Marga Betz v. Her Majesty the Queen, [1996] 3 CTC 2316 (Informal Procedure)

Taylor J.T.C.C.: — These are appeals heard in Calgary, Alberta on May 27, 1996, against amounts for the years 1990 and 1991 in which the Respondent disallowed certain expenses claimed against rental income from real property. The Reply to Notice of Appeal sets out the situation:

4. In computing income for the 1990 and 1991 Taxation Years, the Appellant deducted the amount of $27,076.09 and $53,563.94 respectively as rental losses computed as follows.

YEAR	INCOME	EXPENSES LOSS
1990	$7,619.81	$34,695.90	$27,076.09
1991	$8,606.20	$62,170.14	$53,563.94

5. The Appellant was reassessed in respect of the 1990 and 1991 Taxation Years on November 16,1993 to disallow the net rental losses claimed.

6. The Appellant submitted additional information in respect of the 1990 and 1991 Taxation Years and was reassessed on April 18, 1994 to allow additional expenses of $12,441.89 and $27,123.80 respectively.

7. The Appellant filed notices of Objection in respect of the April 18, 1994 reassessments on May 5, 1994.

8. In reassessing the Appellant for the 1990 and 1991 Taxation Years, on October 31, 1994 the Minister of National Revenue (the “Minister”) allowed additional expenses of $8,306.99 and $26,339.96 respectively.

9. In so reassessing the Appellant, the Minister made the following assumptions of fact:

a) the client operated two rental properties during the 1990 and 1991 Taxation Years, 720 1st Street NW Calgary, Alberta (the “Calgary property”) and 2531 Sokihie Road Maui, Hawaii (the “Hawaii property”);

b) expenses in excess of the amount allowed by the Minister were: (i) not substantiated; (ii) not incurred by the Appellant for the purpose of gaining or producing income from a business or property, but were personal or living expenses of the Appellant; (iii) on account of capital.

The Respondent relied on:

- on sections 3 and 9, subsection 248(1) and paragraphs 18(l)(a), 18(1 )(b) and 18(1 )(h) of the Income Tax Act (the “Act”) as amended for the 1990 and 1991 Taxation Years.

- he submits that the disallowed expenses were not incurred for the purpose of gaining or producing income from a business or property within the meaning of paragraph 18(l)(a) of the Act but were personal or living expenses of the Appellant within the meaning of paragraph 18(1 )(h) of the Act.

- in the Alternative, he submits that if the Appellant did incur the expenses for the purposes of gaining or producing income from a business or property, which is not admitted but is expressly denied, the amounts are capital pursuant to paragraph 18( 1 )(b) of the Act.

The claims for the two years, as filed with her original tax returns by

Ms. Betz were:

1990 Hawaii Calgary Total

Rentals 55.21281 $1.700.00 $7.619,81

Expenses

Property Taxes 466.72 480.00 946.72 Maintenance & repairs 4,822.38 7,047.12 11,869.50 Interest 5,595.97 7,800.00 13,395.97 Insurance 270.70 275.00 545.10

Light, heat & water 897.27 779.50 1,676.77 Advertisement 351.20 112.00 463.20

Administration 840.1.0 4.957.94 5,798.04

Total 13244.34 2145156 34.695.9Q

Loss (7.324.53) (19.751.56) (27,076.09)

Rentals 4386.20 4.220.00 8^606.20

When the trial started, the parties provided to the Court, an agreed position with regard to some of the items still outstanding. In summary this called for the Respondent to allow these further amounts:

The details of these additional items now considered to be deductible by the Respondent, did not appear to follow any evidentiary or case law pattern of which I am aware, and must be regarded as simply an extension of amounts already accorded to the Appellant, as noted above - for whatever reason. The relief provided in the two prior separate reassessments of 1994, particularly the breakdown between Hawaii and Calgary, was somewhat uncertain, but as well as I can understand it, the situation now before the Court would be: (1)

Note (1)

Reconstructed for purposes of these reasons by the Court, from the limited data available. If not completely accurate from a mathematical standpoint, it is not very far wrong, and any small difference should not affect the outcome of this matter. Just for the record I would note that additional amounts of “losses” were claimed in the amounts of $14,996.59 for 1990, and $12,686.52 for 1991 for something called Triangle

M. Developments, operated by Ms. Betz for “Property Subdivision and Sale”, which surprisingly were not viewed by Revenue Canada as having any relationship at all to the instant issues, and were allowed in addition to the totals above eventually allowed for these two “rental” operations. No explanation was provided for that apparent anomaly.

