Heinz Heinze, Edith Heinze v. Minister of National Revenue, [1985] 1 CTC 2046, 85 DTC 51

Tremblay, TCJ:—These appeals were heard on common evidence on June 8, 1984 in the city of London, Ontario.

1. The Point at Issue

The general points are whether each of the appellants, husband and wife, partners in the ownership of an apartment building and of a farm, are correct in the computation of their income

(a) for the year 1977 to claim a mortgage reserve of $28,200 in the sale of the apartment building;

(b) for the years 1978 to 1980 to claim the following expenses with respect to the farm:

$10,292.98 (1978) — $15,051.26 (1979) — $15,307.54 (1980)

The respondent, on the basis that it was more reasonable, reduced the mortgage reserve to $5,640 for each appellant for 1977 so that a capital gain of $22,560 ($28,200 - $5,640) and a taxable capital gain of $11,280 be included in the income of each appellant for the said year 1977.

For the years 1978 to 1980, the respondent disallowed the farming expenses on the basis that the farm was neither held nor used primarily for the purpose of producing income.

2. Burden of Proof

2.01 The burden of proof is on the appellant to show that the respondent’s assessment is incorrect. This burden of proof results particularly from several judicial decisions, including the judgment delivered by the Supreme Court of Canada in Johnston v MNR, [1948] CTC 195; 3 DTC 1182.

2.02 In the same judgment, the Court decided that the assumptions of facts on which the respondent based the assessments are also deemed to be correct. In the instant case, the respondent’s assumptions of facts are described in paragraphs 10 and 11 of the reply to notice of appeal, which read as follows:

10. In reassessing tax as aforesaid, the respondent relied, inter alia, upon the following findings or assumptions of fact:

(a) those facts hereinbefore admitted;

(b) the appellant and his spouse sold in 1976 an apartment building for proceeds of disposition of $775,000, taking back a mortgage of $100,000 and making a total capital gain of $87,422.75 (50% allocated to appellant = $43,711.37);

(c) under the terms of the mortgage taken back on the sale of the apartment building, no amount for the repayment of principal was due until the 1981 taxation year of the appellant, when the entire principal amount became due;

(d) the appellant in filing his return of income for the 1976 and 1977 taxation years claimed a mortgage reserve of $28,200 (50% of $56,400) which amount was not a reasonable amount in respect of the proceeds of disposition from the apartment building that was not due until after the 1977 taxation year as can reasonably be regarded as a portion of the capital gain resulting from the sale of the apartment building;

(e) the farm purchased in 1978 consisted of 93 acres, an old house, a barn, a poultry house and an implement shed;

(f) the farm was not operated by the appellant with a reasonable expectation of profit;

(g) the land on the farm was not used in or held in the course of a business carried on in the 1978, 1979 and 1980 taxation years by the appellant or held primarily for the purpose of gaining or producing income of the appellant from the land for those years;

(h) the appellant with his spouse received the following revenues and incurred the following expenses with respect to the farm:

Year	1978	1979	1980
Revenue	$ 1,100	$ 2,500	$ 2,747
Expenses	11,392.98	17,551.26	18,054.54
Loss	$10,292.98 $15,051.26 $15,307.54;

(i) in 1978 the land and the buildings of the farm were rented out; in 1979 and 1980 only the land was rented out;

(j) the appellant and his spouse did not pay wages to their sons for the purpose of gaining or producing income from a business or property in excess of $1,450 in 1979 and $2,200 in 1980.

11. The purchase price of $131,717 for the farm was attributable as follows:

land	— $116,000
house	— $ 7,500
barn & sheds	— $ 6,500
legal fees	— $ 1,717
	$131,717

3. Settlement on the Mortgage Reserve

At the beginning of the trial, the parties informed the Court that the issue of the mortgage reserve related to the 1977 taxation year will not be necessary to be considered. It can be resolved outside the Court. Therefore the only point concerns the farming operation.

4. Facts

4.01 The only witness was the appellant Heinz Heinze. He was 47 years old in 1977. Previously he had been a carpenter/cabinet maker. Because of health problems however, he was forced to stop.

Jointly with his wife Edith, he acquired apartment buildings. In 1977 they had two; one located at 50 Doon Road, Kitchener and one located at 15 Lang’s Drive, Cambridge. The gross rent income for that year was $31,348.10 and the net rent income was $9,124.28, the part of each one being $4,562.14. The main expenses in that year were:

These figures come from the statement filed as Exhibit R-2.

