Date:
20020827
Docket:
2001-1801-IT-I,
2001-1802-IT-I
BETWEEN:
STELLA PINNOCK
and
STAINTON
PINNOCK,
Appellants,
and
HER MAJESTY THE
QUEEN,
Respondent.
____________________________________________________________________
For the Appellants: The
Appellants themselves
Counsel for the
Respondent: A'Amer Ather
____________________________________________________________________
Reasons for
Judgment
(Delivered orally from
the Bench on
June 28, 2002, at
Toronto, Ontario)
McArthur
J.
[1] These appeals are from assessments made under the Income
Tax Act for the 1996 and 1997 taxation years. The Appellants
are husband and wife and their appeals and the replies thereto
from the Minister of National Revenue are identical. Stella
Pinnock carried the lead role in their joint presentation. An
earlier request for adjournment was denied and the Appellants
were prepared to proceed on June 24, 2002 under the Informal
Procedure. They had been previously informed that federal tax and
penalties is limited to $12,000 under the Informal Procedure and
expenses are limited to $24,000. They had been further informed
that a bump-up to the General Procedure would cost $300. I
am told several letters and telephone calls from the Tax Court to
the Appellants went unanswered. They are aware that their amounts
under appeal exceed the Informal limitations. Presently, the
Appellants are struggling through severe financial times and
cannot afford a lawyer or an accountant or the bump-up fee.
It would appear that they felt their best option was to proceed
on their own under the Informal Procedure.
[2] The limitations that are referred to are set out in section
18.1 of the Tax Court of Canada Act, which
states:
18(1) Every judgment that allows an
appeal referred to in subsection 18(1) shall be deemed to include
a statement that the aggregate of all amounts in issue not be
reduced by more than $12,000 or that the amount of the loss in
issue not be increased by more than $24,000, as the case may
be.
[3] In 1996, the Minister disallowed expenses and interest of
$7,805 and $31,818, respectively, and in 1997, disallowed
expenses and interest of $18,589 and $37,778, respectively. The
amounts are greater than the $12,000 in tax and $24,000 in loss,
yet the Appellants elected to proceed under the Informal
Procedure and limit their individual appeals. It would appear
that the Appellants were unable to pay the $300 referred to as a
"bump-up" fee.
[4] To further complicate the Appellants' proceedings, most
of their relevant documentation was unavailable, having been
retained or confiscated by the Ontario Ministry of Health and/or
their former lawyers and accountants. The Appellant Stella is a
social worker by profession and Stainton had a distinguished
34-year career with the Toronto Police Force.
[5] In 1974, the Appellants purchased, as equal partners, a
boarding-house known as "Lauder Boarding Home" in
Toronto, Ontario, and it is this partnership or business that
claimed the losses which were disallowed and are now under
appeal. It was very difficult to discern the relevant facts
relied on by the Appellants. Exhibits A-1 to A-6
inclusive were presented in a disjointed fashion and are of
little assistance. For example, Exhibit A-1 is a Guarantee
to the Bank of Nova Scotia, signed by Stella only, guaranteeing a
line of credit to 741290 Ontario Ltd. which carried on the
business of Van Del Manor Nursing Home. No principal amount is
mentioned and it is dated 1989. It was this business that ran
afoul of the Ontario Ministry of Health and it was completely
separate from the Lauder Boarding Home, other than the interest
expense claimed which appears to be for money loaned by the
Appellants to 741290.
[6] Exhibit A-2 is also dated 1989 and appears to be a
list of guaranteed investment certificates in the aggregate
amount of $155,000 to support a loan to 741290. Exhibit A-3
is a further list of securities lodged with Canada Trust and
dated 1996, presumably used for the same purpose. Exhibit
A-4 is a Canada Trust powerline monthly statement dated
March 2000 to the Appellants, indicating a minimum payment due of
$23,600. At that time, there was an account balance owing of
$255,703. Exhibit A-5, I believe, is a bank statement dated
February 1999 and I fail to see any relevance in this
document. Exhibit A-6 is an additional Guarantee to the
Bank of Nova Scotia also dated in 1989 and is similar to Exhibit
A-1, with the exception that it has been duly executed by
both Appellants.
