Date:
20020808
Docket:
2002-833-IT-I
BETWEEN:
PHILIP
DURBER,
Appellant,
and
HER MAJESTY THE
QUEEN,
Respondent.
Reasons for
Judgment
Rip,
J.
[1] Philip Durber appeals income
tax assessments for the 1997, 1998 and 1999 taxation years,
claiming that he is entitled to deduct expenses incurred by him
in respect of a mobile home, boat and trailer (collectively
referred to as the "Property")
as well as a 1985 Buick Regal automobile ("Buick"). The
Property and the Buick were owned by Mr. and
Mrs. Durber and at all relevant times were, and are, located
in Havasu, Arizona. The Canada Customs and Revenue Agency
("CCRA") assessed Mr. Durber primarily on the
basis that he did not have a reasonable expectation of profit
("REOP") from the rental of the Property and the Buick
and therefore denied the expenses. At trial I advised Mr. Durber
that in view of the Supreme Court of Canada decisions in
Stewart v. The Queen and Walls v. The
Queen, I would not give
much weight, if any, to whether or not he had a REOP from renting
the Property and Buick and he need not unduly concern himself
with the REOP question. The issue before me is whether
Mr. Durber's activities with respect to the Property
constituted a source of business or property income during the
years in appeal for purposes of section 9 of the Income
Tax Act ("Act").
[2] Mr. Durber sought to deduct losses
of $7,266, $7,929 and $5,678 in filing his tax returns for 1997,
1998 and 1999 respectively. Because he had greater income than
Mrs. Durber, he claimed all the losses from the Property,
notwithstanding that he and she have equal interests in the
Property. I informed him that if he were successful in these
appeals, the losses available to him would be reduced by
one-half, subject to further decreases if the amounts of the
losses were inaccurate, as alleged by the respondent.
[3] Mr. Durber is a captain with
the District of West Vancouver Fire Department. He has worked for
the Fire Department for over 24 years. During the years in appeal
Mrs. Durber worked as a legal secretary. The Durbers have one
child who was born in 1988.
[4] The Durbers had no experience in
owning or operating rental property prior to November 1996, when
they purchased the Property for US$20,000. They mortgaged their
residence in Burnaby, B.C. for $27,000 in order to fully finance
the purchase of the Property. The interest rate on the mortgage
was 6.7 per cent; the blended payments of principal and
interest were payable in monthly installments of $529.62. The
mortgage was paid off in 2001. (In November 1996, the exchange
rate was US$0.75 for C$1.00, according to
Mr. Durber.)
[5] Mr. Durber had visited or
"passed through" the Lake Havasu area on holidays on
about three occasions before 1996, and "realized how popular
a vacation spot it was". Lake Havasu is located in the
Arizona desert. It is a holiday resort. Mr. Durber
understood that a mobile home on Lake Havasu could rent for as
much as a house fixed to the land. The mobile home purchased by
Mr. and Mrs. Durber is about 50 feet long and 12 feet wide.
It contains a kitchen, two bedrooms, living room and bathroom. A
20-foot deck is attached to the home. The mobile home rests on a
pad rented to the Durbers by Beachcomber Resort for US$320 per
month. The rented area also includes a hedge on one side, a
gravel driveway, a 144 square foot yard and a small garden. The
mobile home was 25 years old at time of purchase. Mr. Durber
described the interior as "clean but well used". The
carpets and furniture were "well worn". The boat
included with the purchase of the mobile home was a 21-foot
pontoon, a boat slip was included with the rent of the pad.
Mr. Durber anticipated renting the Buick to tenants who did
not have an automobile available during their vacation at the
resort. He also intended to rent the boat to his tenants. In
fact, he has never rented either the boat or the
automobile.
[6] The US$320 rent paid to the
Beachcomber Resort also includes laundry facilities, a swimming
pool, security and office staff. Most of the tenants of the
Beachcomber Resort stay for at least three months; according to
Beachcomber Resort rules, the minimum sublease is for three
months. The Beachcomber Resort also charged a tenant a US$50
monthly fee when a mobile home was subleased. There are some
full-time residents at the resort. Most, if not all tenants, are
retirees. There are activities for tenants throughout the
year.
