Date: 19980429
Docket: 97-1804(IT)I
BETWEEN:
MIRANDA BECKFORD,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
REASONS FOR JUDGMENT
O'Connor, J.T.C.C.
[1] These appeals were heard at
Toronto, Ontario on April 8, 1998 pursuant to the Informal
Procedure of this Court.
[2] Testimony was given by the
Appellant and by one Kenneth Reid.
Issue
[3] The issue in these appeals is
whether the Appellant is entitled to rental losses claimed in
1993 and 1994.
Facts
[4] The essential facts are set forth
in the Reply to the Notice of Appeal as follows:
2. In
computing income for the 1993 and 1994 taxation years, the
Appellant claimed rental losses from a property located at 21
Lindridge Ave., Brampton, Ontario (the "Property") in
the amounts of $13,009.62 and $9,558.10 respectively.
3. The
Minister of National Revenue (the "Minister") assessed
the Appellant for the 1993 and 1994 taxation years by Notices of
Assessment mailed on April 11, 1994 and March 27, 1995
respectively.
4. In
reassessing the Appellant for the 1993 and 1994 taxation years,
by concurrent Notices of Reassessment mailed on March 25, 1996,
the Minister disallowed the deduction of the rental losses.
5. In so
reassessing the Appellant, the Minister made the following
assumptions of fact:
(a) the Appellant and another person
(the co-owner) purchased the Property (a house) as their
principal residence in September, 1990 for $187,000.00;
(b) during the years under appeal, the
Appellant and the co-owner resided at the Property;
(c) for the years in question, the
Appellant allegedly rented part of the Property to her son and to
her step son;
(d) for the taxation years 1990 to
1992, the Appellant reported gross rental income and claimed net
rental losses from the Property as follows:
|
Year
|
Gross Rental
Income
|
Net Rental
Losses
|
|
1990
|
$4,000.00
|
$9,069.00
|
|
1991
|
$5,000.00
|
$16,618.00
|
|
1992
|
$6,600.00
|
$11,469.00
|
(e) for the 1993 and 1994 taxation
years, the Appellant reported rental income, expenses (before
capital cost allowance) and losses from renting part of the
Property to her son and to her step son, as follows:
|
|
1993
|
1994
|
|
Gross Rental Income
|
$6,000.00
|
$6,000.00
|
|
|
|
|
|
Property taxes
|
2,832.62
|
2,622.00
|
|
Maintenance & repairs
|
3,004.17
|
2,100.00
|
|
Interest
|
19,181.24
|
14,781.00
|
|
Insurance
|
467.22
|
485.00
|
|
Light, heat & water
|
2,493.16
|
3,000.00
|
|
Advertising
|
64.00
|
25.00
|
|
Fees
|
344.00
|
300.00
|
|
|
|
|
|
Total Expenses
|
$28,386.41
|
$23,313.00
|
|
|
|
|
|
- Less Personal Portion of Expenses*
|
9,376.79
|
7,754.90
|
|
|
|
|
|
- Net Expenses
|
$19,009.62
|
$15,558.10
|
|
|
|
|
|
Net Rental Loss
|
$13,009.62
|
$ 9,558.10
|
* the personal portion deducted, of total expenses reported
for the 1993 and 1994 taxation years, amounts to 33.3%.
(f) the Appellant has failed to
provide any documentation to substantiate the claimed maintenance
and repair expenditures for the 1993 and 1994 taxation years;
(g) the documentation provided by the
Appellant to support her claimed interest expenses amounts shows
that the Appellant has overstated the interest expense amounts in
respect of the Property by $5,793.00 for the 1993 taxation year
and by $1,903.00 for the 1994 taxation year;
(h) for the 1995 taxation year, the
Appellant did not report any rental income or losses from the
Property;
...
[5] The space rented by the son and
step son was two rooms and certain common areas. In 1993 the son
was 21 years of age and the step son was 29 years of age. They
both moved out some time in 1995 and there have been no tenants
since that time.