[7] A letter dated October 26, 2000 (Exhibit R-4) from Canada
Customs and Revenue Agency to the Appellants' former
solicitor is of assistance in understanding the situation herein,
and I therefore include the entire document as
follows:
Attention: Mr. Osborne G. Barnwell
October
26, 2000
Dear
Sir:
Re: Mrs. Stella
Pinnock
Notices of Objection for the 1997 and 1996 taxation
years
This
letter is in response to representations in your fax dated
September 18, 2000 and the above Notices of Objection. The fax
dated September 18, 2000 provided photocopies of Charge/Mortgage
of Land
(1) Part of Lot
30 Concession 6 Town of Newcastle; Dated February 1990. Balance
Due Date: February 14, 1991.
(2) Part of Lot
30 Concession 6 Town of Newcastle; Dated February 16, 1990.
Balance Due Date: September 11, 1991.
(3) Lot 69, Plan
1766 City of North York; Dated August 17, 1989. Balance Due Date:
August 17, 1990.
The
Charge/Mortgage of Land are unsupported by any current
documentation.
The fax
dated September 18, 2000 states 'we respectfully ask that a
meeting be arranged with you and the taxpayers so that they would
have an opportunity to explain the circumstances surrounding the
expenses claimed'. Considering the information provided, we
are of the opinion that a meeting would not be an effective use
of your clients' time at this time.
A review of the issues
has now been completed and we wish to make the following summary
and comments. The following are the issues raised in the Notices
of Objection.
Taxation years
|
1997
|
1996
|
Adjustments to Business
Income
|
|
|
|
"296 Lauder Group Home"
|
|
|
|
(1)
Disallowed Insurance
|
|
$ 2,423
|
|
(2)
Disallowed Salaries
|
$
23,794
|
$
12,201
|
|
(3)
Disallowed Interest Expenses
|
$
6,216
|
|
|
(4)
Disallowed Maintenance Expenses
|
$
2,935
|
|
|
(5)
Disallowed Vehicle Expenses
|
$ 4,235
|
$ 1,165
|
|
Total
|
$
37,180
|
$
15,789
|
|
Total
(on T7WC's)
|
$
37,177
|
$
15,609
|
|
Adjusted: Partnership share at 50%
|
$
18,589
|
$ 7,805
|
|
|
|
|
|
(6)
Deductions from Total Income
|
|
|
|
Disallowed Carrying Charges and Interest
Expenses
|
$
75,556
|
$
72,651
|
|
Disallowed Split at 50%
|
$
37,778
|
$31,818
|
We wish
to summarize and comment on all the issues that have been
indicated in the Notices of Objection. Further, we will reply to
specific concerns that have been indicated in the fax dated
September 18, 2000.
(1) The auditor
determined the expenses that were supported by receipts, vouchers
or documents. Based on the review the expensed amounts that were
determined to be undocumented and unreasonable in the
circumstances were disallowed. The auditor's letter dated
June 25, 1999, provided copies of a 'Statement of Adjustments
along with working papers explaining the adjustments that had
been proposed'.
Generally
speaking, all ordinary commercial insurance premiums are
deductible, e.g. fire insurance on plant and machinery used in
the business, use and occupancy insurance. Our review of the
disallowed insurance expense indicates no documentation of the
amount and no evidence of actual bona fide
payment.
(2) The auditor
determined the expenses that were supported by receipts, vouchers
or documents. Based on the review of the expensed amounts that
were determined to be undocumented and unreasonable in the
circumstances were disallowed. The auditor's letter dated
June 25, 1999, provided copies of a 'Statement of Adjustments
along with working papers explaining the adjustments that had
been proposed'.
Generally, salaries paid to employees are deductible
expenditures provided they are laid out to earn income of the
business and they are reasonable. Our review of the disallowed
salaries indicates no documentation of the amount or hours of
work and no evidence of actual bona fide payment to
the employees.
(3) The auditor
determined the interest expenses were unsupported by receipts,
vouchers or documents. Therefore, the allowable interest expenses
were based on the outstanding principal as at December 31, 1996.
The auditor's letter dated June 25, 1999 provided copies
of a 'Statement of Adjustments along with working papers
explaining the adjustments that had been
proposed'.
