Kenneth W Scott, George H Silcox v. Minister of National Revenue, [1984] CTC 3040, 85 DTC 1

Cardin, TCJ:—The appeals of Kenneth W Scott and George H Silcox were heard on common evidence in the city of Toronto on October 5, 1984. The issue is the deductibility of rental losses claimed by each of the appellants in the 1978 and 1979 taxation years.

The facts are not contested. In 1977 each of the appellants acquired a 50 per cent interest in a property in Clearwater, Fla, USA. The property, a two- bedroom single-family dwelling, was purchased furnished by the appellants for $22,500 with a $2,000 downpayment and the balance, on a 5-year term first mortgage held by National Trust at eight per cent interest, amortized over 20 years.

Mr Scott testified that the property was rented four to five months a year and, although he could not remember exactly, he estimated that in 1978, 1979 and 1980, the property was rented for about $200 a month and up to $400 a month in 1981. Although no details were given as to the nature of the expenses (referred to in the appellants’ tax returns simply as travelling Canada-USA, telephone calls and miscellaneous), Mr Scott did state that the last repairs made to the property were with respect to the roof of the single-family residence.

In argument, it was alleged that the evidence clearly established that the intention of the appellants, in acquiring the property, was to operate it as a long-term profitable rental business. However, the total amount of revenues and expenses, as reported in their tax returns with respect to the property from 1977 to 1981 inclusive, does not support their expectation, nor does the type of property acquired and the manner in which the appellants operated what is alleged to have been a profitable rental property, corroborate their contention.

The amounts of revenues and expenses with respect to the property, appearing in the Minister’s reply and not contested by the appellants are as follows:

The expenses claimed by the appellants in 1978 and 1979 (the years actually under appeal) were $2,395 and $2,648 respectively (Exhibits R-l and R-2) and the corresponding losses for each of the appellants for those years was $1,582.99 and $2,097.90. The Minister disallowed the expenses incurred in excess of the rental revenues on the ground that they had not been expended for the purpose of gaining or providing rental income from the property, within the meaning of paragraph 18(l)(a) of the Income Tax Act, RSC 1952, c 148, but were personal or living expenses also not deductible by virtue of paragraph 18(l)(h) of the Act.

The question, of course, is whether the appellants had a reasonable expectation of profit and were in a rental income business in leasing a single-family dwelling. To satisfy the onus, it was necessary for the appellants to establish that, in acquiring the property, they had more than a vague intention of realizing a profit by leasing it, as the appellants’ representative appeared to believe. Counsel for the respondent cited several decisions which indicate clearly that the proof necessary to establish the existence of a reasonable expectation of profit from an enterprise goes well beyond the declared intention of a taxpayer, even given under oath. Such a statement, of course, cannot be ignored but all the facts surrounding the acquisition and the operation of the property, its earning potential and its carrying charges, must be such as to satisfy an objective observer that a profit can reasonably be expected to arise from its rental alone.

The most appropriate comments with respect to the circumstances of this issue are to be found in the decision of D E Taylor, member of the Tax Review Board (now the Tax Court of Canada), in Wesley H Warden v MNR, [1981] CTC 2379; 81 DTC 322, where it is stated at 2388 [328]:

The very fact a loss has been incurred in a taxation year from an operation alleged to be a “business” is a strong reflection against the proposition that there was a reasonable expectation of profit. To be successful in an appeal and overcome this obstacle (a loss which he wishes to claim as deductible from “business”), an appellant should provide substantial proof permitting a conclusion that the loss in question was unavoidable under the circumstances pertaining to that year. “Unavoidable” in the sense that his efforts were directed to making a profit in that year, and that the expectation of reaching that objective (a profit) while attainable, simply eluded him. Since those general criteria apply to an established on-going business, then the proof required must be at least as persuasive, in order to claim a loss, when the argument put forward by a taxpayer is that there was no possibility of a profit in a particular year in question. Simply alleging or even demonstrating that circumstances such as “long-range program”, “new business” or “start-up costs” accounted for the loss, and made it impossible to show a profit, is not an alternate to proving that there was a reasonable expectation of profit.

Irrespective of what the appellants’ situation may have been at the time of acquisition, and regardless of their argument that the property could not be expected to show a profit within the first few years of operation, the property in itself had little, if any, potential of showing a profit as a rental-income- producing-project. While the purchase of a single-family dwelling in Florida for $23,500 may well have been a “bargain price”, it was financed entirely by way of mortgage except for a $2,000 down payment. From the very start, the appellants were subjected to considerable interest charges which were to be added to operational costs taxes and other fixed charges. There was no evidence as to the state of the property on purchase and, as stated earlier, very little details were provided as to the extent of the repairs required or made, other than to the roof.

For the first five years the property was rented, but for only four months a year, and to only two lessees, according to Mr Scott. There is no concrete evidence that any effort was made to rent the residence for a longer period in the year, and Mr Scott was not even quite sure just what rent was being charged in the taxation years under review and in subsequent years. In the circumstances, I do not believe that the appellants would have had to provide the Court with a formal cost-benefit analysis or a market study to establish a reasonable expectation of profit but, surely, the application of elementary business sense and foresight on their part must be shown to have existed before their submission can be accepted. On the basis of the evidence, the appellants failed totally to establish that a profit could have been realized from the rental of their property. Even though the appellants’ representative claimed there was an increase in revenue and a decrease in expenses in 1981, the nature of the property itself and the appellants’ attitude toward it do not support the allegation that they had acquired the property with the intention of investing in a profitable rental business, nor did the appellants convince the Court that they could have had a reasonable expectation of profit on acquiring the property. While it was an assumption on the part of the Minister’s counsel that the appellants must have acquired the property for the purpose of reselling it at a profit, it was a plausible assumption which the appellants did not succeed or even attempt to demolish. Indeed, the evidence is that Mr Scott sold his share of the property in 1982 because he could not afford the consistent losses.

While certainly not as complete nor as determinative as the numerous criteria to be found in many decisions on the point, I cannot help but wonder, for purposes of this appeal, whether the appellants would have risked capital solely on the rental income potential of the property, and counted only on the profit that could be generated from the renting of a single-family dwelling . . ., if they had had no other source of income? I really do not believe so.

For these reasons, I hold that the Minister of National Revenue did not err in disallowing the rental losses claimed by each of the appellants in the 1978 and 1979 taxation years.

The appeals are therefore dismissed.

Appeals dismissed.