Date: 19980219
Docket: 97-129(IT)I
BETWEEN:
MICHELLE BRENTON,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
REASONS FOR JUDGMENT
(Delivered orally from the bench at
Calgary, Alberta on January 29, 1998)
Christie, A.C.J.T.C.
[1] These appeals are governed by the
informal procedure provided for under section 18 and
following sections of the Tax Court of Canada Act. The
years under review are 1992, 1993, 1994.
[2] The Notice of Appeal reads:
"The purpose of this letter is to formally file a Notice of
Appeal to the NOTIFICATION OF CONFIRMATION BY THE MINISTER (copy
attached) re. my income tax assessments for the 1992, 1993 and
1994 taxation years. Please note, I would like to choose the
INFORMAL PROCEDURE.
I am enclosing a copy of a letter I sent to Revenue Canada on
February 26, 1996, to which I received no reply. I am also
enclosing my original Objection filed 18/09/95 by my
representative, I. Graham Berg, C.A. These two documents together
with notifications I have received from Revenue Canada (which I
assume you have access to...if not, I can provide them upon
request) should provide all relevant facts and my reasons for
appealing.
As stated in my letter dated February 26, 1996, I feel very
strongly that I was obeying the law as it existed at that time
and most definitely DID, contrary to the findings as noted in the
NOTIFICATION OF CONFIRMATION BY THE MINISTER, make or incur the
said expenditures to gain or produce income from a property. One
can unfortunately not always predict the outcome of particular
investments but that does not mean one did not have honourable
intentions at the outset.
The Tax Office that dealt with my Notice of Objection is
identified on a letter attached. I would like to request that my
file be sent to and handled by a local Revenue Canada office.
Relevant information can be forwarded
to:
Revenue Canada
Appeals Division
Room 830
220 4th Avenue S.E.
Calgary, Alberta T2G 0L1
ATTN: Jeff Wong
I trust this appeal will receive serious consideration."
As the Notice indicates, a number of documents are attached to
it. The Notification of Confirmation by the Minister includes
this statement:
"You did not make or incur the $2,392.79, $10,540.91 and
$7,125.55 expenditures for rental in the 1992, 1993 and 1994
years to gain or produce income from a business or property. The
expenditures were 'personal or living expenses' as defined in
subsection 248(1). You cannot deduct these expenditures from
income according to paragraph 18(1)(h)."
The letter of February 26, 1996 reads:
"The purpose of this letter is to add to my Objection filed
18/09/95 by my representative, I. Graham Berg, C.A. That Notice
of Objection indicated my reasons for purchasing the property at
4605 Donegal Drive, Unit 6 in Mississauga, Ontario and my
reasons for claiming rental losses in 1992, 1993 and 1994.
Since my Objection was filed last year, I have sold this
property. Because of the difficulties I faced with obtaining
renters, I was unable to turn a profit from this property. I
found it increasingly difficult to cover the mortgage payments on
my own, and based on Revenue Canada's ruling re. the disallowance
of any losses, I felt obliged to sell. It was sold at a
substantial loss to me ($19,750) excluding lawyer's fees, because
of a drop in the townhouse/condo market.
Based on the reasons cited in my earlier Objection and on the
above information, I am appealing to Revenue Canada to give this
matter more attention. I realize that ignorance is no excuse but
I claimed these losses very legitimately with no intent to abuse
the system. My financial planner and accountant advised me
throughout this process to ensure there was no wrong doing. He
was stunned when I was reassessed, stating he knew of many other
cases with larger losses for a lot longer periods of time than 3
years, with no reassessments.
I'd also like to address a telephone call that I made to
Revenue Canada when I originally received my Notice of Assessment
in August/95. The lady I spoke with indicated that Revenue Canada
was attempting to change the rules re. rental properties and that
is why I was being audited. I understand wanting to change the
rules for the future but I don't understand penalizing someone
for following the rules that exist today.
Please add this letter to my file and consider it in your
review. I did legitimately incur the losses claimed and now must
add to that the loss on sale of my home AND a tax bill in excess
of $10,000. This is a huge setback and definitely VERY
discouraging to an honest taxpayer who was just trying to start
an investment portfolio!
Please advise if there are any other measures I can take to
have my case reviewed prior to the normal 12-18 month waiting
period."
The original Objection dated September 18, 1995 reads:
"MICHELLE BRENTON
SIN: 116-506-056
NOTICE OF OBJECTION - ATTACHED SCHEDULE
The property was purchased in 1992 intending to rent it out
wholly as a start for an investment portfolio. The down payment
was quite small but with the income I was earning in these years
I intended applying a substantial amount in principal repayment
annually so that in a short time the property could carry itself.