Generally, interest expense paid are deductible
expenditures provided they are laid out to earn income of the
business and they are reasonable. Our review of the disallowed
interest indicates no documentation of the amount and no evidence
of actual bona fide payment.
(4) The auditor
determined the expenses that were supported by receipts,
vouchers, or documents. Based on the review expensed amounts
which were determined to be undocumented and unreasonable in the
circumstances were disallowed. The auditor's letter dated
June 25, 1999 provided copies of a 'Statement of Adjustments
along with working papers explaining the adjustments which had
been proposed'.
Generally, maintenance expenses paid are deductible
expenditures provided they are laid out to earn income of the
business and they are reasonable. Our review of the disallowed
maintenance indicates no documentation of the amount and no
evidence of actual bona fide payment.
(5) The auditor
determined the expenses which were supported by receipts,
vouchers or documents. Based on the review the expensed amounts
which were determined to be undocumented and unreasonable in the
circumstances were disallowed. The auditor's letter dated
June 2, 1999 provided copies of a 'Statement of Adjustments
along with working papers explaining the adjustments which had
been proposed'.
Generally, vehicle expenses paid are deductible
expenditures provided they are laid out to earn income of the
business and they are reasonable. Our review of the disallowed
vehicle indicates no travel log book for the expenses and no
adjustment for personal portion. The taxpayer has not supplied
any supporting documents. However, the auditor estimated a
reasonable amount attributable to the business.
The
disallowed expenses are in accordance with Section 67, Subsection
9(1), Paragraph 18(1)(a) and 18(1)(h) of the
Income Tax Act.
The first test of
deductibility is contained in subsection 9(1) which states
that:
subject to this
Part, a taxpayer's income for a taxation year from a business
or property is his profit therefrom for the year.
Sections
18 and 19 prohibit the deduction of specified expenditures
through the use of the words 'no deduction shall be
made'. However, the rules in sections 18 and 19 actually
establish general principles or test of deductibility under the
Act. If an expenditure is not prohibited by a rule in
section 18 or 19, that is, if an expenditure passes the set of
sequential tests in these provisions, the expenditure is
deductible.
To pass
the test of deductibility in paragraph 18(1)(a) an expense or
outlay must:
(a) be
made or incurred by the taxpayer for the purpose of gaining,
producing or maintaining income; and
(b) be
expected to generate income related to the taxpayer's
business or property.
The
meaning of 'for the purpose of gaining or producing
income' has been at issue in many cases.
A
business is not permitted to deduct undocumented expenses whose
existence and purpose it failed to demonstrate. In the case of
Expofood (Canada) Ltd., v. MNR, (TCC) 85 DTC 42,
the taxpayer offered no evidence as to the existence, amount or
purpose of these expenses.
Expense
deductions unsupported by any records, receipts or vouchers will
generally be disallowed, unless supported by other evidence.
Records, vouchers and receipts have been at issue in many
cases.
Section
67 of the Income Tax Act places a limitation on the amount
of an outlay or expense that may be deducted. To be deductible,
the nature and amount of the expenditure must be reasonable in
the circumstances.
(6)
Deductions from Total Income
Carrying
charges and Interest
Expense
$75,556 $72,651
Split at
50%
$37,778 $31,818
The
auditor's letter dated June 25, 1999 provided copies of a
'Statement of Adjustments along with working papers
explaining the adjustments that had been
proposed'.
The
deduction of interest on borrowed money is limited to the amount
of interest paid or payable or a reasonable amount in respect
thereof. Interest Deduction is profiled in Paragraph
20(1)(c) of the Income Tax Act.
Interest
is deductible under the following conditions:
(1) it must have
been paid or payable in respect of the year pursuant to a legal
obligation to pay interest; and
(2) the borrowed
money must have been used for the purpose of earning income from
a business or property or the interest must have been on an
amount payable for property acquired for the purpose of gaining
or producing income from the property or from a
business.
A series
of cases in the 1980's stressed the link between a source of
income and the related interest expense.
In the
case of The Queen v. Bronfman Trust, 87 DTC 5059, the
question of income-producing capability was addressed in the
Supreme Court of Canada decision.