[7] Mr. Durber's intention, he
testified, at the time of acquisition of the Property was to rent
the Property and supplement the family income. He anticipated
renting the Property to Canadians during the winter months and to
persons from the Los Angeles area who liked boating and water
sports during the summer months. Mr. Durber explained that
most of the subtenants at Beachcomber Resort were repeat renters
so he hoped that once he rented the Property, the same tenant
would continue renting the Property in future years as
well.
[8] The appellant did not have much
success in renting the Property during the years in appeal. He
canvassed other mobile home owners in the Beachcomber Resort and
realized they also were experiencing difficulty in renting. He
was told that "word of mouth" was the best advertising.
He did not advertise for tenants in Los Angeles newspapers
because of the high cost of doing so. He posted advertisements at
the resort's office and in several traffic areas near the
Beachcomber Resort such as the local Safeway store. The appellant
acquired the Property in November 1996, too late, he said, to
rent on the open market for the winter of 1996-1997. Therefore,
in order to reduce his expenses, he rented the Property to his
parents for part of December, 1996 and about three months in
1997.
[9] Mr. Durber continued to rent
the Property to his parents for four months in 1998 and 1999. His
parents were unable to occupy the Property in 2001 but apparently
paid him the rent for "six or seven
months". His parents had used the
Buick when occupying the mobile home. He and his family also
visited the Property during spring break at the end of March
during 1997, 1998 and 1999. Mrs. Durber and their daughter would
stay about 10 days, Mr. Durber would remain at the Property for
about four to six weeks each year. Mr. Durber testified in
order to reduce expenses, he devoted time while at Beachcomber
Resort to repairing and maintaining the Buick, the boat and the
mobile home.
[10] The respondent claims that
Mr. Durber charged his parents rent that was less than
market value. Mr. Durber testified that he was able to get
the Beachcomber Resort to exempt the US$50 charge on the sublease
to his parents; therefore he could charge them US$50 less than he
would charge other sub-lessees. He explained that he was
new in the rental business "in a market that was quite
literally foreign to me". Also, the condition of the mobile
home was a factor to consider to determining rent. He explained
that he rather have a tenant paying something than no tenant
paying nothing. His parents, Mr. Durber declared, were "a
last resort".
[11] Mr. Durber recalled his parents did
not always pay their rent on time. Payments of rent were made in
cash. They would pay when they had money available. Sometimes
they would pay only a portion of the rent and the balance would
be paid later. On the other hand, his parents would advance him
money for expenses. Mr. Durber did not keep a record of
rental payments. He "knew what my parents owed
me".
[12] The reason for increased costs in
subleasing the Property, according to Mr. Durber, was due to
the fall in the value of the Canadian dollar after he purchased
the Property. "The dropping Canadian dollar greatly affected
my rental market in Canada." He also is of the view that the
market for American tenants decreased "over the next several
years due to events out of my control, namely, poor economy,
dropping stock market, which affected some retirees'
pensions". Mr. Durber is referring to the period from
1997 on. [I take judicial notice that the values of major stock
market indices did not fall from 1998 on but, on the contrary,
started to rise in 1998 and had their greatest values in 2000
but, at time of trial, returned to 1997 values.]
[13] In assessing, the CCRA revised
Mr. Durber's rental income for 1997 from $2,000 to
$2,400. The attached Schedule 'A', which was entered as
Exhibit R-1, shows rental income and claimed expenses for 1996 to
2000 inclusive as well as gross rents and net loss claimed for
2001. Attached Schedule 'B', which was entered as Exhibit
A-5, shows Mr. Durber's "Proposed Profit and Loss for
1997/1998/1999" which he prepared on the eve of trial from
calculations he had made close to the time he acquired the
Property.
[14] In 2001 Mr. Durber also received
rental income from a Mr. Strasman, a
non-arm's length subtenant, for three months.
Mr. Durber charged Mr. Strasman US$650 a month plus the
US$50 charge required by the Beachcomber Resort. Mr. Durber also
obtained a tenant for the period starting the last week of
December 2001 to March 15, 2002; the rent was US$750 per month.