To this end I obtained an open mortgage.
For the following reasons I could not follow this intended
plan:
1. One of the
renters I had lined-up backed out and a replacement at a
reasonable rent could not be found.
2. The rents
of previous years on which I had budgeted could not be realized
because of a drop in the market.
3. The
maintenance and repairs were far greater than I had been lead to
believe or budgeted for.
Because of this I was forced to move out of my apartment as I
could not afford the rent and short fall on the rental property.
I also was unable to make the reductions intended on the
mortgage.
In view of the above I have since put the property up for sale
as it was always greater than my needs. I am moving out and if I
cannot sell it for a reasonable amount, I shall attempt to rent
the whole property until such time as I can.
It was always intended that this be an investment property and
only became my residence as a result of the change in the rental
market and other cost miscalculations."
[3] The opening paragraph and
paragraphs 1 to 9 inclusive of the Reply to the Notice of Appeal
read:
"In reply to the Notice of Appeal for the 1992, 1993 and 1994
Taxation Years, the Deputy Attorney General of Canada says:
A. STATEMENT OF
FACTS
1. With
respect to the first unnumbered paragraph of the Notice of Appeal
he admits that the Minister of National Revenue (herein the
Minister) issued a Notification of Confirmation dated June 28,
1996 for the 1992, 1993 and 1994 Taxation Years.
2. With
respect to the second unnumbered paragraph, he denies that the
Appellant did not receive a reply to the February 26, 1996
letter. He further states that the stated purpose of the letter
was to add to the Appellant's Objection. In response to the
Objection the Minister confirmed the reassessments on June 28,
1996 and also responded by letter dated June 4, 1996. He can
discern no further facts in the remainder of the paragraph to
admit or deny.
3. With
respect to the third unnumbered paragraph of the Notice of
Appeal, he denies that the expenditures were incurred for the
purpose of gaining and producing income from business or
property.
4. He can
discern no further facts to admit or deny in the Notice of
Appeal.
5. The income
tax returns were initially assessed as follows:
1992: 24 June 1993
1993: 25 April 1994
1994: 24 April 1995
6. In
computing income for the 1992, 1993 and 1994 Taxation Years, the
Appellant deducted net rental losses in the following amounts, as
detailed in Schedules 1, 2 and 3 attached herein:
1992: $ 2,392
1993: $10,540
1994: $ 7,125
7. In
reassessing the Appellant for the 1992, 1993 and 1994 Taxation
Years, the Minister disallowed the deduction of the losses.
8. In so
reassessing the Appellant, the Minister made the following
assumptions of fact:
(a) The Appellant
reported the following T4 income from employment:
1992: $59,910
1993: $67,311
1994: $79,320
(b) From 1992 to
1994 the Appellant reported the following losses from renting out
part of her principal residence (herein 'the Residence'):
Taxation
Gross
Net
Year
Income
Expenses
Income (Loss)
1992
nil
$
2,392
($ 2,392)
1993
$3,000
$13,540
($10,540)
1994
$6,000
$13,125
($ 7,125)
(c) The Residence
was a three bedroom condominium unit.
(d) The Appellant
rented out one bedroom and the shared use of the remainder of the
Residence charging $500 per month to her friend, Anne Weremi
commencing in July 1993. The Appellant used the larger master
bedroom and the third bedroom was unoccupied.
(e) Anne Weremi was
the tenant for seven months in 1993 and 12 months in 1994.
(f) At all
material times to this Appeal, the Appellant had no other
tenants.
(g) The address of
the Residence was:
4605 Donegal Drive, unit 6
Mississauga, Ontario
L5M 4X7
(h) The Residence
was purchased in October 1992 and was sold in 1995.
(i) The
Appellant purchased the residence for $186,000 and obtained a
first mortgage of $161,262.
(j) Expenses
claimed in 1992 and up to June 30, 1993 were prior to any renting
of the Residence.
(k) The Appellant
allocated the household expenses (property taxes, maintenance and
repairs, interest, insurance, utilities, condo fees, cable,
telephone etc.) as follows:
rental
expenses
67%
personal
expenses
33%
(l) At all
material times to this Appeal, the Appellant did not advertise
and did not claim any advertisement expenses.
(m) The rent charged of
$500 a month could not reasonably be expected to earn a profit
but did minimally defray costs such as telephone, utilities,
condo fees, interest and maintenance and repairs (as detailed in
Schedules 1, 2 and 3 attached herein).
(n) Expenses claimed
for gas grill, furniture and garage door opener, if found to be
incurred for the purpose of gaining or producing income from
business or property are capital in nature and not deductible as
current expenses.