In the
case of The Queen v. Bronfman Trust, 87 DTC 5059, the
position taken by Revenue Canada was confirmed, where the Supreme
Court of Canada held what was important was the use of the
borrowed funds. In this case, the Supreme Court, in its
examination, was not able to trace the funds borrowed directly to
an income-earning source (eligible use source) and, hence,
denied the deduction of the related interest. In order for
interest on borrowed funds to be deductible, the taxpayer must
still trace the funds borrowed to an income-producing
purpose.
Conclusion:
The
appeal officer has reviewed the facts, the evidence and the
jurisprudence of the disallowed items. All amounts reassessed can
reasonably be regarded as unsupported and unreasonable
amounts.
Based on
our review, we are of the opinion that the disallowed amounts are
in accordance with the following: Section 67, Subsection 9(1),
Paragraph 18(1)(a), 18(1)(h) and 20(1)(c) of
the Income Tax Act.
We trust
our comments will be of assistance. We will defer any processing
action for thirty (30) days to allow your submission of any
additional information or explanation you may wish to have us
consider. If we do not receive your reply within that time, we
will proceed with the confirmation of the reassessments as
explained above.
Delivery
of the information should be to Canada Customs and Revenue
Agency, 5001 Yonge Street, Appeals Division 11th floor, Section
430-2 to the attention of C. McAuley.
Please
contact the appeal officer at the telephone number indicated if
you have any questions.
Your
co-operation is appreciated.
Yours
truly,
C.
McAuley, CMA
Appeal
Officer"
cc:
Mrs. Stella Pinnock
[8] Mr. Tom Kung, who performed the audit in these appeals
for CCRA testified on behalf of the Respondent. Statements of
fact contained on pages 3, 4 and 5 of the Appellants' Notice
of Appeal were read in part by Mrs. Pinnock as
follows:
In 1998
the taxpayer and her spouse, Stainton Pinnock, and two other
shareholders began a business known as 'Val-Del Manor
Nursing Home'. Unfortunately from the commencement of the
business, they began to experience financial problems. The
business was licensed under the Nursing Homes Act of
Ontario which was administered by the Ministry of
Health.
Under
that Act and Regulations, the Ministry of Health
subsidized the residence of the nursing home. ...
...
Records which have been kept at the business and which supported
the fact that advances had been made by the Appellants over the
years were contained in the boxes. Request of the Ministry for
the return of the records have been ignored. Unfortunately, due
to severe financial problems, the Appellant and her spouse have
not been able to afford to undertake a motion to the Ontario
Court to force the delivery of the records.
...
In order to carry on the nursing home business, a second mortgage
was taken out on the Orono Farm. In support of this, a statement
showing the amount of interest paid was submitted to the Agency.
However, the amount was not allowed. Other similar supports were
submitted but were ignored by the Agency.
The
Lauder Boarding Home was a for-profit operation. Both the
Appellant and her spouse operated the business in partnership.
The business involved providing accommodations to certain
individuals such as those without shelter and who were funded by
social services agencies. In order to carry on its business, the
boarding home had to hire workers. The turn-over of the
worker pool was very high. The Appellant and her spouse
experienced great difficulty in attracting long-term
employees. Certain employees, who were hired, demanded they be
paid in cash. In order to carry on a viable business, the
Appellants had little choice. The wages disallowed were with
respect to the amounts paid to those employees.
[9] The Appellants continue to struggle with their investments,
particularly with 741290 Ontario Ltd. They rely on the Supreme
Court of Canada decision in Stewart v. the Queen, [2002]
S.C.J. No. 46. They submit that all the expenses claimed as set
out in their 1996 and 1997 income tax returns under the heading
"Statement of Business Activities" (Exhibits R-2
and R-3) should be allowed because they are accurate and
were set out by their former chartered accountant.
