Enstone v. The Queen, docket 96-4551-IT-G

Date: 19980903

Docket: 96-4551-IT-G

BETWEEN:

J. BRUCE ENSTONE,

Appellant,

and

HER MAJESTY THE QUEEN,

Respondent.

Reasons for Judgment

Lamarre Proulx, J.T.C.C.

[1] The Appellant is appealing the reassessments of income tax made by the Minister of National Revenue (the "Minister") for the taxation years 1991 to 1994.

[2] The issue is about three properties inherited by the Appellant in the year 1991. It concerns the nature of the expenses made for the repairs of the properties: whether they were of a capital or of a current nature, and respecting one property whether there was a rental business. There was an additional question put forward by counsel for the Appellant respecting the treatment of the capital expenses in view of the fact that the Appellant, according to counsel, did not have an ownership interest in the properties but a life-time income interest.

[3] The Appellant and Mr. William Davis, C.A., testified at the request of Counsel for the Appellant. No one testified for the Respondent.

[4] A book of documents was produced as Exhibit A-1. The Appellant explained that on March 7, 1991, his father died. Reproduced at Tab 2 of Exhibit A-1, is the will of the Appellant’s father. This will contains the following clause:

IF MY SON John Bruce Enstone survives me, I give and devise all my real property including any real property over which I have any general power of appointment to my son John Bruce Enstone during the term of his natural life. He shall pay all taxes, rates, levies, insurance premiums, mortgages (principal and interest) and the cost of all reasonable and necessary repairs including repairs of a capital nature for and in connection with the real property. He shall keep the real property in a good state of repair at all times. I give to my son John Bruce Enstone during his lifetime the power to sell any parcel of real property for the purpose only of purchasing a substitute parcel of real property in the Province of Ontario and such substitute parcel or parcels shall continue to form part of the trust of my real property herein created. Notwithstanding the foregoing, in case any parcel of the real property is expropriated or damaged or burnt beyond the point where it can reasonably be repaired I give to my son John Bruce Enstone the power of sale of that parcel only and I give to him the proceeds of such sale for his own use and benefit. Upon the death of the survivor of me and my son my Trustees shall divide the real property among my issue then alive in equal shares per stirpes and not per capita. During the lifetime of my son John Bruce Enstone he shall be the sole Trustee of my said real property for so long as he is able and willing to act as Trustee but upon his death or if for any reason he is unable or unwilling to act as Trustee thereof then in that event his co-trustees hereinbefore named shall become the continuing Trustees of my said real property.

[5] At the time of his death, the Appellant’s father owned the following rental properties: 418 and 420 Hinton Street and 132 Faraday Street, in Ottawa. Each of these properties is a half-double. The Appellant resides in the other half of the double at 134 Faraday Street. The Appellant’s father had acquired the properties as rental properties and had operated them as such. There were no mortgages on these properties. The rental properties had been profitable for many years until two years before his death. This is shown at Tab 1 of Exhibit A-1. The same document shows that the 132 Faraday property was acquired in 1951, where the other two properties were acquired in 1957.

[6] The Appellant’s father had been ill for some time prior to his death and as a result, the properties deteriorated. At the time of his death, all properties were vacant. The document appearing at Tab 1 of Exhibit A-1 shows that 132 Faraday had been vacant since 1987, 418 Hinton Street since 1989 and 420 Hinton Street since a few months after the beginning of 1990. The same document shows that 418 and 420 Hinton Street began to generate rental income in 1995 in the respective amount of $10,175 and $8,800.

[7] The Appellant is a professional engineer. During the material years, according to his income tax returns, (Tabs 3 to 6 of Exhibit A-1), he earned employment income in the respective amounts of $73,085, $74,854.10, $71,236.73 and $15,984.78.

[8] The rental losses for each of the taxation years in question are $23,087.38, $17,992.26, $15,860.46 and $30,450.

[9] The Respondent did not dispute the amounts of expenses incurred by the Appellant to renovate the properties. Counsel for the Respondent at the outset stated that the Respondent accepts that the Hinton properties were a rental business during the years in question. However, the Respondent is not of the same view for the 132 Faraday for the reason that it had not been rented from 1987 to 1996 and in 1996, it was not yet rented. Exhibit R-1 is a description made by Counsel for the Respondent showing what are considered to be capital expenses for the Hinton properties. The result is that some expenses are allowed on the Hinton properties as being current expenses in the respective amounts of $5,867.47, $8,000.79, $8,569.21 and $10,231.37 for each of the taxation years in question. For the 132 Faraday only a global amount of expenses is shown as Respondent did not consider this property to have the status of a rental property in those years. These amounts are $3,019.91, $4,610.49, $5,596.19 and $5,317.54.

[10] As for the Hinton properties, the expenses that were considered capital expenses were the expenses relating to the redoing of, the kitchens, the electrical wiring, the heating system and the purchase of computers and software.

[11] Mr. William Davis, a chartered accountant, testified about what he considered to be the nature of the Appellant’s interest in the properties in question pursuant to the Appellant’s father's will. He said that the Appellant had the use of the real estate assets for the remainder of his lifetime as long as the Appellant accepts to be responsible for the maintenance of the properties. The estate is considered the owner of the properties. However, it does not report the rental income. This has to be done by the Appellant who is entitled to the income. In his opinion, the Appellant could not claim any capital cost allowance because he was not the owner of the property, although he could claim the current expenses.

