Stefan Danis v. Her Majesty the Queen, [1996] 3 CTC 2889 (Informal Procedure)

Taylor J.T.C.C.: — These are appeals heard in Toronto, Ontario, on August 2, 1996 against assessments for the years 1991, 1992 and 1993, in which the Respondent had disallowed rental losses claimed against other income, under the Income Tax Act (the “Act”).

The Notice of Appeal, filed in January 1996 read in part:

TAKE NOTICE THAT Stefan Danis appeals to the Court from:

1991 Reassessment dated March 2, 1995

1992 Reassessment dated March 2, 1995

1993 Reassessment dated March 2, 1995

A. The reason for the reassessments is that Revenue Canada representatives did not consider that Stefan Danis has demonstrated a reasonable expectation of profit, and thus disallowed the claim for rental losses in each taxation year noted above. Stefan Danis believes that he has, in fact, demonstrated such a reasonable expectation.

B. A Schedule of Expected Rental Revenue and Expenses were provided to Revenue Canada during their audit. The analysis (see attached) indicated profitability was possible under expected market conditions.

Conditions in the rental market were very weak causing rental income to fall well below expectations. This caused actual losses instead of the rental profits expected.

C. The above reassessments were confirmed by the Appeals division of Revenue Canada by a letter dated October 11, 1995.

I ELECT to have the informal procedure provided by sections 18.1 to 18.28 of the Tax Court of Canada Act apply to his appeal.

Stefan Danis (signature)

			STEFAN DANIS
		STATEMENT OF RENTAL INCOME AND EXPENSES
	1988	1989	1990	1991
					1992
						1993
Actual rental
income 7,000 $ 16.760		$23.385	$14-304	$17.709	$15,928
					$15.928
Expected
rental
income*	$13,200	$27,000	$28,000	$29,200	$30,300	$31,500
						$31,500
Actual
expense	12.748	26,889	29.071	22.702
					25.312
						23,303
Expected
profit	à 452	$ 11]	($ 1.071)	$6,498	$4-988
						28,197
Loss reported
on Tl	($ 5,748)	($10.129)	($ 5.687)	($ 8.398)	($ 7.604)	($7,376)
						($ 7.376)
Rental
- Basement
(months)	4	12	12	2
					6
						3
- Ist Fir
(months)	3	6	12	12
					12
						I ]
- 2nd Fir
(months)		-

N.B. In 1993, all three units were rentable from September 1993.

* Annual rental increase of $ per cent assumed

In the Reply to the Notice of Appeal dated March 18, 1996, it was

stated:

5. The Minister of National Revenue (the “Minister”) assessed the Appellant for the 1991, 1992 and 1993 taxation years by Notices of Assessment mailed on July 15, 1992, April 16, 1993 and June 20, 1994, respectively.

6. The Minister reassessed the Appellant for the 1991, 1992 and 1993 taxation years, concurrent Notices thereof were mailed on March 2, 1995 to disallow the rental losses.

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

(a) the fact hereinbefore stated;

(b) the Appellant purchased a property situated at 94 Normandy Blvd, Toronto, Ontario (the “Property”) in 1988;

(c) the Property is a 2 storey brick residential home with an in-law basement apartment;

(d) at all relevant times, the Property was the Appellant’s principal residence;

(e) the Appellant divided the Property into three units, the main floor, the basement and the second floor, the Appellant occupied the second floor until October of 1993;

(f) in the 1991, 1992 and 1993 taxation years, the Appellant apportioned 34 per cent of the Property’s expenses as his personal expenses;

(g) during the 1991, 1992 and 1993 taxation years, the Appellant sought to sell the Property ;

(h) in November of 1993, the Appellant moved into his new principal residence situated at 30 Nursewood Road, Toronto, Ontario;

(i) from 1988 to 1994 the Appellant reported rental income, expenses and losses as follows:

		EXPENSES	(LOSS)
YEAR	INCOME
1988	$11,850	$17,598	($ 5,748)
1989	$16,760	$26,888	($10,128)
1990	$23,385	$29,071	($ 5,686)
1991	$14,304	$22,701	($ 8,397)
1992	$17,709	$25,312	($ 7,603)
1993	$15,928	$23,303	($7,375)
1994	$33,200	$35,983	($ 2,783)

