Date: 20000628
Docket: 98-2077-IT-I
BETWEEN:
BRIAN BOWEN,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
____________________________________________________________________
For the Appellant: The Appellant himself
Counsel for the Respondent: Ron Wilhelm
___________________________________________________________________
Reasons for Judgment
(Delivered orally from the Bench at Vancouver, British
Columbia, on September 1, 1999)
Bowie J.T.C.C.
[1] The Appellant purchased a unit in a condominium project in
Florida in 1985. He purchased it as an investment with a view to
renting it at a profit, and in the expectation that after perhaps
15 years or so it would be paid for and would be available to him
and his wife to use during retirement. In each of the years from
1985 to 1995 the unit produced not a profit, but a loss. The
Appellant has filed his returns under the Income Tax Act
(the Act) for all of these years on the basis that these
losses are available to be offset against his other income from
employment and a pension in the calculation of his income for the
year pursuant to section 3 of the Act.
[2] For the years 1992, 1993, 1994 and 1995 the Minister of
National Revenue has reassessed him on the basis that during each
of these years there was no reasonable expectation of profit from
this condominium unit, and that it is therefore not a source of
income, and its losses are not to be taken into account for the
purposes of section 3. It is from these reassessments that he
appeals.
[3] The condominium unit in question is located on the Gulf
Coast of Florida. It was built by an entrepreneur from Hull,
Quebec, and has in total 45 units. The Appellant purchased his
unit for US$65,800, which was raised by way of a mortgage for
US$47,900 and a bank loan for C$25,000, which at the then
prevailing rate of exchange yielded US$17,900. In other words,
all of the money to purchase the unit was borrowed.
[4] Along with the other unit owners, the Appellant entered
into a rental pool, which was governed by a rental pool
agreement, and was operated by a Florida corporation incorporated
for the purpose. That corporation, in effect, took charge of the
units for the purpose of advertising their availability, renting
them, maintaining them, doing the budgeting and financial record
keeping and the maintenance in connection with the units. The
rental pool agreement is one which ensures that it is greatly to
the advantage of the unit holders to remain as part of the rental
pool and, for practical purposes, makes it virtually impossible
for an owner who is dissatisfied to leave the rental pool. For
example, an owner leaving the rental pool would be required to
forego all rents from his unit for the ensuing year, while
continuing to pay the expenses for the unit.
[5] This condominium unit was not used by the Appellant or by
his family members, with the exception of one two-week period,
and two days in the year 1995, when he made a visit to Florida,
the purpose of which I shall deal with more fully in a moment.
Amongst the terms of the rental pool agreement, it was provided
that owners using their units, or any of the units in the
complex, could only do so by paying to the corporation the
wholesale rate for rental of that particular unit. The project
was aimed largely at the Quebec market and, as I understood the
evidence, it was heavily advertised in that market and, indeed,
many of the owners were from the province of Quebec or Eastern
Ontario.
[6] At the time the units were sold a prospectus was given to
would-be buyers which showed projected increases in the market
value of the units of 7 percent per year for the first 15 years,
and projected losses from 1985 to 1990. The projected losses were
in the amount of C$16,568 during the first year, 1985, increasing
to $24,008 in 1986 and then reducing steadily from there to
$17,800 in 1987, $3,343 in 1988, $1,134 in 1989 and $84 in 1990,
a total loss of approximately $63,000 over the first six years of
ownership. The projection also suggests that at a 50 percent
marginal rate of tax half of these amounts could be written off
against a taxpayer's other income.
[7] No doubt, the assumption of these declining projections of
losses is predicated on the assumption that rentals will reduce
the mortgage principal and, thus, the mortgage interest payable
on the units. On the basis of these projections, Revenue Canada
appears to have accepted that, at least during the first three
years of ownership, there would be losses which would be
deductible under section 3, and to have authorized that
withholding taxes be reduced accordingly in the years 1985, 1986
and 1987.