4.02 On July 15, 1978, the appellants purchased a 93-acre farm from Harold Zacks, in trust, for $130,000: $2,500 as deposit, $80,000 as first mortgage from the vendor, $47,700 paid at the time of the purchase. These figures come from the “Statement of Adjustment” prepared by the barrister Shelton Kosky (Exhibit R-1). This farm was located on Bleams Road in the Township of Nilmot.

In the same Exhibit R-l it appears that a liability insurance in the amount of $200,000 and fire insurance on the buildings in the amount of $15,000 were taken out from the Economical Mutual Insurance Company.

4.03 When they purchased the farm, a Mr Peter Nopper was tenant of the farm. On June 26, 1978, the said Mr Nopper signed an acknowledgment of tenancy for the farm. (Exhibit A-l) The rental payment was $2,500 per year: $1,200 for the house (payable $100 per month), $1,200 for the land (payable $1,200 on December 31, 1978). The appellants’ first complete rental year was 1979. For the five months of 1978, the income statement of the farm (Exhibit R-2) shows a loss of $10,292.08 (income $1,100 less expenses $11,393.98). The main expenses are:

4.04 In the spring of 1979, the farm was rented for two years to another person, Mr Lyle Woolner, the owner of the farm next door. No written agreement was filed. It seems that since the appellants could not work the land themselves, they were interested in renting the land to Mr Woolner.

to get the land in better shape; to get it rotated; to get manure; what land needs to be maintained in a good workable condition. (TS pp 13, 14)

4.05 With their sons, the appellants also worked on the land. They did the kind of work that a tenant does not do: clearing land, repairing the fences, maintenance of the buildings, drainage (replacement of broken tile beds), etc. For that work they paid their sons in cash. No evidence (documents, etc) was given to prove the quantum. The roof of the old house was repaired and then the house was used for storage by the tenant, Mr Woolner, and by the appellants.

4.06 With respect to the years 1979 and 1980, the statement of rental income (Exhibit R-2) for the farm was as follows:

4.07 The reason for the purchase of the farm was to work the farm. (TS pp 5, 16)

and the reason why I didn’t work the land was the equipment. (TS p 5)

Indeed on the farm there was no equipment. The basic equipment would have cost $100,000.

We did not have money, we could not pour money in. We were paying mortgage already and then the interest went so high . . .

4.08 Even if the appellants wanted to work the farm, however, they didn’t want to live on the farm because the house on the farm was 130 years old. It was not in good shape. It needed money again to repair it and the appellants already had a house in Kitchener.

4.09 When they purchased the farm in 1978, there was, in addition to the house, a barn. (it constantly needs maintenance, it was an “average usable barn” — TS p 18) and a drive shed, a pig barn and a poultry house. They were mainly interested in the land when they purchased it. The land was good for corn production and alfalfa.

and if there is to be a live herd, there’s a good adequate supply of water. (TS p 18)

At the time of the purchase they really were not interested in renting the farm. They had figured that the next season

we would take it over for ourself. (TS p 19)

However the high cost of acquiring machinery prevented them from working the land themselves. Between 70 to 80 acres out of 93 were workable. The soil is sandy loam.

4.10 In 1981, the appellants sold a property and with the money they paid the Kruskas mortgage (money lent by the parents of Edith Heinze) and the H Zacks trust mortgage.

4.11 For the years 1981 and 1982, Mr Lyle Woolner was still the tenant but for the years 1983 and 1984 his son was. No written agreement was filed. The production is corn and alfalfa. In 1983 on some of the fields, Woolner’s son could take off four crops of alfalfa for ensilage.

4.12 As Exhibit A-2 the appellants filed the appellants’ income statement for 1983. The income and expenses concerning the farm are in substance as follows:

5. Law — Cases at Law — Analysis

5.01 Law

The main provisions of the Income Tax Act involved in this case are:

Sec 18(2)

(2) Limitation re certain interest and property taxes on land. Notwithstanding paragraph 20(1 )(c), in computing the taxpayer’s income for a taxation year from a business or property, no deduction shall be made in respect of any amount paid or payable by the taxpayer in the year and after 1971 as, on account or in lieu of payment of, or in satisfaction of,

(a) interest on borrowed money used to acquire land, or on an amount payable by him for land, or

(b) property taxes (not including income or profits taxes or taxes computed by reference to the transfer of property) paid or payable by him in respect of land to a province or a Canadian municipality,

if, having regard to all the circumstances, including the cost to the taxpayer of the land in relation to his gross revenue, if any, therefrom for that or any previous year, the land cannot reasonably be considered to have been, in that year,

(c) used in, or held in the course of, a business carried on in the year by the taxpayer, or

(d) (Repealed, 1974-75-76, c 26, S 7(2)).