Mr. Durber did not know if this rent included the sublet fee of
US$50. Other tenants were found to rent the Property during the
period of April 20 to May 31, 2002 and from the end of June to
Labour Day 2002.
[15] The greatest expense claimed by the
appellant was not the interest on the money borrowed to acquire
the Property but the pad or trailer park rent paid to Beachcomber
Resort. Interest and pad rent were claimed as follows:
1996
1997
1998
1999
Interest
$210
$1,534
$1,181
$826
Trailer pad
rent
$881
$5,755
$6,713
$6,723
[16] Mr. Durber reported the following rental
revenues:
1997
1998
1999
$2,000
$3,680 $3,566
[17] According to Schedule 'B', Mr.
Durber's projected income from the mobile home was US$700 per
month for 12 months. He also projected rental income of US$350
per month for three months for the car and boat, an aggregate of
US$9,450. To this, he added a 25 per cent exchange rate
to arrive at income in Canadian currency of $11,812.50 per
year.
[18] The bulk of the expenses projected by
Mr. Durber was $6,355.44 in annual interest payments and
$4,800 annual for pad rental (in Canadian funds), a total of
$11,155.44; to this amount he added $360 for miscellaneous
expenses. Until the mortgage was paid off, he projected a modest
profit of $297.11. (Mr. Durber omitted to add another
miscellaneous expense of $125, which would reduce his profit to
$172.11.) However, he claimed interest expenses of only $210,
$1,534 and $1,182 for 1997, 1998 and 1999 respectively. There is
no explanation for the difference in the amounts of interest
projected and due under the mortgage and the amounts actually
claimed as expenses in calculating income. Indeed, during the
trial Mr. Durber stated that his accountant prepared his income
tax returns and he signed them. He declared that he relied on his
accountant and that he, himself, could neither answer nor explain
any amounts, or the reasons for the amounts, in his tax returns.
The accountant was not a witness.
[19] In Stewart, the Supreme Court of
Canada set down tests to determine whether a taxpayer's
activities constitute a source of business or property income for
the purpose of section 9 of the Act.
[20] The words and sections of the Act,
state Iacobucci and Bastarache JJ., determine whether a taxpayer
has a source of income. Section 3 of the
Act refers generally to at least four sources of income:
office, employment, business and property. Section 9 refers to
business and property income; to apply section 9 one must have a
source that is either business or property income. One may have a
source of income from property when a commercial activity falls
short of being a business. And there may be "some taxpayer
endeavours [that] are neither businesses, nor sources of property
income, but are mere personal activities". The Supreme Court
proposed the use of the following two-stage approach with respect
to the source question:
(i) Is the activity of the taxpayer
undertaken in pursuit of profit, or is it a personal
endeavour?
(ii) If it is not a personal endeavour, is the
source of the income a business or property?
[21]
The first stage of the test, the Court says, assesses the general
question of whether or not a source of income exists; the second
stage categorizes the source as either business or
property.
[22]
Iacobucci and Bastarache JJ., explain at paragraph 51,
that:
. . .
[e]quating "source of income" with an activity
undertaken "in pursuit of profit" accords with the
traditional common law definition of "business", i.e.,
"anything which occupies the time and attention and labour
of a man for the purpose of profit": Smith, supra, at
p. 258; Terminal Dock,
supra. As well,
business income is generally distinguished from property income
on the basis that a business requires an additional level of
taxpayer activity: see Krishna, supra, at p. 240. As such, it is logical
to conclude that an activity undertaken in pursuit of profit,
regardless of the level of taxpayer activity, will be either a
business or property source of income.
The purpose of this
first stage of the test is simply to distinguish between
commercial and personal activities, . . . this may well have been
the original intention of Dickson J.'s reference to
"reasonable expectation of profit" in
Moldowan.
. . .
[T]his "pursuit of profit" source test will only
require analysis in situations where there is some personal or
hobby element to the activity in question. Where the nature of an
activity is clearly commercial, there is no need to analyze the
taxpayer's business decisions. Such endeavours necessarily
involve the pursuit of profit. As such, a source of income by
definition exists, and there is no need to take the inquiry any
further.