Note (2)

Ms. Betz still claims all the above ($14,639.87) as “current”, and had not abandoned any of the items completely.

Note (3)

Both years related to Calgary property apparently.

Note (4)

Presumably — a mathematical error or adjustments to some amounts account for this small difference — it was not identified at the trial.

Other than the above items, the Respondent seemed to have reached the final level beyond which he was not prepared to go. As background to the agreed information submitted (above), Counsel noted that from his file it seemed that the question of “reasonable expectation of profit” should have entered into the equation at an earlier stage — perhaps when concessions were made on the two separate occasions in 1994 and the reassessments struck. He referred to the recent Federal Court of Appeal case of Tonn v. R. (sub nom. Tonn v. Canada), [1996] 1 C.T.C. 205, 96 D.T.C. 6001 (F.C.A.), which might indicate some support for the reassessments in 1994, but was unable to provide further information to the Court. The remaining amounts not allowed, even at the trial, were largely in the category of “unvouchered expenses”, or the items which were regarded as clearly capital and not even subject to discussion, according to the Respondent.

Ms. Betz described for the Court her acquisition and interest in the two properties, and she was cross-examined on the details. In summary, in early 1980 she acquired for $250,000 the Calgary property, a wood frame structure built in the early 1900. The lot was only 60 x 100 and it is a three storey building, initially a single family home. She expects to spend a further $80,000.00 to $100,000 on restoring it, with the objective of making some money on it as a Bed and Breakfast establishment. Financing both the purchase and the renovations was extremely difficult, because the building was not “up to code”, as Ms. Betz described it. She discussed some of the items which the Respondent categorized as “capital” items, and described their addition to the place more to bring the building and its furnishings and equipment up to a standard representative of the way it would have been at the turn of the century; or doing things (electricity, paving, etc.) which are required now for its intended use. She had not applied to have the building designated as a “heritage” building since according to her there were certain “restrictions” involved which she did not wish to undertake. She had not received any “heritage” funding. It has been operating as a “bed and breakfast” since late 1991, but she gave no indication that the economics of the operation had improved at all. Recent appraisals have indicated the value to be about $380,000. The property had been used as a low cost rental establishment — five little suites in it before she bought it and she described it as a “rabbit warren”. She received an inspection “report” from the City of Calgary in 1991, but whether that meant the building was “up to code” she could not say. Before purchase she had an engineering report done — which she did not have with her — which primarily listed the more immediate changes to be done. She was at purchase, therefore aware that at least $80,000 would be required for the renovation.

With regard to the Hawaii property, it is a condominium which she owned with another person, from whom she bought it in 1989. She is using it for rental only - and rents it “as much as I can do” — when it is possible to do so, at an appropriate rental. She has visited it once or twice, and wanted to charge off more of the travel cost than has already been allowed by the Respondent.

Counsel for the Respondent provided the Court with a detailed analysis of the case law touching on the subject of rental properties, deductible expenses, and he dealt with the distinctions to be made between “capital” and “current” items, since this did seem to be a major focus of the issue as seen by the Appellant. He conceded that the additional items which the Respondent was prepared to allow today resulted from at least some further supporting information or explanations from Ms. Betz provided at the Court before the trial commenced.

Analysis

First I would note that although the Tonn (supra) judgment from the Federal Court came later than the 1994 reassessments involved in these appeals, earlier decisions of that era (1993 and 1994) seemed to point the way for some people toward a far more generous treatment of expenses claimed against rental property income than previously had been the case. This earlier case law (later referenced in Tonn (supra)) may have had a positive effect on the Revenue Canada posture and review process — at least positive from the viewpoint of Ms. Betz. It appeared to be difficult for Counsel to comprehend the magnitude of the expenses allowed in this matter arising out of the 1994 assessments, and as noted earlier, Counsel could not provide much enlightment on this aspect of the case. The Court made it clear to both parties that such a point was no longer the issue — Revenue Canada had determined, in effect by the reassessments noted above, that there had been a “reasonable expectation of profit” and little or no “personal element” in both properties Hawaii and Calgary, during the years in issue. It should be recognized that these reassessments followed the general outline of the directives to this Court ultimately provided in Tonn (supra), and possibly went beyond Tonn (supra).

