Ravi Sakhuja and Debbie Sakhuja v. Her Majesty the Queen (Informal Procedure), [1994] 1 CTC 2840

Kempo, J.T.C.C. (orally):—These informal procedure appeals of Ravi Sakhuja and Debbie Sakhuja were, on consent application, joined for hearing on common evidence. The taxation years under appeal, 1986, 1987 and 1988 were identical to both appellants as were the issues raised for resolution. Accordingly, and while Debbie Sakhuja did not testify, the evidence given by Ravi Sakhuja will apply and be determinative of the issues raised in her appeal.

The pleadings as filed disclose the core issue being centred on interest-free advances taken by the appellants qua shareholder from a company owned equally by them which was called City Cope Physiotherapy Inc. (hereafter called “City Cope"). The Minister assessed a deemed interest benefit applicable thereto pursuant to section 80.4 of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the "Act") in the sums specified in paragraph 5(a) of each reply to notice of appeal, some of which amounts being admittedly overstated as conceded by paragraphs 11 and 12 thereof. The replies reveal, by paragraph 5(b), that some interest expense amounts were allowed as deductions pursuant to section 80.5 of the Act.

The litigation focused on interest amounts disallowed under section 80.5 and paragraph 20(1 )(c) of the Act respecting the advances taken and purportedly used by the appellants respecting acquisition of rental properties called Crosspointe, Lambs Court, Chrisdon Road, Harbourview and Lakeshore Road. Crosspointe encompassed two apartment condominiums, Lambs Court was a townhouse condominium, Chrisdon Road was not particularly described in the evidence, Harbourview was an apartment condominium and Lakeshore Road was a commercial property to which the appellants had hoped to relocate the physiotherapy practice.

The issue was described in the appellants’ notices of appeal as "the deductions allowed under section 80.5 are substantially less than the appropriate deductions warranted based on the fact that the shareholder advances were utilized for investment purposes". However the issue, as framed in the replies by the respondent acting through the Minister of National Revenue the "Minister") was "whether interest expenses in excess of the amounts allowed were incurred by the appellant for the purpose of gaining or producing income from a business or property”. In my view the respondent's pleading correctly frames the substantive issue in that it recognizes the inclusive operative provisions of paragraph 20(1)(c) of the Act. In other words, the mere acquisition of capital type properties is not enough in itself having regard to these inclusive provisions. Further it is the direct use of the funds as deemed to have been borrowed that is to be determinative: see The Queen v. Bronfman Trust, [1987] 1 S.C.R. 32, [1987] 1 C.T.C. 117, 87 D.T.C. 2059.

By way of overview, section 80.4 of the Act deems a benefit to have been received when an interest-free loan has been received by a taxpayer by virtue of his or her shareholdings in a company, and section 80.5 provides that the amount of that deemed interest benefit will, for the purposes of 20(1 )(c) of the Act, be deemed to be interest paid or payable within that provision. That takes us directly into paragraph 20(1 )(c) which provides that interest on borrowed money used for the purpose of earning income from a business or property, or used to acquire property for the purpose of gaining or producing income therefrom, may be deducted in computing a taxpayer’s income for a taxation year notwithstanding paragraphs 18(1)(a), (b) and (h). This notwithstanding aspect operates to allow deductibility of interest expenditures which would ordinarily be non-deductible on a current basis because of their capitalization requirements. In any event, 20(1 )(c) mandates that the borrowed funds be used directly for the purposes of gaining or producing income as per 20(1 )(c)(i) or from property acquired for that purpose as per 20(1 )(c)(ii).

Before turning to the aforementioned properties one preliminary observation I would like to make is that detailed evidence about each was rather sketchy. There is a strong probability here that the appellants’ agent, a chartered accountant, together with the Minister's officials and counsel, had explored each property as to their particulars and purposes and had failed to come to any consensus, all of which likely gave rise to Mr. Sakhuja’s tendency to frame his evidence-in-chief using expressions involving conclusions rather than facts. The appellants’ case was conducted by the aforementioned chartered accountant, Mr. Joseph Schlett, who tended to put questions to Mr. Sakhuja in a leading and broad conclusive form contrary to the Court's expressed cautions and concerns. It is the Court's experience that when this happens the facts underpinning the opinion-based evidence-in-chief are either omitted or are incomplete, and the case as a whole suffers thereby. In any event, I shall do the best I can, given the oral testimony and the documents filed as exhibits.