It should also be
noted that the source of income assessment is not a purely
subjective inquiry. Although in order for an activity to be
classified as commercial in nature, the taxpayer must have the
subjective intention to profit, in addition, as stated in
Moldowan, this determination should be made by looking at
a variety of objective factors. Thus, in expanded form, the first
stage of the above test can be restated as follows: "Does
the taxpayer intend to carry on an activity for profit and is
there evidence to support that intention?" This requires the
taxpayer to establish that his or her predominant intention is to
make a profit from the activity and that the activity has been
carried out in accordance with objective standards of
businesslike behaviour.
[Footnotes added]
[23]
The REOP of a taxpayer's activity is only one of several
factors to consider, and it is not a conclusive factor. The
overall assessment to be made, caution Iacobucci and Bastarache
JJ., is whether or not the taxpayer is carrying on the activity
in a commercial manner. This assessment is not to
second-guess a taxpayer's business judgment. A judge
evaluates the commercial nature of the taxpayer's activity,
not anyone's business acumen.
[24]
The deductibility of an expense itself is a separate question
from the existence of the underlying source of income. Thus a
taxpayer may have income from a business but certain deductions
may be disallowed because they are personal; the business itself
is not affected and all other expenses may be deductible in
computing the income from the business.
[25]
Their Lordships summarized their reasons at paragraph
60:
. . .
[t]he issue of whether or not a taxpayer has a source of income
is to be determined by looking at the commerciality of the
activity in question. Where the activity contains no personal
element and is clearly commercial, no further inquiry is
necessary. Where the activity could be classified as a personal
pursuit, then it must be determined whether or not the activity
is being carried on in a sufficiently commercial manner to
constitute a source of income. However, to deny the deduction of
losses on the simple ground that the losses signify that no
business (or property) source exists is contrary to the words and
scheme of the Act. Whether or not a business exists is a separate
question from the deductibility of expenses. . . . As well,
unlike many statutory stop-loss rules, once deductions are
disallowed under the REOP test, the taxpayer cannot carry forward
such losses to apply to future income in the event the activity
becomes profitable. As stated by Bowman J.T.C.C. in
Bélec, supra, at p.123: "It would be ... unacceptable to permit the
Minister [to say] to the taxpayer ... 'The fact that you lost
money ... proves that you did not have a reasonable
expectation of profit, but as soon as you earn some money, it
proves that you have now such an expectation.'"
[Footnote
added]
[26]
There is no doubt that there is a personal element in
Mr. Durber's activities. First, the Property was rented
to his parents and second, he and his family used the
Property. [I acknowledge that Mr. Durber worked on the Property
in order to reduce expenses.] The payment of rent by his parents
to Mr. Durber was dependent on the parents having the cash
to pay the rent. Mr. Durber maintained no records of
payments from his parents or how much rent was due at any
particular time and when any amount due was eventually paid. The
only other persons on the Property during the years in appeal
were the appellant, his wife and daughter.
[27]
I am also disturbed by the fact Mr. Durber was unable to
answer questions with respect to various items included in his
income tax returns or on documents attached to the returns that
were put to him by the respondent's counsel. There is no
explanation as to why the interest expenses claimed in his tax
returns are less than those actually incurred. His attitude was
that his accountant prepared the material and he relied without
hesitation on his accountant. It did not appear that
Mr. Durber instructed or assisted his accountant in
preparing the returns or the financial information attached to
them. I assume that a taxpayer engaged in business would have at
least some rudimentary knowledge of his or her business accounts,
Mr. Durber appears to lack this knowledge.
[28]
Mr. Durber did not establish that his predominant intention
on acquiring the Property in 1996 was to make a profit from the
activity and that activity was carried out in accordance with
objective standards of businesslike behaviour. That
Mr. Durber did not have a net profit from the Property
during the years in appeal does not lead me to conclude that the
Property was not a source of income to him. In my view when he
acquired the Property he was of two minds, one, to rent the
Property and two, to make the Property available to his parents
while they could enjoy it and to his family, and the latter was
his motivating reason to purchase the Property. During the years
in appeal, the Property was not a source of income to the
appellant.
[29]
The appeals are dismissed.
Signed at Ottawa, Canada,
this 8th day of August 2002.
J.T.C.C.
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