(j) at all relevant times, the Property’s gross rents were not sufficient to cover the Property’s expenses;

(k) during the 1991 and 1992 taxation years and in the 1993 taxation year until the month of October, the Appellant rented out the basement and the main floor of the Property to help defray his personal expenses;

(l) the rental expenses in excess of the rental income (the “Disallowed Expenses”), as set out in Schedules I, were personal or living expenses of the Appellant;

(m) the Disallowed Expenses were not incurred for the purpose of gaining or producing income from a business or property;

(n) the Appellant had no reasonable expectation of profit from the Property during the 1991, 1992 and 1993 taxation years;

(o) in the alternative, Disallowed Expenses were not reasonable in the circumstances.

B. ISSUES TO BE DECIDED

8. The issue is whether the Appellant is entitled to deduct the Disallowed expenses in the 1991, 1992 and 1993 taxation years and, in the alternative, whether the Disallowed Expenses were reasonable in the circumstances.

C. STATUTORY PROVISIONS, GROUNDS RELIED ON AND RELIEF SOUGHT

9. The Respondent relies on sections 9 and 67, subsection 248(1) and paragraphs 18(1 )(a) and 18(1 )(h) of the Act as amended for the 1991, 1992 and 1993 taxation years.

In his testimony, Mr. Danis provided the following information on some of the points noted in the Reply to Notice of Appeal (above):

(c) the property is a duplex

(d) he did reside there during 1991 and 1992 but moved out during 1993

(e) there were two finished units when he purchased the property, and he proceeded to improve the basement area so that it could be rented, although he occupied it himself for some time. Also on other occasions when one of the upper apartments was vacant he did use it.

(f) after he moved out of the property in 1993, he charged all of the expenses to the rental income

(i) he agreed this represented the operating results for the seven year period

(k) he considered that the rental income from the basement helped to defray the cost of the investment property, not defraying his personal expenses

(l) he would be able to present receipts for the expenses charged to show they were not “personal expenses”

(m) he purchased the property in order to make a profit

(n) in his view the property is now showing a profit

Counsel for the Respondent filed with the Court, a copy of a questionnaire which the Appellant had completed during the assessment process. Among other statements therein were the following answers to relevant

questions:

- It should be noted that this property has been for sale on and off during the period assessed.

- N.B. In 1993, all three units were rentable from October 1993 (Annual rental increase of four per cent assumed)

In 1988, the occupancy rate in Toronto was going through the roof, thus favouring landlords. Unfortunately the real estate market fell and the rest is history.

- I only signed leases with tenants who requested it. I was told that leases are not enforceable anyways when someone leaves. I was successful with the main floor tenant. The basement apartment was a cheaper rent, typically appealing to fringe tenants, less committed, unhappy to be in a basement to start with, because of its lack of light. They were often single, students, with no furniture. Essentially, I took what we could. That apartment catered to a transient group. The apartment was always left looking like a dump, and required repainting to maintain it.

- The market turned from a high 98 per cent occupancy rate in the late 80’s, to a more modest occupancy rate. Both commercial and residential got hard hit. The house was older, tired and needed some work to be maintained. The upkeep was necessary to attract tenants and to keep them.

I couldn’t really increase the price for the long-term tenant as price sensitivity told me they would have left had they been increased. I raised them their first year and was then happy to have them as a quality, caring tenant. This was proven to be the right thing as when they ultimately left, I wasn’t able to replicate their rent and had to settle for a cheaper rent. Therefore, had they left as a result of an increase, I would have lost more revenues as they would have been replaced with a cheaper rent. I tried to increase the rent in the basement, but market. conditions dictated the amount of money I could get. I had to offer parking space as an incentive at times, which was a hassle as someone needed to jockey the cars.

[...]

As important, I tried to get rid of this money loser frequently to cut my losses. However, the losses would have been far more significant had I sold as I would have sold $50K below the price I paid, + commission. At the time, I wanted the house maintained as I was also trying to sell it at certain times during that period and also wanted to attract tenants.