Analysis:
[10]
The issue in these appeals
is the allowability of those expenses claimed for the operation
of the Lauder Boarding Home in excess of the amounts allowed by
the Minister. It is the Respondent's position that the
expenses are to be disallowed because they are unsupported by
receipts. The second issue is whether the Appellants are entitled
to claim interest on loans taken out at various times to invest
in 741290 Ontario Ltd. The Respondent relied in part on a partial
financial statement (Exhibit R-1) which indicated that no
advances were made to 741290. Without doubt, the Appellants'
books and records were all but non-existent. I accept their
submissions that their bookkeeping records were in the possession
of the Ontario Ministry of Health and with their previous lawyers
and accountants. They cannot afford to undertake legal remedies
to force delivery of these records. They are unfamiliar with
subpoenas and other legal processes. They are left at a
tremendous disadvantage. I have no doubt that they have had
substantial business losses over the years that they cannot
substantiate with documentation. In the past, they relied on
accountants. They are now left with little more than their oral
testimony which includes general statements such as the statement
of: "Business activities in our 1996/1997 returns must be
correct because they are prepared by a chartered
accountant".
[11] I
find the Appellants to be an honest, hardworking couple who find
themselves in their 60s and desperately struggling with serious
financial difficulties. They have been funding losses of 741290
Ontario Ltd. for over 10 years. I accept their evidence that they
borrowed several hundred thousand dollars on the security of
their home, their farm, and the Lauder Boarding Home, all of
which they owned jointly. They advanced all or most of the
proceeds of these loans to invest in 741290 Ontario
Ltd.
[12] The
Minister's position in disallowing the interest carrying
charges is that they were unsubstantiated, and the 1997 balance
sheet of 741290, carrying on the nursing home business, indicated
that the advances from shareholder was nil. Three pages of this
document were placed in evidence. It appears the entire document
was at least nine pages. The Appellants' interest payments of
$31,818 in 1996 and $37,778 in 1997 are the amounts claimed. They
both stated in evidence that they paid these amounts in interest
for the purposes of earning income from the Lauder Boarding Home
and from 741290 which operated the nursing home. I believe them,
and I cannot totally disregard their evidence because they lacked
documentation. The Appellants could not explain the nil advances
on the 1997 balance sheet. There was an entry signifying advances
from shareholders in 1996 of $38,747. Without the
accountant's explanations, these entries are hardly
conclusive.
[13] The
third page of this statement submitted reflected mortgages
payable by 741290 Ontario Ltd. of $1,742,897 in 1997 and
$1,751,143 in 1996. There appear to be four mortgages registered
against the nursing home property as at March 31, 1996. It would
appear from the four pages of the financial statements that the
corporation was liable for mortgages totalling $2,151,639. A
reference was made to "Note 5" which was not, however,
included in the Exhibit R-1 filed in evidence by the Respondent.
This evidence is of little assistance, although one could
speculate that in addition to the mortgages totalling $1,751,143
registered against the nursing home property, there was an
additional $400,000 in mortgage financing for which 741290
Ontario Ltd. was liable. This would tie into the Appellants'
evidence that they granted mortgages on their three other
properties owned personally for the benefit of 741290 and that it
was liable for the interest payable thereon. The single page for
741290's 1996 balance sheet further reflects bank
indebtedness as at March 31, 1996 of $347,842. Without any
details or explanation, this is of limited assistance except it
indicated that 741290 was in debt with many mortgages and with
the bank in 1996 and 1997.
[14] Based on the Appellants' evidence and the corroborating
evidence, I somewhat arbitrarily conclude that each of the
Appellants is entitled to claim a total of $24,000 for interest
expense in each of the years 1996 and 1997. I believe this to be
a common-sense conclusion. I have no doubt that they paid
substantial interest and are entitled to relief pursuant to
paragraph 20(1)(c) of the Act. The interest amounts
claimed in excess of $24,000 by each Appellant is disallowed. I
believe the Minister was justified in disallowing the general
expenses. For the reasons given by Respondent's counsel, I
find that the general expenses of $7,805 in 1996 and $18,589 in
1997 are disallowed. Because of the expense limitations under the
Informal Procedure, it does not serve a useful purpose to
analyze these disallowed expenses.
[15] In conclusion,
the appeals are allowed for the purposes of permitting the
Appellants to each claim a total of $24,000 for interest or
carrying charges in each of 1996 and 1997, and the assessments
are referred back to the Minister for reconsideration and
reassessment.
Signed at Ottawa, Canada,
this 27th day of August, 2002.
J.T.C.C.
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