(e) held primarily for the purpose of gaining or producing income of the taxpayer from the land for that year,

except to the extent that the taxpayer’s gross revenue, if any, from the land for that year exceeds the aggregate of all other amounts deducted in computing his income from the land for that year.

Sec 18(3)

(3) Meaning of certain expressions. In subsection (2),

(a) “Land". — “land” does not, except to the extent that it is used for the provision of parking facilities for a fee or charge, include

(i) any property that is a building or other structure affixed to land,

(ii) the land subjacent to any property described in subparagraph (1), or

(iii) such land immediately contiguous to the land described in subparagraph (ii) that is a parking area, driveway, yard, garden or similar land that is necessary

for the use of any property described in subparagraph (1); and

(b) “Interest on borrowed money used to acquire land". — “interest on borrowed money used to acquire land” includes

(i) interest paid or payable in a year in respect of borrowed money that cannot be identified with particular land but that may nonetheless reasonably be considered (having regard to all the circumstances) as interest on borrowed money used in respect of or for the acquisition of land, and

(ii) interest paid or payable in the year by a taxpayer in respect of borrowed money that may reasonably be considered (having regard to all the circumstances) to have been used to assist, directly or indirectly, another person with whom the taxpayer does not deal at arm’s length to acquire land to be used or held by that person, otherwise than as described in paragraph (2)(c) or (e), except where the assistance is in the form of a loan to that person and a reasonable rate of interest thereon is charged by the taxpayer.

5.02 Analysis

5.02.1 Income from Property

The appellant contends that the farming operation is part of the appellants’ business operation. There is no evidence that the income from the whole rental operation of the appellants is a business income. Therefore the Court must consider that income as income from property.

Concerning the appellants’ farming operation, the Court, basing on the evidence:

(a) of the existing lease agreement at the time of the purchase of the farm,

(b) on the well-known increase in interest rates in 1978 which prevent the appellants from purchasing farm machinery,

(c) on the weak health of the appellant,

(d) on the renting of the farm in 1979 to a Mr Woolner and later to the son of the latter until now (paragraphs 4.03, 4.04, 4.07), the Court cannot consider that the income is from farming operation but rather, income from rental operation; income from property.

5.02.2 Application or not of 18(2)(3)

The main contention of the respondent is that the appellants’ farm land is undeveloped land within provisions 18(2) and (3) quoted above (paragraph 5.01) and thence that interest expense property taxes are not deductible. The appellants’ contention is that these provisions apply essentially to vacant land held for resale or development. This contention would be correct if the provision had not been changed in 1979 with an application from November 16, 1978. Before that date indeed, subparagraph (c) reads as follows:

(c) used in, or held in the course of, carrying on a business by the taxpayer other than a business in the ordinary course of which land is held primarily for the purpose of resale or development, or . . .

Since November 16, 1978, the change varies the interpretation. Indeed, the present provisions 18(2) and (3) quoted above in paragraph 5.01, with the exception of commercial parking lots [18(3)(a)] apply only to undeveloped land.

In sum, the expenses (interest and property taxes) may not be deducted unless in all of the circumstances it can be reasonably considered that the land was in the year either:

(a) used or held in the course of a business carried on in the year by the taxpayer; or

(b) held primarily for the purpose of earning income from the land in the year. (18)2)(c), (e))

In my opinion, during the years involved the farm land was not “used in or held in the course of, a business carried on in the year by the taxpayer’’ pursuant to paragraph 18(2)(c). The appellant indeed had no business.

Concerning provision 18(2)(e), having regard to the cost of the land, ($130,000) and the gross rent income ($3,000), it cannot be reasonably said that the land was “held primarily for the purpose of gaining or producing income of the taxpayer of the land’’ for those years. It seems to me that it is not only a question of intention but that the criteria must be objective as suggested by the wording of the provision.

