Anita Edwards v. Her Majesty the Queen (Informal Procedure), [1994] 2 CTC 2184, 95 DTC 234

Sarchuk J.T.C.C.:—These are appeals by Anita Edwards from assessments of tax with respect to her 1990 and 1991 taxation years. Pursuant to the provisions of section 18.1 of the Tax Court of Canada Act, R.S.C. 1985, c. T-1, the appellant has elected to have the informal procedure apply. Edwards was represented by an agent.

In computing income for these taxation years Edwards claims rental losses from a property described as 1121 Sandhurst Circle, Unit 2, Scarborough, Ontario in the amounts of $18,366 and $23,825.99 respectively.

In reassessing the appellant for those years the Minister disallowed the deduction of the rental losses. At issue before me is whether the expenses disallowed were incurred by Edwards for the purpose of gaining or producing income from property. This issue leads to an examination of the facts before me to determine whether she had a reasonable expectation of profit from the property in the 1990 and 1991 taxation years.

Mrs. Edwards purchased the property in September 1989 for $180,000. She financed approximately 92 per cent of the purchase price by way of a first mortgage of $139,500 at an interest rate of 12 per cent per year and a second mortgage of $26,500 at an interest rate of 16.75 per cent per year.

The property itself was intended to provide two rental units: an upstairs suite consisting of three bedrooms, bath, kitchen, dining room and living room and a self contained basement suite consisting of one all purpose room, a kitchenette and bath. Edwards testified that she was assured by the Century 21 real estate agent who convinced her to buy the property that it was located in a good area, was eminently rentable and capable of generating returns of $2,000 to $2,200 per month. In response to a leading question from her agent Edwards agreed that her belief of a reasonable expectation of profit flowed solely from the glowing scenario painted by the real estate agent. I gather from her subsequent testimony that she now understands that these projections were essentially a salesman's hyperbole.

After acquiring the properties she advertised in a Toronto newspaper, placed posters and made the property's availability for rent known by word of mouth. In 1990 the basement suite was rented a period of one month (at $600) while the upstairs was rented for $1,200 per month. The gross rental income in that year was $14,400, while the expenses totalled $32,766 of which $23,579 represented mortgage interest.

In 1991 the rental income dropped to $10,800 while the total expenses increased to $34,627, which amount again included a substantial amount of mortgage interest. In 1991 Edwards had a great deal of difficulty in finding a tenant for the basement suite and it was virtually empty for the whole year. The upstairs suite was rented to three individuals who shared the cost. One moved out and the other two apparently refused to pick up the rental shortfall.

In 1992 the remaining upstairs tenants moved out and it and the basement suite remained unrented. Ms. Edwards continued to encounter extreme difficulty in finding tenants with the result that the suites remained vacant. Ultimately the lending institution acted on its security and Edwards lost her property.

Conclusion

As I understood the appellant's position she believed, relying on the projections made for her by the real estate agent, that the property constituted a viable rental operation and had a reasonable expectation of profit.

The Minister’s position is that the appellant did not have a reasonable expectation of profit from this operation in the years in issue and thus it did not constitute a business.

At issue in this appeal is the right of Ms. Edwards to deduct for tax purposes the rental losses incurred by her. Paragraph 18(1 )(a) of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the "Act") provides:

18(1) In computing the income of a taxpayer from a business or property no deduction shall be made in respect of

(a) an outlay or expense except to the extent that it was made or incurred by the taxpayer for the purpose of gaining or producing income from the business or property.

In order to succeed she must demonstrate that the expenditures in issue were made for the purpose of gaining or producing income from business or property. From this flows the requirement that she was in fact carrying on a business within the meaning of the Income Tax Act. The burden of proof is upon her to establish that at the time that she carried on with this venture there was a reasonable expectation of profit.

The significant words found in paragraph 18(1)(a) are “for the purpose of producing income from the business or property". When we speak about a profit or a reasonable expectation of profit we are talking about a business. As Dickson J. said in Moldowan v. The Queen, [1978] 1 S.C.R. 480, [1977] C.T.C. 310, 77 D.T.C. 5213 at page 485 (C.T.C. 313, D.T.C. 5215):

Although originally disputed it is now accepted that an order to have a "source of income” the taxpayer must have a profit or reasonable expectation of profit. Source of income thus is an equivalent term to business.

The concept of reasonable expectation of profit thus is the fundamental principle applicable to situations such as the one before me.

The proof necessary to establish the existence of a reasonable expectation of profit from an enterprise goes well beyond the declared intentions or a taxpayer, even given under oath. Such statements, of course, cannot be ignored, but all of the facts surrounding the acquisition and the operation of the property, its earning potential, the carrying charges, the previous earning history and so forth must such as to satisfy an objective observer that a profit can reasonably be expected to flow from the venture.

In order to discharge the onus which rests upon her Ms. Edwards need not demonstrate that in buying the property she acted on the basis of some sophisticated analysis or advice regarding the prospects of rental income vis-a-vis rental expenses. However, she must put some evidence before the Court from which it can be objectively concluded that her conduct was that which could be expected of a reasonably prudent person becoming involved in a commercial undertaking designed to earn a profit from renting real estate. That is not the case here.

It is clear and well settled law that no activity can be regarded as a business within the meaning of paragraph 18(1)(a) of the Act if there is no reasonable expectation of realizing a profit from it. In my view this principle necessarily assumes that the primary intention of the businessman is to realize a monetary return from carrying on his business. It also goes without saying that there cannot be a business within the meaning of paragraph 18(1 )(a) of the Act if the maximum possible profit that can be expected from a business does not cover the necessary expenses of operating it (DeMontigny v. M.N.R., [1982] C.T.C. 2012, 82 D.T.C. 1034 (T.R.B.) (Cardin J.)). In this case Ms. Edwards has failed to establish that there existed a reasonable expectation of profit. Thus, in the circumstances, the appeal must be dismissed.

Appeal dismissed.