As I see it, while the evidence to support the additional deductions agreed to just before the trial (see above) is very limited, the Court has little input to make there. With regard to the other items apparently totalling some $14,639.87 (see above) including those the Respondent states to be “capital”, not “current” I did not find in the testimony of Ms. Betz or the documentation available any support at all, for a conclusion different than that reached by the Respondent. That is the items are “capital” if deductible at all, not “current”. By any reasonable standards of which I am aware, Ms. Betz has been phenomenally successful in pursuit of her objectives with Revenue Canada to claim all (in the end most) of the expenses against the minimal income earned. I am not persuaded that there is anything particularly unusual or unique about the fact that the Hawaii property had not been rented before she took it over which is the only assertion she made to support her claim. For the Calgary property that, at least in her mind, had some heritage or historical significance to warrant the deductions permitted. Ms. Betz was unable to provide any other rationale for the relief she had already been granted or that she sought at this trial for the Calgary property, and it is difficult for me to see any substantive distinction between that background together with the intended purpose as a “bed and breakfast” establishment, and a routine purchase, renovation and rental of any other property. The description of the remaining items categorized by the Respondent as “capital” (see above $8,950.50) in Ms. Betz attempt to have these identified as “current” left me with the impression that she saw virtually anything expended on any property as immediately deductible, without regard to the long term nature of an investment, or the prospects of economic return. While these may have a “capital” element, as proposed by the Respondent, the nature of them and the use intended is so uncertain that I am not prepared to even agree with the Respondent that they are capital, since that would eventually require assigning items to particular classifications for possible capital cost allowance, details of which have not been demonstrated by either the Respondent or the Appellant. I am not required in this matter to determine if there was a “personal” element although the facts may point in that direction. That was negated by the Respondent’s earlier reassessments. But I do adopt the reservations in Tonn (supra) regarding such personal element, particularly condominium property. I note from Fiore v. R. (sub nom. Fiore v. Canada) (sub nom. Fiore v. Minister of National Revenue), [1993] 2 C.T.C. 68, 93 D.T.C. 5215 (F.C.A.), at page 69 (D.T.C. 5216):

Further, the evidence in the record disclosed that the work done by the applicants considerably exceeded that of maintenance and repair done to preserve a capital asset, and in fact involved a significant improvement to that asset.

As an overview of my own thinking on this specific matter of “capital” versus “income” I would refer to the case of Wager v. Minister of National Revenue, [1985] 1 C.T.C. 2208, 85 D.T.C. 222, wherein at pages 2209-11 (D.T.C. 223-24) the following comment is made:

To carry the perspective of the appellant in this matter to its extreme — a taxpayer could acquire the remnant of a building — virtually little but the shell — perhaps almost only walls and a floor, reconstruct the entire building for investment purposes, and charge the cost as repairs and maintenance” on the basis that during the year there had been some “rental income”. That situation I believe is absurd, but that absurdity does not arise only out of the strict wording of sections 18(l)(a) or 18(1 )(b) of the Act. The situation must be seen in the context of the distinction between sections 18(1 )(a) and 18(1 )(b) arising out of the relevant jurisprudence which has attempted to identify and highlight that contrast. Therefore, as I see it, the nature of an individual expenditure itself may not be, in circumstances such as this case, the sole criterion upon which the distinction is made. Clearly a replaced “door” can be a repair, but it also can be a capital expenditure in circumstances where the general overview of that accomplished by all the repairs is a total reconstruction or rehabilitation of the structure. The Minister, in assessing, is entitled to take an overview of the entire expenditure program, and it may almost be necessary, on some occasions, that the breakdown be done somewhat arbitrarily between “current” and “capital”. I am not aware of jurisprudence which would mandate for the Minister a course of accepting any or all individual items of expenditures as “current”, rather than viewing some of those expenditures as on the same continuum as the original capital asset purchase, leading toward a completion of that capital expenditure program.

While the Tonn (supra) judgment discounted the necessity to demonstrate positively a “reasonable expectation of profit”, that has already been accepted as a given in this matter, by the Respondent. Beyond that, I am unable to see even in the broadened perspectives of Tonn (supra) any basis in the evidence provided for relief above that agreed to already by the Respondent before the trial.

The appeals are allowed in order that further amounts of $5,609.41 and $2,403.92, for a total of $8,013.33 may be deducted against the rental income earned for the years 1990 and 1991 as agreed by the Respondent. The Appellant is entitled to no further relief. The entire matter is referred back to the Minister of National Revenue for reconsideration and reassessment.

Appeal was varied.