Submissions of the Appellant
[6] The Appellant submits that the
claimed expenses and the fact of certain discrepancies referred
to in paragraph 5(g) of the Reply are the fault of the tax
preparer. The Appellant further complains of the fact that the
Minister only reassessed on March 5, 1996 with respect to 1993
and 1994, that this is an undue delay and has resulted in her
being responsible for large amounts of interest. She also
believes on the merits that over time there was a reasonable
expectation of profit.
Submissions of the Respondent
[7] The Respondent submits that the
rents declared fell far short of meeting the fixed expenses such
as interest and real estate taxes, that there was a personal
element in that the house was the principal residence of the
Appellant and moreover was rented in part to a son and a step
son.
Analysis and Decision
[8] The most recent decisions of the
Federal Court of Appeal dealing with rental losses, namely,
Tonn, Mastri and Mohammed have established certain
criteria as to when a reasonable expectation of profit
exists.
[9] In Tonn et al. v. The
Queen, 96 DTC 6001. Mr. Justice Linden, speaking for the
court, said at page 6008:
The Moldowan test is stricter that the business purpose
tests set out in subsection 9(1) and paragraph 18(1)(a).
As mentioned above, these tests stipulate that a taxpayer be
subjectively motivated by profit when incurring an expenditure.
The Moldowan test, however, also requires the presence of
a profit motive, but, in addition, it must be objectively
reasonable. In reality, in most situations, the objective
Moldowan test and the subjective statutory tests will not
yield many different results. A subjective intention is often
determined by what may be reasonably inferred from the
circumstances. Someone who claims a subjective intention that is
foolish may not be believed. A taxpayer's intention to produce
profit normally has to be reasonable before a Court will accept
it.
[10] At pages 6009 and 6010 he said:
A closer look at this jurisprudence will illustrate that this
is the approach now taken in most of the cases. The cases in
which the "reasonable expectation of profit" test is employed can
be placed into two groups. One group is comprised of the cases
where the impugned activity has a strong personal element. These
are the personal benefit and hobby type cases where a taxpayer
has invested money into an activity from which that taxpayer
derives personal satisfaction or psychological benefit. Such
activities have included horse farms, Hawaii and Florida
condominium rentals, ski chalet rentals, yacht operations, dog
kennel operations, and so forth. Though these activities may in
some ways be operated as businesses, the cases have generally
found the main goal to be personal. Any desire for profit in such
contexts is no more than a "pious wish" or "fanciful dream". It
is only a secondary motive for having set out on the venture.
What is really going on here is that the taxpayer is seeking a
tax subsidy by deducting the cost of what, in reality, is a
personal expenditure.
[11] At page 6011 he said:
The other group of cases consists of situations where the
taxpayer's motive for the activity lacks any element of personal
benefit, and where the activity cannot be classified as a hobby.
The activity, in these cases, seems to be operated in a
commercial fashion and not as a veiled form of personal
recreation. Usually these deductions are not challenged by the
Department, and, therefore, they do not get appealed and are not
reported very often in the law reports. The Courts still have a
role, however, in deciding whether there exist less apparent
factors which might suggest a different conclusion in cases such
as these. The Courts are less likely to disallow these expenses,
but they do so in appropriate circumstances.
[12] At page 6012 he said:
When the cases are categorized into two groups as above, one
cannot help observing that the hobby and personal benefit cases
are rarely decided in the taxpayer's favour. In contrast, where
the activity is purely commercial, they rarely are challenged. If
they are the Courts have been reluctant to second-guess the
taxpayers, with the benefit of the doubt being given to them. I
also note that in terms of sheer numbers, the
hobby/personal-benefit cases vastly outnumber those of the
commercial activity and variety, which are quite rare, indicating
that taxpayers are challenged less often in such situations.
[13] At page 6013 he said:
However, where circumstances suggest that a personal or
other-than-business motivation existed, or where the expectation
of profit was so unreasonable as to raise a suspicion, the
taxpayer will be called upon to justify objectively that the
operation was in fact a business. Suspicious circumstances,
therefore, will more often lead to closer scrutiny than those
that are in no way suspect.
[14] At page 6015 he said:
The property was not a vacation site. The house was not used
to give free or subsidized housing to relatives or friends. They
made an honest error in judgment and lost money instead of
earning it. It is not for the Department (or the Court) to
penalize them for this, using the reasonable expectation of the
profit test, without giving the enterprise a reasonable length of
time to prove itself capable of yielding profits.