Exhibits A-1 was a voluminous book of documents with the evidence-in-chief being directed mainly to the shareholder loan accounts and financial statements within tab F.

Crosspointe was two apartment condominiums to be constructed which were acquired by interim agreement dated March 21, 1986 (see tab E). The purchase payments were progressive to match construction stages. There was no clear evidence as to when actual possession was gained. One letter dated December 19, 1986 from a lawyer, Bruce Hillyer, to the appellants implies occupancy had not yet been gained. An August 18, 1986 letter from the builder indicates construction had then commenced, and then there are lawyer reporting letters one year later regarding the purchase. Strangely enough the shareholders’ loan account as prepared (tab F) indicates a credit of $45,000 recorded as "deposit of personal funds sale of Crosspointe" under the date September 1986, purportedly to offset the shareholder advances used for their purchase. This must have been an error because the 1987 and 1988 returns of income reported net losses arising from the Crosspointe rentals along with their sale in 1988 at a net gain of $35,000 which was fiscally claimed by the appellants on account of capital. The reason for the rental losses was attributed to one bad tenant who would neither pay the rent nor vacate the property. The other renters broke their lease and vacated early. The appellants’ plan was that market value rentals would be charged which should carry each unit. That would not be the immediate situation however. Rents were expected to rise with the rising real estate values and thus a break even point would be enjoyed followed by actual profits if rent increases continued. Having had the bad tenant experience (this being the first such venture) and knowing that prices for real estate were accelerating, a decision to sell rather than to try again was made.

Apparently the appellants made no contingency plans for those commonly experienced situations or risks normally involving bad tenants and vacancies as the properties were profitably sold soon after being faced with these events.

In my view the appellants have failed in their onus to establish on an evidentiary balance of probabilities that there was any reasonable expectation of profit arising out of the Crosspointe property acquisition, see Moldowan v. The Queen, [1978] 1 S.C.R. 480, [1977] C.T.C. 310, 77 D.T.C. 5213 at C.T.C. page 313 (D.T.C. 5215), and the subparagraph 20(1 )(c)(ii) provisions have therefore not been met.

The Lambs Court townhouse was acquired by agreement (undated) which called for occupancy on 31 March 1987; see tab E of Exhibit A-1. The 1987 returns of income reported its sale that year at a net gain of $13,675 which was claimed as a capital gain. That return also reported nil rental income with expenses (and therefore loss) totalling $4,886.77. The evidence was that it was held for a few months with no luck in obtaining tenants. No business plan was produced. In my view the appeals should fail respecting this property for essentially the same reasons as noted respecting Crosspointe.

Chrisdon Road was apparently acquired in June of 1988. No rental income or expenses were reported for that year. For the period of January 1 to October 31, 1989, gross rentals were reported of $3,465 with expenses of $3,643. The evidence again was replete with bad tenant experiences and vacancies. One tenant was a Chartered accountant who stayed only two months rather than twelve months as per the lease and he put stop payments on his rent cheques. It seems that having already suffered bad tenant problems the appellants’ naivety in this field of endeavour was continuing as any reasonable amount of intelligent preplanning would have taken bad tenant risks into account. The evidence was unclear as to whether this property was sold, although I believe that was the case. The appeal concerning this property also fails for the same reasons as Crosspointe and Lambs Court.

With respect to H arbourview, this property was admittedly acquired on behalf of City Cope and was not beneficially owned by either of the appellants. The appeals must therefore fail respecting this property.

Turning lastly to the Lakeshore Road in Burlington, this was said to be a commercial building acquired by 744492 Ontario Inc. (the "numbered company") which was incorporated effective 22 December 1987 and was owned equally by Mr. Sakhuja and Dr. Jeffrey Morris, both of whom were its directors and officers. The property acquisition occurred sometime during December 1987 and/ or January 1988. No purchase transaction documents were provided at trial, nor was there any factual evidence provided as to the property's rental and situational attributes. Mr. Sakhuja testified that Dr. Morris was to have put his medical clinic on the main floor, and City Cope's physiotherapy clinic was also going to be a tenant through relocation to the second floor of these premises (next to other tenants on that floor) as it was thought to be a better situs for its business. Mr. Sakhuja said architectural plans were drawn up for the physiotherapy space and a permit obtained. Apparently Dr. Morris fell behind in contributing his share of the financing shortfall (see pages 62 and 63 of tab E), he married and moved to the United States, ostensibly abandoning part of the financial and all of the tenancy commitments he had made.

