Mendoza v. The Queen, docket 2001-2508(IT)I (Informal Procedure)

Date: 20020425

Dockets: 2001-2508-IT-I, 2001-2509-IT-I

BETWEEN:

CRESENCIANO J. MENDOZA,

ENCARNACION MENDOZA

Appellants,

and

HER MAJESTY THE QUEEN,

Respondent,

                ___________________________________________________________________

                For the Appellants:                                               Cresenciano J. Mendoza

                Counsel for the Respondent:                              Michael Taylor

                ____________________________________________________________________

Reasonsfor Judgment

(Delivered orally from the Bench at Vancouver, British Columbia, on Wednesday, January 16, 2002)

Margeson, J.T.C.C.

[1]            In the matter before the Court at this time, the issues still outstanding were set forward by counsel for the Respondent in his argument. There are two issues: (1) were the expenses of Fil-Canadian Express ("Partnership") claimed by the Appellant as incurred by the Partnership properly deducted by the Appellants in the years in issue; (2) if yes, what percentage can each claim? The Appellant Cresenciano Mendoza claimed 70 per cent and his wife, Encarnacion Mendoza, the other Appellant, claimed 30 per cent.

[2]            It is the Appellants' duty in a case like this to establish, on a balance of probabilities, that the Minister of National Revenue's ("Minister") assessments were incorrect. There is no duty upon the Minister.

[3]            The Minister made the assessments and has disallowed these expenses. Counsel argued that there was insufficient evidence before the Court upon which the Court could conclude that these expenses were made. There was no transparency in what took place. There were no cheques issued to pay the alleged bills. There were no invoices presented to confirm that the bills were owed and were paid. There was no paper trail with respect to these expenses. The whole thing is shrouded in mystery.

[4]            The evidence of the witness called on behalf of the Appellants was that there were no actual monies exchanged, that there were merely debit and credit notes made in books. There was no evidence of the books before the Court at all. Financial statements were prepared presumably, sometime at the end of the year but they were not presented to corroborate the Appellants' position. There was no paper trail from which the Court could conclude that these expenses were incurred; that the expenses were paid for and that these were reasonable and legitimate expenses of this business.

[5]            On the basis of the evidence before the Court, it is not satisfied that the Appellants have met that burden. Red flags have been raised because of the manner in which these expenses were allegedly incurred and paid. The Court is not satisfied that the evidence has established that these were legitimate expenses and that the business should be able to deduct them. Consequently, the Court will have to dismiss the appeals in that regard and confirm the Minister's assessments.

[6]            Specifically with respect to the claim for office space expenses for the use of the living room in the 5275 Chester Street, Vancouver, B.C. ("Chester property"), the position taken by counsel for the Respondent was that under subsection 18(12) of the Income Tax Act ("Act"), no amount could be claimed for the Chester property with respect to office space because that was the property in which the principal residence of the Appellants was located. It was not used exclusively for the purpose of the business. There was no evidence substantially which showed that it was the principal place of business that was used exclusively for such purposes, according to the evidence. Those expenses cannot be claimed.

[7]            The remaining issue is whether or not the Appellants are entitled to deduct their share of the partnership losses for the rental business with respect to the 1008-1177 Hornby Street, Vancouver, B.C. ("Hornby property"). The question raised was whether or not there was a reasonable expectation of profit in the years 1996 and 1997 with respect to the operation of this rental property.

[8]            With respect to reasonable expectation of profit, counsel has referred to the appropriate case law on this matter. The case of Moldowan v. The Queen, 77 DTC 5213, is the most important one. The case of Tonn v. The Queen, 96 DTC 6001, is very significant, the case of A.G. of Canada v. Mastri et al., 97 DTC 5420, and the case of Mohammad v. The Queen, 97 DTC 5503. All of these cases are paramount in consideration of whether or not there was a reasonable expectation of profit.

[9]            In order for the Appellants to deduct the losses in the years in question, there must have been a profit or a reasonable expectation of profit. There must have been a source of income against which the losses could be deducted. If there was no profit or reasonable expectation of profit, then there was no source of income and the expenses cannot be deducted.

[10]          This is an objective determination which has to take into account all of the various factors which counsel for the Respondent has referred to: the profit and loss experience in other years; the nature of the expense and whether or not there was a personal element involved in the situation and the presence or absence of any plan which would indicate that there was a reasonable expectation of profit in the years in question. All these factors, and others, have to be looked at.

[11]          The Court is satisfied that there was a personal element involved in the case at bar. The property was used partially for the rental to the son and would appear to have been rented at less than fair market value, possibly for as little as one-half of what the fair market value might be for that apartment and therefore a personal element is involved. The Court certainly has to take into account the decision in Tonn, supra, which says that where a personal element is involved, one has to look at the situation much more cautiously and the reasonable expectation of profit test must be applied more strictly.

[12]          Where there is a personal element involved and where the factual situation makes it glaringly obvious that one could not reasonably conclude that there could be a profit, one does not apply the Moldowan, supra test less strictly. This is a case where the Moldowan principle should be applied and the Court has to conclude whether or not in the years in question there was a reasonable expectation of profit.

