Charron v. R., [1998] 1 CTC 3096

Lamarre Proulx T.C.J.:

The appellant is appealing under the informal procedure from reassessments made by the Minister of National Revenue (“the Minister”) for the 1990, 1991 and 1992 taxation years.

The point at issue is whether in those years the appellant incurred expenses in the amounts of $8,428, $10,223 and $1,882 respectively in order to gain or to produce income from rental property within the meaning of s. 18(l)(a) of the Income Tax Act (“the Act”).

The facts on which the Minister relied in disallowing the inclusion of the aforementioned expenses in the calculation of the appellant’s income are set out in Paragraph 7 of the Reply to the Notice of Appeal (“the Reply”), and are as follows:

[TRANSLATION]

(a) during the taxation years at issue the appellant was the owner of a building located at R.R. 1, chemin Lepine, in Masson, province of Quebec;

(b) the appellant lived in this building until he moved to the Sherbrooke area on July 16, 1990;

(c) in his tax returns filed for the 1990, 1991 and 1992 taxation years the appellant reported the following rental income and expenditure associated with this building:

1990	1991	1992
Gross rental income	$800	$1,630	0
LESS:
Property taxes	$1,187	$1,310	0
Maintenance and repair	$4,156	$1,455	$600
Interest costs	$5,692	$6,502	$450
Insurance	337	392	$381
Heating and electricity	582	0	$422
Other - legal etc.	0	564	29
Total expenses	$11,954	$10,223	$1,882
Less
Personal share	$3,546	0	0
Expenses claimed	$8,428	$10,223	$1,882
Net rental loss	$7,608	$8,593	$1,882

(d) mortgage interest, property taxes and insurance by themselves totalled as fixed costs $7,216 for 1990, $8,204 for 1991 and $831 for 1992 as against gross income of $800, $1,630 and $0 respectively...

The appellant admitted subparagraphs 7(a) to (d) of the Reply.

In 1987 the appellant purchased a property in Buckingham in the Outaouais for $58,000. It was a small house which the appellant began enlarging by adding new rooms, including a kitchen. The maintenance and repair expenses mentioned in Paragraph 7(c) of the Reply are expenses for the construction of the kitchen and were incurred to lay flooring and install kitchen cupboards.

On July 16, 1990 the appellant moved and settled in the Eastern Townships. He put up his house for sale or rental. On October 8, 1990 he signed a one-year lease at a monthly rent of $400. This is indicated in Exhibit A-1. The lease contained an additional agreement providing that the tenant would pay the reduced rate of $400 instead of $550 and intended to do renovations. The materials would be paid for by the owner.

The amount of the mortgage was $50,000. The interest on the mortgage loan was $5,692 in 1990 and $6,502 in 1991, as mentioned in subparagraph 7 (c) of the Reply. In 1992 the appellant entered the amount of $450. The explanation he gave at the hearing was that it was possible that in that year he already knew that the rental expenses claimed in preceding years might be disallowed and he wished to reduce the expenses.

The sale of the house was again given to a real estate agent on April 17, 1992 and it was sold on September 1, 1992.

On June 3, 1994 the appellant signed a waiver of application of the usual reassessment period for 1990 (Exhibit I-1). The subject of the waiver was [TRANSLATION] “all fiscal consequences resulting from the review of rental income and expenditure”. This fact was raised in the appellant’s Notice of Appeal prepared by an accountant, the appellant’s agent. He suggested without providing any explanation that the appellant should not have signed such a waiver. I quote the relevant paragraph of the Notice of Appeal:

[TRANSLATION]

For the 1990 and 1991 taxation years Claude Charron signed waivers for the presumed or prescribed years without being clearly informed of the consequences of his signature. He was apparently told [TRANSLATION] “This would get the matter settled more easily” or something of that kind. As he is now aware of the consequences of the said signature, Claude Charron states that he would never have signed these forms if at that date he had known what it meant.

The appellant appeared for himself at the hearing. He repeated that the accountant who made up the Notice of Appeal told him that he should not have signed the waiver and that in signing it he had waived the usual assessment period, which is three years for an individual. The appellant said he signed because he felt he could trust the Minister’s officer.

Before discussing the subject of rental losses I will deal with that of the waiver, which is a procedure mentioned in s. 152(5)(c) of the Act.