[8] In fact, the losses proved to be much greater than those
shown on the projection found in the prospectus. The gross
income, according to a table reproduced at paragraph 6(h) of the
Reply to the Notice of Appeal, and accepted by the Appellant as
being accurate, is shown in 1986 as being $16,976. The following
year it had reduced to $13,616 and in 1989 it was $10,354. By
1991 it was reduced to $2,875 and it declined from there steadily
to $1,635 in 1994, with an upturn to $3,571 in 1995. Expenses in
the meantime were seldom less than twice the gross income, and
during the years from 1991 to 1995 they seem to have been
generally about five or six times the gross income, producing
losses in the years 1991 to 1995 of $8,854, $3,921, $9,154,
$7,734 and $6,198. The apparent reduction in the loss for the
year 1992 is probably attributable to the fact that the Appellant
failed to include in his computation for that year what are
referred to as monthly subsidy payments. By that time, and in
fact probably earlier, the condominium directors, in preparing
their budget for each year, were projecting losses such that it
was necessary to make assessments at the beginning of the year
upon the unit owners so that there would be operating funds to
carry the condominium throughout the year. For example, in 1993
the assessment is described as an eight-month subsidy and the
amount of it in Canadian dollars is $4,800. In 1994 it was $3,600
over a six-month period and in 1995 it was $3,600 over a
six-month period.
[9] These losses were sustained by the Appellant,
notwithstanding that in 1988 he had sold certain other assets in
order to pay off the bank loan and thereby reduce the amount of
his yearly interest payments. By 1989 the owners of the units had
begun an action against the builder as a result of all these
losses, alleging that there had been certain misrepresentations
in connection with the original prospectus and the selling price
of the units. I was not given particulars of the exact nature of
the cause of action, but it clearly had its origins in the
unhappy financial results that the owners were then experiencing.
This action was abandoned in 1994.
[10] In 1995 the Appellant visited the complex and stayed
there for two days. During this visit he spoke with the manager
of the property, and with people engaged in the real estate
business in the area. At about the same time he also had
discussions with one or two people in Canada engaged in selling
real estate. Ultimately, his conclusion was that this investment
was, for practical purposes, a lost cause, and after two years of
unsuccessful attempts to find a buyer for the property he sold
his equity in the unit for ten dollars.
[11] The issue before me is whether, viewed objectively, as
the authorities require, it can be said that in 1992, 1993, 1994
or 1995 it was reasonable to expect that this condominium unit
might produce a profit. In other words, was it, during any of
that period of time, a source of income, such that the losses
emanating from it might be applied in the section 3
computation?
[12] I should say at this point that I do not view this as
being one of the class of cases described by Linden J.A. in
Tonn et al. v. The Queen[1] as a personal use property. While the
Appellant apparently had at least a vague intention that he might
use this property in retirement, this certainly was a long way in
the future and did not, I think, form any very definite part of
his planning at the time of purchase. The case, in my view, falls
to be determined simply on the prospects of the property being
able to produce an income in all of the circumstances.
[13] The Appellant in his evidence blamed the lack of success
of this property on a lengthy list of factors, including the
unfavourable rate of exchange between Canadian and American
dollars; adverse weather and, in particular, Hurricane Mitch
which devastated a good deal of the Florida coast; international
politics, both in Canada and in Europe; certain random shootings
which took place of European visitors to Florida; the Quebec
referendum and federal/provincial politics in general; the
recession; the high interest rates which prevailed at some times;
the high cost of medical insurance for people vacationing in
Florida; and the fact that, while his particular property was a
desirable one which rented easily, because of the pooling
arrangement it had to subsidize the results of less desirable
properties. Of all of these factors, only Hurricane Mitch could
be described as one which by the year 1992 was unknown or
unanticipated. All of the others were part of the environment of
the late 1980s and the early 1990s.
[14] It is, of course, trite to say that the Court should not
be quick to second-guess the business judgments made by
taxpayers. That said, however, it was clear before 1992 that this
condominium unit was far short of living up to the projections
which had been put forward by the vendor in the initial
prospectus, to which I referred earlier, and was not producing a
net income, even after the time when the bank loan was paid
off.
