15 May 1998 Internal T.I. 9866660 - EXPECTATION OF PROFIT

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the Department.

Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle du ministère.

Reasonable Expectation of Profit

Notes for Rick Biscaro speech in Toronto - May 1998

1. Financing of shares that do not pay dividends

As set out in Bronfman Trust (87 DTC 5059), the purpose of the use of the borrowed money, and not the purpose of the borrowing, is the critical issue. If the shares cannot pay dividends it cannot be said that the purpose of the use is to earn income ie: no expectation of profit.

Draft paragraph 20(1)(qq) proposes to limit the deductibility of interest on preferred shares that pay a fixed dividend to the lessor of the interest paid or the amounts included in income. This supports the admin. position that where there are no dividends paid ie: no income then no interest would be deductible.

2. Borrowing to finance real estate

It is the current department position that where the return on a property (other than a preferred share) is lower than the interest on funds borrowed to acquire the property it is considered that there is no expectation of profit and the interest is not deductible. However, the gross revenue generated from the property is included in income.

In the recent Federal Court of appeal case Mohammed v. the Queen 97 DTC 5503 supported the position that to be deductible, losses must arise from situations where there is a reasonable expectation of profit. It was held that such a test was not eliminated by the Tonn decision. The court also held that the expectation of profit test must be applied independently of section 67 and such a test is “all or nothing”.

3. Capital Gains & Expectation of Profit

As stated in paragraph 5 of IT-445 subsection 9(3) provides that income from a property does not include any capital gain from the disposition of that property. Therefore, the potential capital appreciation of a property cannot be used to support a deduction under paragraph 20(1)(c).

This is supported by Ludmer (F.C.A) 95DTC 5035 and Ludco Enterprises Limited 98 DTC 6045 where the taxpayer was holding the shares in non-resident companies for capital appreciation and the dividend rate on those shares was much less than the cost of borrowing. It was held that the interest on monies borrowed to acquire the shares was not deductible since there was no expectation of profit since pursuant to subsection 9(3) capital appreciation is excluded from the determination of “income from property”.

In Glenda McPherson v. The Queen (98 DTC 1062) the court allowed carrying charges on the acquisition of a rental property even though the taxpayer admitted that it was acquired with the intention of making a profit from the resale of the property and not to earn rental income. The court considered and accepted that even though the taxpayer had reported the property as a rental property, the transaction was an adventure in the nature of trade. The property was inventory to the taxpayer.

The Department does not intend to appeal this decision as it was a finding of fact. Although, the court did not find that there was an expectation of profit it relied on the position that there was an adventure in the nature of trade.