- First method is researching comparative rentals in the area, bordered by Coxwell, Gerrard. Woodbine, and the Upper Beaches. There was always some trial and error as well and you found out by interviewing prospective tenants that your prices were too high for the unit or vice versa. I assessed comparative rentals for either basement apartments or two bedroom units.

- Although I would be thrilled to turn a profit on the property, I’d rather get out. The property is always for sale. If a decent offer came through, say around $300,000, which represents approximately a $60,000 loss, I would take it. However, til then I am encouraged to say we have probably turned the corner, despite the fact that, as I learnt the hard way, there is always a large risk, especially with interest rates on the way up.

Basically, Mr. Danis, summarized his position - that he had grown up in a business oriented family, that he had examined the prospects for profitability when he purchased the property, and while he had been frugal and careful, the real estate market had changed in about 1991 and he continued to lose money while attempting to sell the property. He believed it now should continue to be profitable. He read into the record, certain excerpts from the recent case of Tonn v. R., [1996] 1 C.T.C. 205, 96 D.T.C. 6001 (F.C.A.), in which he saw support for his cause. His present calculations showed him that he could expect a profit of some $870,000 over the next 20 years of operation. He made the point that he could also anticipate a capital gain “on the property” when it might be sold in the future.

Counsel for the Respondent regarded the issue as quite simple, and dealt directly with Tonn, supra, since this had appeared to be so vital to the Appellant’s contentions. The explanations and corrections provided by the Appellant dealing with the Reply to Notice of Appeal (above) were minor, and did not affect the total impact of the facts and assumptions. The evidence presented had not demonstrated a “reasonable expectation of profit{} during the years under appeal, according to the “Moldowan Test”

in Moldowan v. R., (sub nom. Moldowan v. Minister of National Revenue) [1978] 1 S.C.R. 480, [1977] C.T.C. 310, 77 D.T.C. 5213, at pages 485-86 (C.T.C. 313, D.T.C. 5215). The Court was empowered to deal with this lack of a reasonable expectation of profit” issue, since there had been a “personal element” in the circumstances (suggested in Tonn, supra as important), in that the Appellant had resided in the property during the years in question. That for Counsel was sufficient to permit the Court, even under Tonn, supra to go directly to the Moldowan, supra criteria. It was pointed out that Mr. Danis himself had not had real estate experience prior to purchasing this property, and there was no evidence that, at the time of purchase in 1988, he had developed a realistic operating plan which would show the operation as capable of making a profit. Counsel identified several areas in the years under appeal, where some of the claimed expenses appeared to be somewhat distant from rental activity, and the same situation might have occurred in years previous to those under appeal.

Analysis

I would commence by repeating a comment made by the learned Judge Hamlyn of this Court, in Watt v. R., (sub nom. Watt Estate v. The Queen) (sub nom. Watt v. Canada) [1995] 2 C.T.C. 2148(D), 95 D.T.C. 423 from page D.T.C. 425:

When there has been no actual profit it would appear that fact alone is a presumption against a finding of a reasonable expectation of profit. That presumption, however, may be rebutted by the evidence submitted on behalf of the taxpayer.

In my opinion, the circumstance of this case which were presented to the Court do not support the contention of the Appellant, but rather might indicate that Mr. Danis acquired the property with the intention to renovate and repair it, live in it when it was convenient or economical to do so, rent it out for whatever revenue he could get and if possible sell it at a profit, perhaps during the period 1988 to 1990, but certainly after that time. I need make no final determination on that specific point, but I do recognize that Mr. Danis indicated to the Court, relying on certain comments from Tonn, supra, that he should be permitted the deduction of these operating losses, based on an eventual anticipated capital gain. The reference from Tonn, supra, at page 229 (D.T.C. 6015) 1s:

A further matter worthy of mention is that real estate, like shares, may be purchased not only to create an income stream but with an eye to an eventual capital gain. Mr. Tonn testified that “real estate is a good long term investment”. One reason why real estate and securities alike present good investment possibilities is that they offer the possibility both of earning income and of obtaining capital gains in the future. Purchasers usually intend to profit from both the income and the longer-term capital aspects, and, if they do, they pay tax on both sources of profit.