[15] The principle which governs in cases such as this is to
be found in the reasons for judgment written by Robertson J.A. of
the Federal Court of Appeal in Mohammad v. The Queen,[2] where he said at
page 5505:
Frequently, taxpayers acquire a residential property for
rental purposes by financing the entire purchase price.
Typically, the taxpayer is engaged in unrelated full-time
employment. Too frequently, the amount of yearly interest payable
on the loan greatly exceeds the rental income that might
reasonably have been earned. This is true irrespective of any
anticipated downturn in the rental market or the occurrence of
other events impacting negatively on the profitability of the
rental venture, e.g., maintenance and non-capital repairs. In
many cases, the interest component, is so large that a rental
loss arises even before other permissible rental expenses are
factored into the profit and loss statement. ...
Further on he says, at page 5506:
The above analysis is to the effect that there can be no
reasonable expectation of profit so long as no significant
payments are made against the principal amount of the
indebtedness. This inevitably leads to the question of whether a
rental loss can be claimed even though no such payment(s) were
made in the taxation years under review. I say yes, but not
without qualification. The taxpayer must establish to the
satisfaction of the Tax Court that he or she had a realistic plan
to reduce the principal amount of the borrowed monies. As every
homeowner soon learns, virtually all of the monthly mortgage
payments go toward the payment of interest during the first five
years of a tweny to twenty-five year amortized mortgage loan. It
is simply unrealistic to expect the Canadian tax system to
subsidize the acquisition of rental properties for indefinite
periods. Taxpayers intent on financing the purchase of a rental
property to the extent that there can be no profit,
notwithstanding full realization of anticipated rental revenue,
should not expect favourable tax treatment in the absence of
convincing objective evidence of their intention and financial
ability to pay down a meaningful portion of the purchase-money
indebtedness within a few years of the property’s
acquisition. ...
[16] In the present case, the loan for the down payment was
paid off within a few years, but this quite clearly did not make
the property a profitable one. Indeed, the loss reported for 1988
was $15,537 and for 1989 it was $10,178. The conclusion would
seem to be, therefore, that of the 1988 loss, only one-third was
eliminated by paying off the bank loan. I was not furnished in
the evidence with any particulars of the rate of rental of the
property, and so cannot conclude that the unfortunate financial
results of this project are attributable, either in whole or in
part, to a failure of the company running the rental pool to be
able to meet the initial projections with respect to occupancy
rates.
[17] In the present case, the Appellant certainly recognized
by 1995 that he could not reasonably anticipate profits from this
unit. In my view, all of the facts satisfy me that he should have
reached that conclusion at least by 1992, and probably a good
deal earlier than that. The Appellant, in the course of argument,
relied on the judgment of Thorson P. of the Exchequer Court in
National Trust Co. Ltd. (R.R. McLaughlin) v. M.N.R.,[3] where, according to
some abstract of that case that he had read, he said that the
Court there had found a reasonable expectation of profit,
notwithstanding something like 30 years of losses.
[18] I do not find in President Thorson’s judgment any
statement to the effect that there had been 30 years of
continuous losses by Mr. McLaughlin. In any event, Mr. McLaughlin
was a farmer and the appeal brought by his Executor was against
income tax assessments for the two years, 1944 and 1945. There
was substantial evidence in that case that Mr. McLaughlin had
been a very hard-working and knowledgeable farmer who had built
up a substantial and high-quality herd of Holstein cattle.
The finding of the Court was based very specifically upon expert
evidence that was led to the effect that Mr. McLaughlin had a
better-than-average herd, that it had become one of the best
herds in Canada, and that at any time during the last few years
of his operations, which of course, included the years under
appeal, Mr. McLaughlin could, if he had seen fit, have sold his
herd and shown a profit. The case, therefore, turns on that very
specific evidence, and has no application to the situation at
bar.
[19] As I have said, a person viewing objectively the
circumstances as they existed prior to 1992 would have reached
the conclusion that this condominium unit was not capable of
producing a profit, and it follows that the appeals are
dismissed.
Signed at Ottawa, Canada, this 28th day of June, 2000.
"E.A. Bowie"
J.T.C.C.
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