(o) Maintenance and
Repair expenses claimed in 1993 in the amount of $515.09 were not
proven.
(p) At all material
times to the Appeal, the Appellant's rental of part of her
Residence did not provide the Appellant with a source of
income.
(q) The Appellant
did not have a profit or a reasonable expectation of profit from
the renting part of her Residence during the 1992, 1993 and 1994
Taxation Years.
(r) The expenses
claimed in relation to the renting part of her principal
Residence were personal or living expenses of the Appellant and
were not incurred for the purpose of gaining and producing income
from business or property.
(s) Alternatively if
the Court finds that the expenses were incurred for the purpose
of gaining or producing income, the expenses and the Appellant's
delineation of the household expenses between personal and rental
were not reasonable in the circumstances.
B. ISSUES
TO BE DECIDED
9. The issue
is whether the Appellant had a reasonable expectation of profit
from the renting of part of her Residence in the 1992, 1993 and
1994 Taxation Years and whether the Minister properly denied the
rental expenses claimed.
SCHEDULE 1
MICHELLE BRENTON
STATEMENT OF INCOME AND EXPENSES
October 15, 1992 - December 31, 1992
Gross rental
income
0
less Expenses:
Property
taxes
$ 333.13
Maintenance and
repairs
961.43
Interest
574.60
Insurance
10.13
Light, heat,
water
300.17
Condo
fees
1,217.54
Total expenses
claimed
$2,392.79
Net loss
claimed
($2,392.79)
Note:
1. No tenant
until July 1993.
2. Client claimed
2/3 of household expenses as rental
expenses from purchase date
to December 31, 1992.
SCHEDULE 2
MICHELLE BRENTON
STATEMENT OF INCOME AND EXPENSES
1993
Gross rental income ($500 x 6
months)
$ 3,000.00
less Expenses for a 12 month period:
Property
taxes
$1,634.80
Maintenance and
repairs
2,025.61
Interest
7,118.00
Light, heat,
water
968.70
Telephone
389.41
Cable
186.85
Condo
fees
1,217.54
Total expenses
claimed
$13,540.91
Net loss
claimed
($10,540.91)
Note: 1. No tenant until July
1993.
2. Appellant claimed 2/3 of household expenses for full
year.
SCHEDULE 3
MICHELLE BRENTON
STATEMENT OF INCOME AND EXPENSES
1994
Gross rental income ($500 x 12
months)
$ 6,000
less Expenses for a 12 month period:
Property
taxes
$1,661.06
Maintenance and
repairs
1,054.15
Interest
7,621.32
Telephone
349.09
Cable
217.84
Light, heat,
water
1,008.30
Condo
fees
1,213.78
Total expenses
claimed
$13,125.55
Net loss
claimed
($ 7,125.55)
Note: 1. Claimed 2/3 of household
expenses as rental expenses."
[4] Schedules 1, 2, 3 show the
deductions by way of rental losses claimed by the appellant in
computing her income. Exhibits R-1, R-2, R-3 are statements of
real estate rentals included in the appellant's returns of income
for the years under review. They show that in 1992 total expenses
were $500.00 and the amount allocated to personal use was
$167.00. The same figures for 1993 are $2,451.00 and $816.00 and
for 1994 they are $11,426.00 and $3,805.00. Translated into
percentages this means that in each year the amount allocated to
personnel use was 33.3% of total expenses and the balance of
66.7% was allocated to renting. At trial the appellant readily
conceded that 50-50 would have been a more reasonable
distribution.
[5] Tonn v. The Queen, 96 DTC
6001 is a decision of the Federal Court of Appeal relied on by
the appellant. The issue in that case was also the deductibility
of rental losses. It purported to explain the true meaning and
intent of the reasons for judgment of Dickson J. (as he then
was), speaking for the Supreme Court of Canada, in Moldowan v.
The Queen, 77 DTC 5213. I note in passing that
Moldowan is by far the most frequently cited case in
Canadian jurisprudence in respect of litigation pertaining to the
taxation of income. In order to deduct losses, whether they be in
relation to property or business, there must be a source of
income. In Moldowan, Dickson J. said at page 5215:
"Although originally disputed, it is now accepted that in order
to have a 'source of income' the taxpayer must have profit or a
reasonable expectation of profit." Later he added at the same
page: "In my view, whether a taxpayer has a reasonable
expectation of profit is an objective determination to be made
from all of the facts."
[6] In Tonn Linden J.A., who
delivered the judgment of the Court, said at page 6009:
"It seems to me that for most cases where the
department desires to challenge the reasonableness of a
taxpayer's transactions, they need simply refer to section 67.
