Kirkaldy v. R., [1997] 2 CTC 2259

Somers D.J.T.C.:

This appeal was heard in Toronto, Ontario, on November 27, 1996, pursuant to the Informal Procedure of this Court concerning the Appellant’s 1991, 1992 and 1993 taxation years.

The issues in this appeal are:

(a) whether the Appellant had a reasonable expectation of profit from the rental of the Property in the 1991, 1992 and 1993 taxation years;

(b) whether the rental expenses were incurred by the Appellant for the purpose of gaining or producing income from a business or property; and

(c) in the alternative, whether the disallowed rental expenses were reasonable in the circumstances.

The Respondent relied on sections 3, 9, and 67, subsection 248(1) and paragraphs 18(1)(a), 18(1)(b) and 20(1)(c) of the Income Tax Act, R.S.C. 1985, c. 1 (5th Supp.) (the “Act”) as amended for the 1991, 1992 and 1993 taxation years.

In assessing the Appellant the Minister of National Revenue (the “Minister”) made the following assumptions of facts which the Appellant admitted or denied:

(a) the Appellant and his spouse acquired a three-bedroom single family dwelling located at 131 Kane Avenue, Toronto, Ontario, M6M 3N1 (the “Property”) in 1989 as their personal residence; (admitted)

(b) beginning in 1989, the Appellant rented the basement of the Property, allocating approximately 50% of the total expenses to the rental activity; (admitted)

(c) from 1991 to 1993 the Appellant reported rental income, expenses and losses from the Property as follows: (admitted)

YEAR INCOME		INTEREST TOTAL		RENTAL	LOSS
		EXPENSE	EXPENSE	PORTION
1991	$4,700	$18,064	$22,295	$11,147	$6,447
1992	$4,800	$18,815	$23,967	$11,983	$7,183
1993	$2,100	$10,880	$14,894	$7,654	$5,554

(d) in 1989 and 1990 the Appellant also reported net rental losses in the amounts of $4,263 and $6,909 respectively; (admitted)

(e) the rental income received by the Appellant in 1991, 1992 and 1993 taxation years from the Property did not cover the interest expense allocated to the rental activity; (admitted)

(f) the Appellant rented part of the property to family members and charged rent below fair market value; (denied)

(g) the Appellant rented part of the Property to help defray the cost of maintaining his principal residence; (denied)

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

(i) the rental expenses claimed were not made or incurred for the purpose of gaining or producing income from a business or property; (denied)

(j) the rental expenses claimed were personal or living expenses of the Appellant. (admitted)

For the purposes of this appeal, it is sufficient to rely on paragraphs 18(1)(a), 18(1)(h) and 20(1)(c) of the Act which read as follows:

Section 18: General limitations.

(1) In computing the income of a taxpayer from a business or property no deduction shall be made in respect of

(a) General limitation - an outlay or expense except to the extent that it was made or incurred by the taxpayer for the purpose of gaining or producing income from the business or property;

(h) Personal and living expenses - personal or living expenses of the taxpayer, other than travelling expenses incurred by the taxpayer while away from home in the course of carrying on his business;

Section 20: Deductions permitted in computing income from business or property.

(c) Interest - an amount paid in the year or payable in respect of the year (depending upon the method regularly followed by the taxpayer in computing his income), pursuant to a legal obligation to pay interest on

(i) borrowed money used for the purpose of earning income from a business or property (other than borrowed money used to acquire property the income from which would be exempt or to acquire a life insurance policy),

(ii) an amount payable for property acquired for the purpose of gaining or producing income from the property or for the purpose of gaining or producing income from a business (other than property the income from which would be exempt or property that is an interest in a life insurance policy),

(iii) an amount paid to the taxpayer under

(A) an Appropriation Act and on terms and conditions approved by the Treasury Board for the purpose of advancing or sustaining the technological capability of Canadian manufacturing or other industry, or

(B) the Northern Mineral Exploration Assistance Regulations made under an Appropriation Act that provides for payments in respect of the Northern Mineral Grants Program, or

(iv) borrowed money used to acquire an interest in an annuity contract in respect of which section 12.2 applies (or would apply if the contract had an anniversary day in the year at a time when the taxpayer held the interest) except that, where annuity payments have commenced under the contract in a preceding taxation year, the amount of interest paid or payable in the year shall not be deducted to the extent that it exceeds the amount included under section 12.2 in computing the taxpayer’s income for the year in respect of the taxpayer’s interest in the contract,

The Appellant and his spouse bought the house in 1989 as their personal residence, financed with a first mortgage in the amount of $141,450.28 and a second mortgage in the amount of $42,500 for a total of $183,950.28. The questionnaire submitted for their responses indicated that interest payments in 1991, amounted to $12,355.37, in 1992, $18,815.96 and in 1993, $18,651.61.

A basement apartment was built for rental purposes as an investment. The bachelor apartment consisted of an open bedroom, equipped with a fridge, a toilet and a shower. There was an outside entrance to the apartment.

The apartment was rented in 1991 and 1992 to Mrs. Wilda Kirkaldy’s brother-in-law, at a rental rate of $400 per month, in 1991 and $450 in 1992. The apartment was rented to the Appellant’s son in 1995 at a rate of $350 per month. The apartment is still rented at $350 per month.

In cross-examination, the Appellant admitted that he did not make a profit, but the apartment was rented to create some revenues due to the high mortgage payments.

The Appellant would be allowed to deduct rental losses if he had a reasonable expectation of profit. The common law test requiring a “reasonable expectation of profit” was articulated by the Supreme Court of Canada in the case of 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.

The application of this test can be verified by reviewing, over a certain period of time, the profit or the reasonable expectation of profit. In this appeal it appears the Appellant cannot expect to make a profit. In fact the rental rate was reduced in 1993 in order to accommodate the Appellant’s son. That same rental rate of $350 was still in effect in 1996.

The Federal Court of Appeal in the decision of Tonn v. R., (sub nom. Tonn v. Canada) [1996] 1 C.T.C. 205, 96 D.T.C. 6001, 96 D.T.C. 6001, expresses itself in the following terms, at page 225 (D.T.C. 6013):

However, where circumstances suggest that a personal or other-than-business motivation existed, or where the expectation of profit was so unreasonable as to raise a suspicion, the taxpayer will be called upon to justify objectively that the operation was in fact a business. Suspicious circumstances, therefore, will more often lead to closed scrutiny than those that are in no way suspect.

The Tonn case, at page 221 (D.T.C. 6010), referred to the Huot v. Minister of National Revenue decision, [1990] 2 C.T.C. 2364, 90 D.T.C. 1818, illustrating the personal benefit element:

In this case, the taxpayer acquired certain properties from his parents and in turn rented one of them to his parents for a rental value far below the market rate. The applicant then attempted to deduct losses arising from this arrangement. The Tax Court Judge properly found that the applicant did not entertain a reasonable expectation of profit and dismissed the appeal.

The Appellant did not justify that the amount of the rent was established by the market rate. It is objectively quite evident that there was no reasonable expectation of profit.

The Appellant did not have a reasonable expectation of profit from renting the property in the 1991, 1992 and 1993 taxation years, the losses were personal or living expenses of the Appellant and, therefore, the Appellant was properly reassessed in accordance with paragraphs 18(1)(a) and 18(1)(h) of the Act.

The appeal for the 1991, 1992 and 1993 taxation years is hereby dismissed.

Appeal dismissed.