As I read the opinion expressed by the learned Justices above, I do not view this set of circumstances as one in which the co-mingling of the tax results from direct operating losses -(at issue) and the possibility of a future capital gain, (not in issue) is mandated. Mr. Danis did not bring to the Court’s attention any case law which might put the kind of interpretation on the words of the learned Justices which he has asserted, and I am not prepared to do so.

In dealing with the more general thrust of the Tonn, supra judgment as I noted above, Counsel for the Respondent regarded the evident “personal” aspects of the rental situation as effectively removing this matter from the results in Tonn, supra and thereby left it to be determined on the basis of “reasonable expectation of profit” according to Moldowan, supra. I have already recorded my views regarding some of the difficulties of putting too narrow an interpretation on the words of subsection 248(1) of the Act in Joseph v. R., [1996] 2 C.T.C. 2388 (T.C.C.) as follows, at pages 2396-97:

The comments of Counsel for the Respondent indicate that in cases of claimed losses it is not a simple task for the Respondent to ascertain all aspects of the “personal or living expenses” which may be involved or what “use or benefit” a taxpayer may see or anticipate in a particular venture (Section 248 of the Act). It is not entirely clear that it should be for the Respondent to so establish, in order to fulfil the provisions of section 248 of the Act, since the total specific knowledge on that aspect rests entirely with the taxpayer.

and

The personal agenda, or the social and psychological urges which would warrant this taxpayer to commence and to pursue a course so evidently un- profitable from a simply economic perspective, might well be an area not only beyond the responsibility of the Respondent to critically examine, but perhaps even beyond the right or capability so to do.

That being said, I am not certain from my reading of Tonn, supra that the mere occupancy by the proprietor of a vacant portion of a rental property places such an indelible and irrémissible blight on an appeal in a rental loss claim. Again I need make no final determination of that point in this matter -1 leave that to those more learned in the law. But I do point out that I would have difficulty accepting as the only requirement to escape from the conditions outlined in Tonn, supra - (as suggested by Counsel for the Respondent) - would be some limited personal use of the property. I do see other points which when added to the clear presence of this “personal” element, do make a “prima facia" case at least, in support of the Respondent’s assessments, and which would tend to bring it within the guidelines stated in Tonn, supra at page 224 (D.T.C. 6012):

The difficulty the taxpayer could not overcome was the inference, derived from the unreasonable nature of the expenses, that the business was in fact not operated for business reasons.

Among these I would note one, which is somewhat allied to the “personal” contention argued by the Respondent above, and was referenced by Counsel, that Mr. Danis had some inherent interest and longing to be in “business”, as his parents had been, and this acquisition fulfilled to some degree one of the criteria suggested in Tonn, supra at page 221 (D.T.C. 6010):

Rather, the element of personal enjoyment is the dominant, motivating force.

Further, it cannot be overlooked that another major factor to be found as part of a quotation in Tonn, supra at page 223 (D.T.C. 6011) was met at least in the eyes of the Respondent:

There should be a reasonable period in which to permit the enterprise to become self-supporting.

For the years 1988, 1989 and 1990 the Appellant had calculated and claimed losses totalling some $21,562.00, apparently without challenge by the Respondent - a respectable, possibly generous application of the law - and the most important factor in my mind.

This taxpayer is not asserting some odious “second guessing of business decisions” by the Respondent as the cause of these appeals. He is arguing that circumstances changed in 1991 and beyond and that in response to those changed circumstances, if he had disposed of his property he would have lost $50,000.00 or $60,000.00 - and he therefore chose to retain the property, continue to lose money and claim the losses. Neither of these directions would have given him any assurance whatever of a gain during the years in question, according to his evidence. That is not a question of a “bad business decision”. Rather it is a matter of choos- ing which alternative appeared to be the lesser of the two evils for him personally. While a completely understandable individual reaction, it bears none of the hallmarks of a business decision, other than that he expected to continue claiming the operating losses against other income and thereby reduce his tax burden. In what way this operation, no longer with a “reasonable expectation of profit”, might still be classified as a “bona fide business” tends to escape me.

It does not appear to me that the circumstances of this case for the years at issue, fit easily into a continuation of the exception noted for “start up costs” referenced in Moldowan, supra at page 486 (C.T.C. 314, D.T.C. 5215) as follows:

One could not expect a farmer who purchased a productive on going operation to suffer the same start-up losses as the man who begins a tree farm on a raw land.