Section 152(5) of the Act reads as follows:

(5) There shall not be included in computing the income of a taxpayer for a taxation year, for the purposes of any reassessment, additional assessment or assessment of tax, interest or penalties under this Part that is made after the normal reassessment period for the taxpayer in respect of the year, any amount

(a) that was not included in computing the taxpayer’s income for the purposes of an assessment of tax under this Part made before the end of the normal reassessment period for the taxpayer;

(b) in respect of which the taxpayer establishes that the failure so to include it did not result from any misrepresentation that is attributable to negligence, carelessness or wilful default or from any fraud in filing a return of the taxpayer’s income or supplying any information under this Act; and

(c) where any waiver has been filed by the taxpayer with the Minister, in the form and within the time referred to in subsection (4), with respect to a taxation year to which the reassessment, additional assessment or assessment of tax, interest or penalties, as the case may be, relates, that the taxpayer establishes cannot reasonably be regarded as relating to a matter specified in the waiver.

[My emphasis.]

In Cal Investments Ltd. v. R. (1990), 90 D.T.C. 6556 (Fed. T.D.), Joyal J, of the Federal Court Trial Division explained the purpose and circumstances of such a waiver as follows:

A waiver of the sort at issue in this case, might be interpreted as an accommodation between the Crown and a taxpayer for the better administration of the Income Tax Act and to provide a more efficient determination of any liability thereunder. In the light of the limitations on assessments under s. 152 of the Act, the Crown requests a waiver so that it may continue its assessment or audit work in a normal administrative mode without having to worry about limitations. The taxpayer, on the other hand, knows full well that on an assessment being made, he alone has the burden of proving it wrong, That burden becomes much heavier if the Crown, facing the end of the limitation period, issues what might be termed a premature assessment which, for purposes of abundant caution, would include many sundry items which the taxpayer would have to traverse one by one, The taxpayer in those circumstances would look upon a waiver as being to his own benefit as well as the Crown’s and would ordinarily comply with the Crown’s request.

In many cases, also, the waiver might be limited to specified issues, 1.e., those where assessing or auditing processes have not been completed and which in fact remain the only outstanding items on which the Crown can ultimately decide to assess or reassess. This narrows the field of the assessment and again provides mutual advantages to both the Crown and the taxpayer.

In Bailey v. Minister of National Revenue (1989), 89 D.T.C. 416 (T.C.C.), at 419, Judge Rip of this Court said the following on the same point:

A waiver is usually given by a taxpayer to the respondent when there is an unresolved dispute over one or more specific matters and the three year time period within which the respondent may reassess is fast approaching. The execution of a waiver avoids a hasty reassessment by the respondent; it provides the taxpayer with further opportunity to consider adjustments proposed by the respondent and to allow him to make further representations to support his claim.

The purpose of a waiver is to continue analysis of a transaction or matter concerning which the basis of the assessment is in question. It is hard to see why the accountant raised doubts in the appellant’s mind as to the relevancy of signing the waiver and it should be noted that the accountant is no longer representing the appellant at the hearing. The Minister could have assessed immediately since he was still within the normal assessment period. As Joyal J. said, for the sake of efficiency it was just as well to accept this mutual accommodation rather than make a hasty assessment, which would not be in the interests of the taxpayer or of the Minister as the administrator of the Act. I see no reason in this case for casting any doubt on the validity of the waiver: accordingly, it is valid.

I now return to the main point of the case, namely the deductibility of the rental expenses. The appellant maintained that the rental property was profitable from 1992 onwards. Counsel for the respondent submitted that this was rental property acquired for personal reasons and not commercial ones, and that the reasonable expectation of profit test should be applied. She further submitted that the reason the house was put up for rent was that the owner was waiting to sell it and that he sold it as soon as this was possible.

Counsel for the respondent referred to the Federal Court of Appeal judgment in Tonn v. R. (1995), [1996] 2 F.C. 73, 96 D.T.C. 6001 (Fed. C.A.), a judgment in which there was a general analysis of the deductibility of expenses incurred to earn income and of the circumstances in which the reasonable expectation of profit test should be applied.

I cite the reasons for judgment at 85 and 103:

(p. 85)

Subsection 9(1) has therefore been regarded as the provision of “first recourse” [1] in a deductibility analysis, and by its reference to “profit” as been interpreted to incorporate a business test for deductibility. The deductibility test implied by the section, as stated many years ago by Thorson P. in Royal Trust Co., The v. Minister of National Revenue, is grounded in “well-accepted principles of business practice”^ [2]

[T]he first approach to the question whether a particular disbursement or expense was deductible for income tax purposes was to ascertain whether its deduction was consistent with ordinary principles of commercial trading or well accepted principles of business ... practice.^ [3]

Among other things, well accepted principles of business suggest that only expenses incurred as relevant and working expenses of some process of income earning are deductible. Those which bear no relation to the income earning process, and those which are of a personal nature, are not.