According to Mr. Sakhuja the shareholder advances received from City Cope as itemized in tab F of Exhibit A-1 were used as shareholder loans to the numbered company to enable it to keep its financial commitments going respecting the Lakeshore Road property. These amounts were transacted continuously in this manner until March 30, 1989 at which time Mr. Sakhuja transferred his 50 per cent interest in the numbered company to City Cope. According to the numbered company's financial statements, it was shown to be indebted to Mr. Sakhuja for $62,604 as at March 31, 1988 and for $88,346 to City Cope as at March 31, 1989. The latter financial statement includes comparative figures which by note states these debts were non-interest bearing with no fixed repayment terms.

Mr. Sakhuja said he transferred his interest in the numbered company to City Cope in March of 1989 because he was no longer financially able to fund its debt load and that City Cope had the funds and resources to do so.

To Mr. Sakhuja the advances received from City Cope and paid to the numbered company up to March 31, 1989 satisfied paragraph 20(1 )(c) of the Act because they were made for the purpose of gaining or producing income from the Lakeshore property which at the outset was subject to a well thought out business plan with a reasonable expectation of profit. From this he said there was an expectation of a stream of income in the form of dividends to be gained from the numbered company. This however proved not to be the case as the financial statements show it in a continual loss situation until 1990 when it sold all its fixed assets (being land, building and equipment) at a gain of $286,864.

No factual evidence was tendered respecting Lakeshore's profitable potential which would have enabled the Court to objectively assess its projected revenues and expenses and thus objectively test the reasonableness surrounding those projections. No description of the structure, the site, its history or its ability to attract tenants was given. Indeed, and apart from the aforenoted occupation intentions, no factual evidence was produced to test the reasonableness of the project as envisaged. The City Cope physiotherapy clinic did not move in notwithstanding its alleged better location and neither did Dr. Morris. The numbered company suffered operational losses until it sold the assets at a gain reported on account of capital. Where are the projected dividends, real or anticipated, excepting out of the sale of the asset?

Even if the Lakeshore property had different attributes from the other properties, including the desirable elements arising out of more direct control by its owners via their planned occupancy, the evidence was totally deficient as to any concerted efforts being made to hold it for rentals under a revised plan. Was there actual total frustration? If so, what were its particulars so that the Court could have objectively analyzed and confirmed that this indeed was the case.

Persuasive inferences arise from the evidence that the original plan never really got off the ground, that Mr. Sakhuja simply gave up after Dr. Morris left, that he had or was having difficulties with other rental properties and that by transferring his interest to City Cope he was essentially trying to make the best out of a situation within which he was very vulnerable. The Lakeshore Road property was acquired and the shares held in the numbered company were transferred at a time of rising real estate prices. As noted earlier, the sale ultimately produced dividends, But they were sourced in capital gains and not from operations.

The evidence in its totality leaves me dissatisfied that the evidentiary onus has been met by the appellants respecting compliance with paragraph 20(1)(c) of the Act. Lakeshore Road, like the others, was given up when it presented less than ideal circumstances for the appellant. This is not the mark of an investor. One could say that the two and one-half years of holding before its sale was not short, and I would agree that that is so. But it is only one analytical factor of importance to be utilized in a determination respecting stated investment purpose. No original or alternative plans, prospects or projections were produced into evidence from which an objective determination could be made with respect to addressing the overriding statutory concern of a reasonable expectation of profit emanating into an income stream in the form of dividends or otherwise directly from the numbered company or indirectly from City Cope after March of 1989.

Mr. Sakhuja's subjectively based testimony and opinions do not provide the ultimate answer as that is the Court's function which must be drawn from and based on the evidence as presented. I do not question his sincerity or credibility, but the failure to produce appropriate objective evidence to support his views, opinions and position has fatally impaired his case.

Conclusion

For the reasons given, the appellants having failed to meet the requisite evidentiary onus of profit to show error on the part of the Minister, the appeals are to be allowed, without costs, and the matter is referred back to the Minister of National Revenue for reconsideration and reassessment solely to enable the appellants to have the benefit of the admission made in paragraphs 11 and 12 of the replies to notice of appeal that the deemed interest benefit pursuant to section 80.4 of the Act is to be reduced by $118 for the 1987 taxation year and by $2,755 for the 1988 taxation year.

Appeals dismissed.