This section provides that an expense may be deducted only to the
extent that it is reasonable in the circumstances. They need not
resort to the more heavy-handed Moldowan test."
And at page 6012 he said:
"The primary use of Moldowan as an
objective test, therefore, is the prevention of
inappropriate reductions in tax; it is not intended as a vehicle
for the wholesale judicial second-guessing of business
judgments."
And at page 6013 he said:
"I otherwise agree that the Moldowan test should be
applied sparingly where a taxpayer's 'business judgment' is
involved, where no personal element is in evidence, and where the
extent of the deductions claimed are not on their face
questionable. 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."
I think the fact that the appellant lived in and shared the
premises being rented introduces a "personal element" in this
case. Also the first tenants which the appellant sought were the
appellant's sister and a friend of two years,
Anne Weremi.
[7] In Brill et al. v. The
Queen, 96 DTC 6572 Linden J.A. said at page 6578:
"In applying Moldowan, it is not whether profit is
earned, but whether it could reasonably be earned.
As long as the business has a reasonable chance of earning profit
in the year or in the near future, the interest is deductible,
whether or not there actually was a profit earned in a given
taxation year. That is the lesson of the Tonn case, which
only seeks to restate and clarify the application of the
principle of Moldowan. Thus, where as here, if no profit
is possible in the year or in the near future, no deduction can
be allowed (at least as long as Moldowan continues to
govern cases such as these).
[8] Attorney General of Canada v.
Mastri et al. is another decision of the Federal Court
of Appeal dealing with rental losses. It is reported in 97 DTC at
page 5421. In this case counsel for the Minister took the
position that Tonn was wrongly decided and urged the
differently constituted panel that dealt with Mastri to
"overrule" Tonn or "at the very least 'clarify' what was
decided in Tonn". I must say as an aside that it has been
a mystery to me why the Attorney General did not seek leave to
appeal Tonn to the Supreme Court of Canada when there was
still time to do so. In any event, the invitation to overrule was
declined. But Robertson J.A., who delivered the judgment of the
Court, did acknowledge that confusion had arisen about what was
actually decided by Tonn. He said this at page 5243 with
reference to that judgment:
"It is simply unreasonable to posit that the Court intended to
establish a rule of law to the effect that, even though there was
no reasonable expectation of profit, losses are deductible from
other income sources unless for example the income earning
activity involved a personal element. The reference to the
Moldowan test being applied 'sparingly' is not intended as
a rule of law, but as a common-sense guideline for the judges of
the Tax Court. In other words, the term 'sparingly' was meant to
convey the understanding that in cases, for example, where there
is no personal element the judge should apply the reasonable
expectation of profit test less assiduously than he or she might
do if such a factor were present. It is in this sense that the
Court in Tonn cautioned against 'second-guessing' the
business decisions of taxpayers."
And further on the same page he said:
"In summary, the decision of this Court in
Tonn does not purport to alter the law as stated in
Moldowan. Tonn simply affirms the common-sense
understanding that it is not the place of the courts to
second-guess the business acumen of a taxpayer whose commercial
venture turns out to be less profitable than anticipated."
[9] Turning now to the relationship
between rental income and the expenses allocated to renting which
gives rise to the losses sought to be deducted. In 1992 there was
no income and the expenses were $2,393.00. The same figures for
1993 are $3,000.00 and $13,541.00. For 1994 they are $6,000.00
and $13,126.00. This means that in the years when there was
rental income it constituted 22% and 46% respectively of the
rental expenses in those years. In 1993 income was only 42% of
the mortgage interest alone. That percentage for 1994 was 83.
That is to say that, even when there was rental income in each of
the 12 months in 1994, it was insufficient to cover interest
alone.
[10] Bearing in mind what has been said in
the authorities cited and its relationship to the whole of the
evidence, I am of the opinion that a reasonable expectation of
profit did not exist with respect to the appellant's rental
activities as structured in 1992, 1993, 1994 or in the near
future if the appellant had carried on those activities.
[11] At trial the appellant made reference
two or three times to start-up costs. they relate to a start-up
period which has been described as "a grace period for emerging
operations". But such a period would not commence until the
appellant's rental undertaking was so structured, organized and
financed that it could be found to be reasonably capable of
yielding a profit in due course. In this regard I refer to
Patricia Watt By Her Executor Donald Watt v. The Queen, 97
DTC 5459, a recent decision of the Federal Court of Appeal.
[12] In the light of what I have said here
this morning these appeals cannot succeed. Accordingly judgment
shall issue dismissing them.
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