[12] Both Counsel seemed to agree that the Appellant’s interest in the properties was a lifetime income interest and not an ownership interest. No author nor case law was cited to the Court in respect of this right.

[13] Counsel for the Appellant submitted that because the Appellant did not have an ownership interest, he was not entitled to capital cost allowance and that I should take that into consideration in determining whether the rental expenses were of a current or of a capital nature. Again, no case law was cited to me as to how I should interpret the Act for this purpose.

[14] The expenses had been disallowed at the reassessments level on the basis that the Appellant did not engage in a rental operation or that there was no reasonable expectation of profit. The nature of the Appellant’s right in the property was not raised.

[15] Addressing the subject of the 132 Faraday property, Counsel for the Appellant submitted that it was not businesslike to differentiate between the properties. They should be treated as a whole. Why, he asked, would one be differentiated from the other only because it did not have tenants? He argued that this was a business decision relative to the timing of the expenses which properly belonged to the Appellant. It should also be taken into account the fact that in this decision there is no element of personal interest, the third property never having been a residential property of the Appellant and not having been acquired for that purpose either.

Conclusion

[16] On the aspect of the particular interest that the Appellant has in these properties, both counsel have agreed that it was a life-time income interest without any debate of the matter. Although I have the greatest doubt as to the submission by counsel for the Appellant that no proprietary interest of any sort had been passed to the Appellant, I will not disturb this proposition because I do not consider that it has any influence on my decision on the litigious issues.

[17] Both counsel agreed that current expenses would be deductible by the Appellant if he met the requirements of paragraph 18(1)(a) of the Act since the Appellant had incurred these expenses to earn rental income that will have to be reported by him.

[18] Respecting the capital expenses, Counsel for the Appellant thought that they would not be deductible because the Appellant had not acquired any ownership interest in the properties. After a review of the Act and the case law I conclude that Counsel for the Appellant is right: a right of ownership is a requirement to a claim of capital cost allowance. In this regard I will only refer to Saskatoon Community Broadcasting Co. Ltd. v. M.N.R., 58 DTC 491. Counsel for the Appellant suggests that, in circumstances similar to the ones at bar, the capital expenses should be considered to be expenses on the income account. As I have mentioned previously, no case law was submitted to me in this regard nor am I aware that the jurisprudence has evolved in the manner desired by counsel for the Appellant.

[19] Both expenses, capital and current are incurred to earn income (see British Columbia Railway Co. v. M.N.R. [1958] CTC 21 (S.C.C.) at 31 and Farmers Mutual Petroleums Ltd. v. M.N.R., [1967] CTC 396 (S.C.C.) at 400). The current expenses are subject to the limitation of paragraph 18(1)(a) of the Act and the capital expenses to the regime provided for by paragraph 18(1)(b) of the Act. The nature of an expense as to whether it is capital or current, is not determined by its general purpose of generating income but by the particular reason why it was made.

[20] Therefore, respecting the Hinton properties, I am of the view that the expenses that were classified as capital expenses by the Respondent for these properties were properly so. They were not repairs of the normal wear and tear made on a current basis. As is stated in a decision of the Supreme Court of Canada, to which Counsel for the Respondent had referred me, M.N.R. v. Haddon Hall Realty Inc., 1961 DTC 1001, at page 1002:

Expenditures to replace capital assets which have become worn out or obsolete are something quite different from those ordinary annual expenditures for repairs which fall naturally into the category of income disbursements. ...

[21] Respecting the 132 Faraday property, a person in a rental operation of various rental properties generally uses separate and common means in their administration. Each property is evaluated by the person in rental business as a particular source of income and on its ability to generate profits. It surely cannot be said because a person operates a rental business consisting of several properties that these properties will not be individually considered. A time schedule as to repairs and renovations is established regarding each property. Sometimes the repairs are of a current nature, other times they are of a capital nature.

[22] In the years in question, the 132 Faraday property was not an ongoing rental activity due to a stoppage of activity of a length that was much outside normal commercial practice. Sometimes a rental activity has to be stopped for the purpose of major repairs. This may not change the nature of the activity if it is done in accordance with commercial practice. In this particular case, the length of the stoppage was not within the normal commercial bounds. The evidence has shown that the property did not have tenants for nine years and contrary to what was done on the Hinton properties, no substantial repairs were made on the Faraday property and there was no advertising for rental nor listing with a leasing agent. As there was no ongoing rental business regarding that property, the expenses incurred in those years for the basic upkeep of the property, are not current expenses made for the purpose of earning income from a business or from a property. They may be capital in nature but, I do not have to decide on this matter.

[23] These appeals are allowed on the basis of the amounts consented to by the Respondent at the outset of the hearing as shown by Exhibit R-1.

[24] The Appellant, having succeeded for a good part, is entitled to one-half of the costs.

Signed at Ottawa, Ontario, this 3rd day of September, 1998.

"Louise Lamarre Proulx"

J.T.C.C.