(p. 103)

I otherwise agree that the Moldowan test should be applied sparingly where a taxpayer’s “business judgment” is involved, where no personal element is in evidence, and where the extent of the deductions claimed are [sic] not on their face questionable. 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 closer scrutiny than those that are in no way suspect.

The property in question in the instant case is a family residence which was converted into a house for rental or sale because the appellant and his family moved. These are accordingly circumstances which suggest that a personal and other-than-business motivation was the reason for the purchase of the house, and in such circumstances the reasonable expectation of profit test must be applied. As stated by the Supreme Court of Canada per Dickson J. in Moldowan v. R. (1977), [1978] 1 S.C.R. 480 (S.C.C.), at 485 and 486, this test is as follows:

Although originally disputed, it is now accepted that in order to have a “source of income” the taxpayer must have a profit or a reasonable expectation of profit. Source of income, thus, is an equivalent term to business: Dorfman v. M.N.R.. [4] See also s. 139( l)(ae) of the Income Tax Act which includes as “personal and living expenses” and therefore not deductible for tax purposes, the expenses of properties maintained by the taxpayer for his own use and benefit, and not maintained in connection with a business carried on for profit or with a reasonable expectation of profit...

There is a vast case literature on what reasonable expectation of profit means and it is by no means entirely consistent. In my view, whether a taxpayer has a reasonable expectation of profit is an objective determination to be made from all of the facts. The following criteria should be considered: the profit and loss experience in past years, the taxpayer’s training, the taxpayer’s intended course of action, the capability of the venture as capitalized to show a profit after charging capital cost allowance. The list is not intended to be exhaustive. The factors will differ with the nature and extent of the undertaking: The Queen v. Matthews. [5]

The evidence clearly showed that as long as the mortgage payments remained as high as they were there was no chance that the rental of the property could become a profitable business. There was no evidence that the mortgage loan could have been reduced so as to make the rental profitable in 1992, as the appellant maintained. There was thus no chance that the business as capitalized would make a profit and as there are always many other expenses in renting a property the rental business was not a genuine commercial undertaking.

Furthermore, the great majority of expenses claimed related to the construction of the house, not its maintenance. They are therefore not operating expenses but expenses in the nature of capital and could not be deducted in calculating income as a consequence of s. 18(1 )(Z?) of the Act, which reads as follows:

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

(b) an outlay, loss or replacement of capital, a payment on account of capital or an allowance in respect of depreciation, obsolescence or depletion except as expressly permitted by this Part...

As regards the distinction to be made between expenses incurred for income and those incurred on capital account, I think it is worth citing Jackett

P. in Canada Starch Co. v. Minister of National Revenue (1968), 68 D.T.C. 5320 (Can. Ex. Ct.), at 5323:

For the purpose of the particular problem raised by this appeal, I find it helpful to refer to the comment on the “distinction between expenditure and outgoings on revenue account and on capital account” made by Dixon J. in Sun Newspapers Ltd. et al. v. The Federal Commissioner of Taxation, (1938) 61 C.L.R. 337 at page 359, where he said:

The distinction between expenditure and outgoings on revenue account and on capital account corresponds with the distinction between the business entity, structure, or organization set up or established for the earning of profit and the process by which such an Organization operates to obtain regular returns by means of regular outlay, the difference between the outlay and returns representing profit or loss.

In other words, as I understand it, generally speaking,

(a) on the one hand, an expenditure for the acquisition or creation of a business entity, structure or organization, for the earning of profit, or for an addition to such an entity, structure or organization, is an expenditure on account of capital, and

(b) on the other hand, an expenditure in the process of operation of a profit-making entity, structure or organization is an expenditure on revenue account.

Applying this test to the acquisition or creation of ordinary property constituting the business structure as originally created, or an addition thereto, there is no difficulty. Plant and machinery are capital assets and moneys paid for them are moneys paid on account of capital whether they are

(a) moneys paid in the course of putting together a new business structure,

(b) moneys paid for an addition to a business structure already in existence,

or

(c) moneys paid to acquire an existing business structure.

I therefore find that the rental of the house was not a commercial undertaking, that is, a business organized with the expectation of producing a profit, and that the Minister properly assessed the appellant in fact and in law in not including the rental expenses claimed in calculating income for the years in question.

The appeal is dismissed without costs.

Appeal dismissed.