5.02.3 However to the extent that the land, which does not meet the criteria described in (c) and (e) of 18(2), produces revenue in the year, after deducting all amounts deductible in computing income, the expenses of interest and property taxes may be deducted on a current basis. This is expressed in the last part of 18(2) after paragraph (e). In doing such computation, it is important to take into account the validity of the following expenses: the salary paid to the appellants’ son for maintenance labour, capital cost allowance and the residence on the farm.

5.02.4 Concerning the payment of salary to the sons, the respondent accepted the amount of $1,450 in 1979 and $2,200 in 1980, pursuant to paragraph 10(j) of the assumptions of facts quoted in paragraph 2.02 above. No evidence was given concerning more substantial payment. The Court must maintain the respondent’s position on that point.

5.02.5 Capital Cost Allowance

Pursuant to the assumption of fact paragraph 11 of the reply to notice of appeal quoted above in paragraph 2.02, the purchase price of $131,717 for the farm is attributable as follows:

No evidence was given by the appellants concerning the value of those buildings. Pursuant to the statement of adjustments (Exhibit R-l) a fire insurance of $15,000 (paragraph 4.02) on the buildings confirms the position of the respondent. In the appellants’ financial statement for 1983, the undepreciated capital cost for the barn was $18,500, for the drive shed $1,650 and for the pig barn $3,200. Only in the years 1978, 1979 and 1980 had they already claimed $10,702 of depreciation. Even at first glance, the appellants’ claims seem quite exaggerated. The Court therefore must maintain the respondent’s position.

5.02.6 Moreover, no evidence was given that in 1979 and 1980 the house was rented to Mr Woolner (paragraph 4.04). No written agreement was filed despite the fact that it existed. In the allegation of the notice of appeal, the appellant said

. . . by excluding the residence from the lease agreement. . .

clearly stated in fact that the residence was not rented to Mr Woolner. Therefore no rent income for the residence can be taken into consideration for the years 1979 and 1980. In the 1978 [sic], the respondent took this into consideration because the tenant had paid them $1,200 for the residence. (paragraph 4.03)

5.02.7 The Kruska Mortgage

Concerning the Kruska mortgage, it is not clearly stated by the evidence that the $833 of interest thereon paid in 1978 (paragraph 4.03), $2,000 in 1979 and $1,980 in 1980 (paragraph 4.06) was a result of a loan made concerning the farm. No agreement was filed concerning such a loan. One can see from the financial statements (Exhibit R-2) that in 1977 $2,800 of interest was paid concerning the said mortgage but only on the Doon Road property, (paragraph 4.01) The same quantum of $2,800 was again paid in 1978, 1979 and 1980 on the mortgage of the Doon Road property (Exhibit R-2). No payment appears concerning the said mortgage on the Lang’s Drive property in 1977, 1978, 1979, 1980 (Exhibit R-3) and 1983 (Exhibit A-2). Concerning the latter year however, the interest paid on the said mortgage on the Doon Road property (Exhibit A-2) appears to be $6,878. It was no longer in effect on the farm property for the year 1983. According to the appellant it was paid in 1981 (paragraph 4.10). No explanation was given concerning the $6,876 paid in 1983. Was it a new loan, or the transfer of the mortgage from the farm property on the Doon Road property? or both? the Court does not know. One can say it is not pertinent. However the absence of explanation seems to confirm the appellants’ allegation in paragraph 5 of his notice of appeal, which reads as follows:

By mistake the “Kruschka Mortgage” was spread over all properties though that mortgage existed before against all rental properties as a collateral mortgage; therefore, this mortgage cannot be considered a mortgage against the farm property per se.

In conclusion on this point, the Court must consider that the Kruska mortgage is not related with the farm. No evidence was given that the loan (or loans) was made for business purposes or renting property purposes.

5.02.8 Following the decision above, it would be appropriate to the parties to compute the appellants’ income, with respect to the years 1978, 1979 and 1980 to know whether the last part of subsection 18(2) as referred to in the first part of paragraph 5.02.3 is applicable or not. Moreover it would also be appropriate to settle the point concerning the mortgage reserve (paragraph 3) with respect to the year 1977.

6. Conclusion

The appeals are allowed in part and the matter referred back to the respondent for reassessment in accordance with the above reasons for judgment.

Appeals allowed in part.