[Emphasis added.]

and

(a) man who changes occupational direction and commits his energies and capital to farming as a main expectation of income is not disentitled to deduct the full impact of start-up costs

[Emphasis added.]

This was not a “productive on-going operation” by 1991, nor was it the “main expectation of income” of the Appellant. Based on the record, I am not impressed by the assertion of Mr. Danis, that he is now making a profit, and expects huge future profits. I would refer him to a comment from Joseph, supra at page 2397, which could provide some relief for him in future years as and if his expectations are realized:

Two statements from Mrs. Joseph’s Notice of Appeal, supra are of specific interest:

5. When the Business makes money Revenue Canada will claim its share as it always does.

6. I deem it unfair that which [sic] I make a loss, Revenue Canada refuses to accept my business as valid and bona fide.

Whether it was in her mind I do not know, but it raises the intriguing prospect of using the provisions of section 111 of the Act, part of which reads:

Losses deductible

(1) For the purpose of computing the taxable income of a taxpayer for a

taxation year there may be deducted such portion as he may claim of -

(a) non-capital losses - his non- capital losses for the 7 taxation years immediately preceding and the 3 taxation years immediately following the year;

I can appreciate that in her understandable zeal to utilize to the fullest extent the more immediate deduction provisions in the Act, this taxpayer might have tended to reject consideration of the above provision. Whether she could claim such “loss” deductions (even if initially denied by Revenue Canada) against profits actually realized later on, which profits would then help to prove her claim of the viability of the questioned venture would require examination. Such a practice might even lend itself to an added incentive for earlier profit production from such a venture, or conversely acceptance of the reality that the financial results demonstrated. A small ultimate profit in one year, still might not be adequate to overturn years of losses - to make a “source of income” - but I need make no determination of that point at this time. It might also be argued that the provisions of Section III above were inserted in the Act for the express purpose of providing a reliable and useful route for recording, even possibly reporting, but not immediately deducting, early or “start-up” losses incurred, as opposed to the more contentious “front-end loading” avenue frequently pursued.

Since both parties relied so specifically on Tonn, supra, I would refer to two other recent cases in which it has figured significantly in the decisions:

- Mastri v. R., [1996] 3 C.T.C. 2702 (T.C.C.) - allowed

- Betz v. R., [1996] 3 C.T.C. 2316 (T.C.C.) - dismissed

In my view, even with the generous areas for consideration expressed in Tonn, supra, these appeals fit more into the category evidenced by Betz, supra rather than by Mastri, supra.

Finally, I would quote from a judgment of the Federal Court of Appeal, Poetker v. R. [1996] 1 C.T.C. 202, (sub nom. Poetker v. Minister of National Revenue) 95 D.T.C. 5614, in which the learned Justice Stone commented at page 203 (D.T.C. 5615):

It is perhaps necessary to observe that a taxpayer who is able to deduct losses indefinitely where no reasonable expectation of profit from a property business exists, is, in effect, having those losses subsidized by the public at large.

There was evidence before the Tax Court judge to the effect that from the beginning the applicant had anticipated the resort development becoming a year-round operation rather than only a winter skiing resort. In the face of that evidence and the other evidence that was before her, the Tax Court judge found, at page 4:

My analysis of the whole situation is that while Mr. Poetker acted reasonably with a reasonable plan and approach when he acquired these two units in 1980, their profitability was, and remained, fundamentally locked into the resort being a year-round facility, a condition over which he had absolutely no control. What he did decide to do was to continue his high hopes that successive owner/developers would keep their promises in this respect.

In concluding that the applicant had no reasonable expectation of profit in the taxation years in question, the Tax Court judge had regard to the decision of the Supreme Court of Canada in Moldowan v. R., [1978] 1 S.C.R. 480 and to subsequent cases.

We are unable to distinguish the present case from that which was decided by the majority of this Court in Landry v. R., 94 D.T.C. 66242. It was there determined that the reasonable expectation of profit test was applicable. We do not read the majority decision as founded upon the presence of some personal benefit element in the taxpayer’s business activity.

The Respondent’s assessments are upheld, and the appeals are dismissed.

Appeal dismissed.