Gougher v. R., [1997] 2 CTC 2523

Sarchuk T.CJ.:

These are the appeals of Mr. Gougher from assessments of income tax for 1991, 1992 and 1993 taxation years. In computing income for those years, he claimed rental losses of $5,320, $4,710 and $3,430, respectively. The Minister assessed disallowing the deductions of these losses and on the basis that the Appellant did not have a reasonable expectation of profit from the rental operation in the years in issue.

I am going to read paragraph 18(l)(a) of the Income Tax Act, Mr. Gougher. It provides:

18(1) In computing the income of a taxpayer from a business or property no deduction shall be made in respect of

(a) 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;

That section has been the subject of a great deal of legal interpretation and it ended up in the Supreme Court of Canada in a case called Moldowan v. R., (1977), 77 D.T.C. 5213 (S.C.C.) which counsel for the Respondent has referred to. In that decision, the Chief Justice of Canada made a number of comments with respect to what this Court is to look at in the context of deciding whether an individual was carrying on a business, in other words, whether an individual had a reasonable expectation of profit. It is a somewhat difficult concept, if I may put it that way, for an ordinary taxpayer to understand but it is one that has to guide us.

You made reference to the case of Tonn v. R., (1995), 96 D.T.C. 6001 (Fed. C.A.). In my view Tonn applies principally to what can be described as clear cases where the property was a rental property and there is no personal implication of any kind. It certainly, in my view, does not readily apply to cases where there is a personal factor involved. Those are the hobby cases. Those are the cases where somebody buys a house and rents half of it to her mother for $50 per month and tries to write it off as a business expense and so forth. Tonn does not apply to those kind of cases at all.

Your case falls somewhere in between the two. There is, in my view, a personal element in that the acquisition of the house is clearly aided by the existence of a source of revenue. I am putting it badly, but I think you understand what I am getting at. On the other hand, there is no reason why in certain circumstances, the acquisition of a property which contains a rental unit cannot be viewed equally as the acquisition of a small rental property for revenue and income earning purposes.

The onus, what we call the responsibility, for establishing in any given case that there was a reasonable expectation of profit from that rental property lies on the taxpayer. It is the taxpayer that has to prove it, if I can put it that way.

Although I have a great deal of sympathy for your position, there are three major factors that lead me to conclude that the Minister’s assessment was correct.

First, the property was totally under-capitalized. If I could put it to you this way by analogy, just using your numbers for the sake of comparison. The purchase price of the house was $168,000. You say one-third of it constituted the unit downstairs in size approximately. That would be some $55,000 to $56,000 for that unit. If I were to ask you, would you go to the bank and borrow $56,000 to buy that unit as a profit-making venture, I think you know what your answer would be. It just does not wash, not if it is 100% financed. It is not a rational decision to make an expenditure of that amount of capital in the context of acquiring a revenue-producing property when you know that the cost inherent in the acquisition and you know the rentals which are available or might be available within a reasonable period of time.

That is probably the major point that concerns me. In that context, I have to go back to the Supreme Court decision since one of the criteria which the Supreme Court set out in the Moldowan case was the probability of the venture as capitalized to show a profit after charging capital cost allowance. Now, capital cost allowance does not even enter into the picture here. Your accountant never took capital cost allowance. It was not necessary, but conceptually, that is something else that we have to take into account.

As I said, given the fixed expenses and the rental market, it was, in your words, a dream or a faint hope that the property could, in the foreseeable future, show a profit.

The second part that troubles me is that the calculation of the share to be allocated to the rental property is disproportionate and not just in size. Because even if it is 33% of the total residence, it is certainly inappropriate to deduct 39% without some very good explanation. You may say that responsibility primarily rests with your accountant. But it must be said that a taxpayer, because it is his return, is ultimately the one who is responsible and certainly is the one who ends up paying any extra tax that has to be paid. More than that, the sketches which are attached to the questionnaire, which is Exhibit R-5, I believe would indicate that one-third is even excessive because there are areas such as the hallway, the furnace room, the utility room or whatever is down in the basement which are not part of the rented suite (for obvious reasons) and an access area which is allocated to the rental unit. But there has to be some access to the owner of the residence to get downstairs to attend to the furnace and the hot water tank and whatever else might be there, so that even on that basis, one-third appears to be slightly on the high side. That skews the expenses. That is a question that perhaps might more appropriately be considered in the context of section 67 but it is also a factor which was taken into account in my decision.

The last matter that gives me cause for concern is the fact that you chose, from the outset, to rent in what I would consider to be a non-busi- nesslike manner. I cannot think of another phrase. That is a little stronger than what I want to say. No effort was made to obtain, on the evidence anyway, permanent tenants, tenants that would come in on a yearly lease or something of that nature. I appreciate it might have been easier to rent to students but the simple fact is, students come and go. That means that there are dead periods in which you cannot rent the unit.

Every time there is a dead period that is a reduction in the potential income. In none of the three years in issue did the property ever produce a full year’s revenue. That is something that either was not taken into account at the time that the purchase was made or it was taken into account and was accepted. In either case, one is, in my view, a questionable business decision and the other demonstrates what counsel for the Respondent has ar- gued, a lack of planning before entering into what must be a business venture if you want your expenses to be deductible.

So, on the balance, sir, I am not able to find that the facts before me establish the existence of a reasonable expectation of profit in the taxation years in issue and your appeals will have to be dismissed. I say that with some sympathy. As I said before, you were an honest and forthright witness and I commend you for that, sir. I am sorry to have to reach this conclusion but that is more a matter of how I feel about it rather than what, in my view, the law requires me to do.

Appeal dismissed.