[15] After the decision in Tonn, the
Federal Court of Appeal in A.G. of Canada v. Mastri et
al., 97 DTC 5420 stated that there was no doubt that
Tonn was correctly decided. The decision of the Tax Court
of Canada was reversed on the basis that it was an error in law
to say that just because there was no personal element involved
an unchallenged finding of fact that there was no reasonable
expectation of profit was not sufficient grounds for disallowing
the loss. The error of the Tax Court of Canada appears to have
been in the interpretation that it put on Tonn that the
absence of a personal element superseded the finding of no
reasonable expectation of profit. In fact, the finding of the Tax
Court of Canada that there was no personal element appears to
have been suspect since the taxpayers bought the house to be used
as their personal residence and in fact, after one year, they
moved into it.
[16] In Mohammad v. The Queen,
97 DTC 5503 it was held to be an error in law to reduce
the amount of interest deductible by an arbitrary amount under
section 67. In Mohammad there was 100% financing. At page
5506 Robertson J.A. said:
The above analysis is to the effect that there can be no
reasonable expectation of profit so long as no significant
payments are made against the principal amount of the
indebtedness. This inevitably leads to the question of whether a
rental loss can be claimed even though no such payment(s) were
made in the taxation years under review. I say yes, but not
without qualification. The taxpayer must establish to the
satisfaction of the Tax Court that he or she had a realistic plan
to reduce the principal amount of the borrowed monies. As every
homeowner soon learns, virtually all of the monthly mortgage
payment goes toward the payment of interest during the first five
years of a twenty to twenty-five year amortized mortgage loan. It
is simply unrealistic to expect the Canadian tax system to
subsidize the acquisition of rental properties for indefinite
periods. Taxpayers intent on financing the purchase of a rental
property to the extent that there can be no profit,
notwithstanding full realization of anticipated rental revenue,
should not expect favourable tax treatment in the absence of
convincing objective evidence of their intention and financial
ability to pay down a meaningful portion of the purchase-money
indebtedness within a few years of the property's acquisition. If
because of the level of financing a property is unable to
generate sufficient profits which can be applied against the
outstanding indebtedness then the taxpayer must look to other
sources of income in order to do so. If a taxpayer's other
sources of income, e.g., employment income, are insufficient to
permit him or her to pay down purchase-money obligations then the
taxpayer may well have to bear the full cost of the rental loss.
Certainly, vague expectations that an infusion of cash was
expected from Aunt Beatrice or Uncle Bernie will not satisfy the
taxpayer's burden of proof. In practice, the taxpayer will
discharge that burden by showing that significant payments were
in fact made against the principal indebtedness in the taxation
years closely following the year of purchase.
[17] Based upon all of the facts of this
case and relying on the criteria set forth by the Federal Court
of Appeal whose decisions are binding on me, I find, without
difficulty, that the Appellant did not have a reasonable
expectation of profit in the years in question. My principal
reasons are that the rents clearly could not meet the fixed costs
of mortgage interest and real estate taxes and there were
personal elements present of principal residence and renting to
relatives. The Appellant has the burden of proof. In this case it
was an extremely difficult one and the onus has not been
discharged.
[18] The Appellant also complained about the
lateness of the reassessment and the resultant interest charges.
As I have no authority to waive or reduce interest, I can only
recommend that the Appellant apply to the Minister of National
Revenue for application of the fairness package in this regard.
The Appellant also complains about the behaviour and bad advice
of the tax preparer. This is only too common in cases of this
nature where tax preparers represent that rental losses can be
claimed as deductions from employment income thereby reducing the
amount of tax a taxpayer must pay. The difficulty is that the tax
preparers do not always explain the full significance of the
deduction and the fact that the rental operation must have a
reasonable expectation to truly qualify for rental loss
deductions.
[19] In conclusion, applying the criteria of
the Federal Court of Appeal as described above I find that there
was no reasonable expectation of profit and consequently the
appeals must be dismissed.
Signed at Ottawa, Canada this 29th day of April 1998.
J.T.C.C.
Email this Content