILITY OF EXPENSES

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.

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the Department.

Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle du ministère.

Principal Issues:

Whether there is any relief available to a taxpayer that permits a deduction for an outlay or expense incurred in a year in which he no longer carries on a business or no longer owns the property which was the source of his property income.

Position TAKEN:

no

Reasons FOR POSITION TAKEN:

-Paragraph 18(1)(a)
-files 932751 & 940016

						September 1, 1994

	XXXXXXXXXX District Office	Head Office
	Business Enquiries  		Rulings Directorate
B. Kerr
						957-8953
	Attention: XXXXXXXXXX

						941384

Court Settlement

This is in response to your memorandum of May 19, 1994, wherein you requested our assistance in determining whether there was any relief available to a taxpayer in respect of a settlement that required him to make a payment to a former tenant in a year in which he no longer owned the rental property.

The situation identified in your memorandum involves a taxpayer who held a single rental property. In a prior year he withheld and reported as income a portion of a "rental deposit" from a former tenant as a result of the tenant "quitting" the property. The tenant contested this action and several years later a settlement was reached, such that the taxpayer refunded an amount on account of the deposit plus interest and paid some of the tenant's legal costs. However, prior to the settlement the taxpayer disposed of the rental property. In your view, since the taxpayer no longer has a source of income, he would be precluded from claiming a deduction for these payments. You have stated that this seems unfair and have asked us if there is any relief available to the taxpayer. We note that you have considered Interpretation Bulletins IT-359 and IT-467R and found no relief.

Our Comments

Paragraph 18(1)(a) of the Act provides that no deduction may be made in computing income from a business or property in respect of an outlay or expense except to the extent that it was made or incurred for the purpose of gaining or producing income from the business or property. In the case of the rental of real property, the determination of whether a taxpayer is carrying on a business or deriving income from a property is a question of fact. In this regard the comments in Interpretation Bulletin IT-434R may be of assistance. However, in any event, for an outlay or expense to be deductible, they would have to be incurred while the taxpayer was carrying on a business or at a time when the taxpayer had a property from which it could derive income. Since in your situation the taxpayer no longer has the real property which was the income source the amounts paid would not be deductible.

Furthermore, we are not aware of any other provisions in the Act that would permit the deduction of these outlays or expenses.

However, with clarification of the facts, some relief may be available to the taxpayer. For example, we note from your letter that you have referred to the withheld amount as a "rental deposit", however you have not defined this term. Does this represent a damage deposit or prepaid rent. You have stated that a portion of this amount was brought into income. In order for it to have been brought into income the taxpayer must of either recognized it at that time as accrued rent or as an amount referred to in paragraph 12(1)(a). If it was brought into income under paragraph 12(1)(a), the taxpayer would have had to conclude that his rental operation was a business and he would have been entitled to a reserve under paragraph 20(1)(m). If it was not accrued rent and if his rental operation was not a business then it should not have been brought into income under paragraph 12(1)(a). For additional comments on prepaid rent you may wish to refer to Interpretation Bulletin IT-261R. Another possibility would be to determine whether the amounts represent accrued expenses and hence were a "genuine liability" or whether they were a "contingent liability" in an earlier year. If they represent accrued expenses and therefore an accrued liability then they may have been deductible in an earlier year. However, if in that earlier year they were only "contingent liabilities" paragraph 18(1)(e) of the Act would have prevented them from being deducted. In the determination of these facts you may wish to refer to Interpretation Bulletin IT-215R for assistance. Unfortunately, the only taxpayers permitted to deduct contingent liabilities for damages or settlements paid at a future time when it becomes a genuine liability and at a time they no longer carry on a business are those that report their income on the "cash basis" as provided for in paragraph 10 of IT-467R. In your situation the taxpayer would have been required to use the "accrual basis".

In the event that one of these situations was in fact the case, the taxpayer would be able to go back as far as his 1985 taxation year and amend the particular tax return in which the error is applicable in accordance with the provisions of subsection 152(4.2) and as outlined in Information Circular IC-92-3.

R. Albert
for Director
Business and General Division
Rulings Directorate
Policy and Legislation Branch