Pamela M. Reid and Jennifer A. Jackman v. Her Majesty the Queen (Informal Procedure), [1993] 2 CTC 3145

Bowman, T.C.C.J. (orally):—These are my reasons for judgment in the cases of Pamela M. Reid, 93-1080, and Jennifer A. Jackman, 93-1081.

These appeals were heard together on common evidence. The issues and amounts are identical. The question in each case is whether amounts spent by the appellants in 1989 were, as contended by the respondent, not laid out for the purpose of gaining or producing income from a business or property within the meaning of 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") and were, in any event, personal or living expenses within the meaning of paragraph 18(1)(h) or, as contended by the appellants, laid out for the purpose of earning income from a rental operation carried on by them and as a necessary cost of that operation. It was not contended that any of the expenses were capital in nature.

Mrs. Reid is a management consultant. Dr. Jackman is a medical doctor and is at present the Chief Executive Officer of the Chedoke-McMaster Hospital. In 1986 they both worked in Ottawa and lived in a rented house on Sandhurst Avenue in that city. In April of 1986 they purchased a semi-detached house at 11 Malden Square, Ottawa as an investment. The purchase was financed through a mortgage with the Bank of Nova Scotia and through demand loans with the Bank of Montreal.

The house was in good condition when they bought it, but some maintenance work and painting was done on it and they leased it for one year to a couple. They retained the services of a property manager who found the tenants, collected the rents and dealt with the tenants. When they left, the property was in good condition. The property manager found another couple, both real estate agents. The man left after three or four months and his girlfriend remained and her son and two dogs moved in. They moved out on July 31,1989.

They had caused the property to fall into a state of disrepair and disarray. Outside, the garden was overgrown, the lawn was ruined, plants and bushes were dead and the floor and railing of the deck which the appellants had built was smashed. Inside, the floors were scratched or ruined by ground-in dirt; the carpets were torn and soaked with do urine; the windows were broken; doors were off kitchen cupboards; the walls had holes in them; pieces of the sink were missing; the counter was damaged; appliances were not working and most of the lighting fixtures had disappeared. Moreover, the place smelled. In short, it was a shambles.

The appellants dismissed the property manager and undertook the task themselves of restoring the property to its original state and finding new tenants. This was largely done in the months of August, September and October of 1989. I need not detail the work that was done. Invoices were put in evidence in Exhibit A-1 and I accept that the work was done and that the money was spent.

The appellants had decided to try to find suitable tenants for the property themselves and they made enquiries among friends and relatives. Given their experiences with the most recent tenants, they wanted to be careful in the screening of prospective tenants. Students were generally considered unsuitable and unreliable. They wanted a couple with steady jobs who would take care of the property. They were not successful in finding such tenants, and in October of 1989 they had decided that they would move into 11 Malden Square themselves. They gave one month's notice to their landlord at Sandhurst Avenue in October and moved into Malden Square on November 1, 1989. Dr. Jackman stated that even after giving notice they would have been able to withdraw the notice and stay at Sandhurst had they found suitable tenants for the Malden Square property.

The total expenses claimed by the appellants in filing their returns of income were $32,018.99, each appellant claiming 50 per cent thereof. The $32,018.99 consisted of $2,198.20 in property taxes, $16,512.97 in respect of repairs and maintenance, $12,694.43 for interest, $373.33 for insurance and $240 for management fees. I was informed that of the $16,512.97 expenses, only $549.15 was allowed by the Minister. At this point the evidence gets a little murky. I was informed that the property taxes, interest and insurance of $15,506.02 represented %2 or /u of the total expenses — and this was not clear, which one — and that the $16,512.97 maintenance and repairs expense represented 80 per cent of the actual expenses incurred. The income tax returns show no such proration and I shall assume that the expenses claimed are indeed a portion of those actually incurred.

The Minister on assessing allowed only $549.15 of the expenses of $16,512.97 and only /i2 of the insurance, property taxes and interest, being the portion attributable to the period up to July 31, 1989 when the tenants moved out.

The Minister’s assessment is based upon the premise that there was a change of use of the property on July 31, 1989 from a rental property to a personal-use property; i.e., as the taxpayers' principal residence. This premise, in my view, is erroneous. It remained a source of income and an investment property until they moved into it on November 1, 1989, While they may have considered the alternative of using it for their own residence, the application of the Income Tax Act is not based upon the vagaries of a taxpayer's consideration of alternative uses. The change of use did not occur until November 1, 1989 when they in fact moved into 11 Malden Square.

They are, therefore, entitled to claim the interest expense, insurance and property tax expense up to November 1, 1989; that is to say, %2 of the annual costs of such items.

So far as the expenses of $16,512.97 are concerned, there are two bases upon which such expenses in my opinion are permissible deductions. In the first place, they were laid out for the purpose of gaining or producing income from property. It was their intention to rent the property up to the point at which they moved into 11 Malden Square. That intention was reasonable and there was certainly a reasonable expectation of profit. It would be an absurd interpretation of the Income Tax Act and a distortion of commercial reality if every time a rental property became vacant the expenses of maintaining it became non-deductible.

Here, admittedly, they ultimately moved into the property in November of 1989. The purpose on the facts and on the evidence, which I accept, was, however, to rent the property. That would be sufficient to dispose of the matter. It is, however, important that a somewhat broader principle be stated as well. The expenses which they incurred arose directly out of the rental operation that the appellants carried on. They were a direct and necessary cost of the operation. Since this is an informal procedure case, I do not propose to cite much jurisprudence, but the principle was stated in Canada at least as early as 1947 by President Thorsen of the Exchequer Court in Imperial Oil Ltd. v. M.N.R., [1947] C.T.C. 353, 3 D.T.C. 1090. I shall not quote from that case because the entire judgment, in my view, is the locus classicus on this point. It runs counter to ordinary common sense and to the concept of fundamental commercial reality to say that such expenses, which are a necessary and ordinary cost of operating a rental property, are not deductible simply because they were paid after the tenants who occasioned the expenses had moved out. To say that the expenses — or losses on one view of the matter — that were incurred as a direct result of the rental operation are not deductible is, in my view, an unrealistic and mechanical interpretation of paragraph 18(1)(a).

The appeals are allowed and the assessments referred back to the Minister of National Revenue for reconsideration and reassessment in accordance with these reasons. Counsel for the appellant is directed to prepare a formal judgment setting out the precise figures to be submitted to the Court. If the parties are unable to agree, it may be spoken to.

The appellants are entitled to their costs. There should, however, be only one counsel fee for both appeals.

Appeal allowed.