[13]          If this Court is wrong in concluding that there was no personal element involved, this is a situation where the facts make it obvious that during the years 1996 and 1997, there could not reasonably have been a profit.

[14]          All one need do is look at the expenses that were claimed in the years in question, 1996 and 1997, and one can see that the income in 1996 was only $9,650. The interest alone on the mortgage was $11,860.87. In that particular year there were repairs and maintenance of $4,845.92. That meant that even taking into account the interest on the mortgage alone, there would have been a shortfall of roughly some $2,000, without taking into account any other expenses which one would normally expect to have occurred in a property of this nature.

[15]          In the year 1997, the revenue was $9,025. The mortgage interest again was $10,528.20. There were repairs and maintenance expenses of $4,577.99. So again, just to pay the interest alone would have taken all of the revenue from the property and there would have been none left over for any of the other expenses. So on those bases, it would appear to be glaringly obvious that, unless something was done with respect to that mortgage such as a plan to reduce the mortgage interest over a reasonable period of time, it would have been impossible to have made a profit in the years in question.

[16]          There were other factors as well. The amount of rentals that the Appellants had were not as they had expected because of a downturn in the Asian economy and the fact that there were fewer students in the area to rent the properties and their other business had not expanded to the extent that they had expected it to. If they had and if the students had been greater in number, then they might have had more money by way of income than they had. But the Court is not satisfied that any of the evidence showed that even if they maximized their income from their other partnership, or from the students or from any other source, that there would have been enough income generated to reasonably expect a profit during the years in question.

[17]          The factual situation that presents itself to the Court is one that forces the Court to conclude that during the years in question, there was no financial capability existent on behalf of the Appellants to pay down their mortgage over a reasonable period of time and, until that matter was dealt with, there was no way that the Court could see that there was any reasonable expectation of profit. Indeed, there was no expectation of profit at all.

[18]          The Court has not seen any plan that the Appellants relied upon or put in place in order to show that within a reasonable period of time the mortgage would be paid down or within a reasonable period of time the business would be turned around and there would be a profit. The Court asked Mr. Mendoza, when he was testifying, to explain what reasons there were for not obtaining a profit in the years 1996 and 1997, even though his position was that from the beginning, he expected that there would be a profit.

[19]          Mr. Mendoza said that part of his plan was to sell the property if the market was available. That was his plan in 1995 when he purchased it and when he rented it in 1996. He said that if he sold it, he would have made a profit. But what the Court is dealing with in the present case is a rental business and the Court has to decide whether or not in the years in question there was a reasonable expectation of profit from that business. The only income that he had in the years in question was the rental business.

[20]          The Court cannot help but conclude from what Mr. Mendoza said that when he purchased this property, which he admits himself was the most important factor that prevented him from making a profit, that if he had not thought that he was going to make a profit on that property by way of sale and relatively soon, that he never would have bought it. The rental business was just an afterthought.

[21]          The Court offered Mr. Mendoza the opportunity to explain what prevented him from realizing a profit in the years in question or within some reasonable period of time thereafter. Unfortunately, the Appellant was unable to do so, except to suggest again that he was not able to sell the property as fast as he thought that he could to make a profit therefrom. His other business did not materialize to the extent that it would have allowed him the leeway that he wanted by using some of that money to apply to the mortgage and reduce it, thereby making it easier to make a profit.

[22]          The fact that the student population was reduced to some extent in Vancouver in the years in question from what the situation had been in prior years, together with the other suggestions by the Appellants, were not sufficient to rebut the conclusion that the Court has reached or the evidence, that in the years in question there was no reasonable expectation of profit.

[23]          The Court does commend Mr. Mendoza, as counsel for the Respondent did, for recognizing the predicament that he is in and that he has been attempting for some time to sell those properties. When he does so, this situation that he is in will better itself. But unfortunately, as of 1996/1997, the Court must conclude that the Appellants have not met the burden upon them to show that there was a reasonable expectation of profit.

[24]          Further, the Court has already found that the expenses of the Partnership were not deductible in the years in question.

[25]          It is to be noted that the Appellant Encarnacion Mendoza did not testify.

[26]          The appeals are dismissed and the Minister's assessments are confirmed.

Signed at Ottawa, Canada, this 25th day of April 2002.

"T.E. Margeson"

J.T.C.C.

COURT FILE NO.:                                                 2001-2508(IT)I

                                                                                                2001-2509(IT)I

STYLE OF CAUSE:                                               Cresenciano J. Mendoza and

                                                                                                Encarnacion Mendoza and

                                                                                                Her Majesty The Queen

PLACE OF HEARING:                                         Vancouver, British Columbia

DATE OF HEARING:                                           January 16, 2002

REASONS FOR JUDGMENT BY:      The Honourable T.E. Margeson

DATE OF JUDGMENT:                                       January 24, 2002

DATE OF WRITTEN REASONS:      April 25, 2002

APPEARANCES:

For the Appellants:                                                               Cresenciano J. Mendoza

Counsel for the Respondent:                              Michael Taylor

COUNSEL OF RECORD:

For the Appellant:                

Name:                     

                                               

Firm:                       

                                                                                               

For the Respondent:                                             Morris Rosenberg

                                                                                                Deputy Attorney General of Canada

                                                                                                Ottawa, Canada