Beckford v. R., [1998] 3 CTC 2443

O’Connor T.C.J.:

These appeals were heard at Toronto, Ontario on April 8, 1998 pursuant to the Informal Procedure of this Court.

Testimony was given by the Appellant and by one Kenneth Reid.

Issue

The issue in these appeals is whether the Appellant is entitled to rental losses claimed in 1993 and 1994.

Facts

The essential facts are set forth in the Reply to the Notice of Appeal as follows:

2. In computing income for the 1993 and 1994 taxation years, the Appellant claimed rental losses from a property located at 21 Lindridge Ave., Brampton, Ontario (the “Property”) in the amounts of $13,009.62 and $9,558.10 respectively.

3. The Minister of National Revenue (the “Minister”) assessed the Appellant for the 1993 and 1994 taxation years by Notices of Assessment mailed on April 11, 1994 and March 27, 1995 respectively.

4. In reassessing the Appellant for the 1993 and 1994 taxation years, by concurrent Notices of Reassessment mailed on March 25, 1996, the Minister disallowed the deduction of the rental losses.

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

(a) the Appellant and another person (the co-owner) purchased the Property (a house) as their principal residence in September, 1990 for $187,000.00;

(b) during the years under appeal, the Appellant and the co-owner resided at the Property;

(c) for the years in question, the Appellant allegedly rented part of the Property to her son and to her step son;

(d) for the taxation years 1990 to 1992, the Appellant reported gross rental income and claimed net rental losses from the Property as follows:

Year	Gross Rental Income	Net Rental Losses
1990	$4,000.00	$ 9,069.00
1991	$5,000.00	$16,618.00
1992	$6,600.00	$11,469.00

• (e)

for the 1993 and 1994 taxation years, the Appellant reported rental income, expenses (before capital cost allowance) and losses from renting part of the Property to her son and to her step son, as follows:

	1993	1994
Gross Rental Income	$ 6,000.00	$ 6,000.00
Property taxes	2,832.62	2,622.00
Maintenance & repairs	3,004.17	2,100.00
Interest	19,181.24	14,781.00
Insurance	467.22	485.00
Light, heat & water	2,493.16	3,000.00
Advertising	64.00	25.00
Fees	344.00	300.00
Total Expenses	$28,386.41	$23,313.00
-Less Personal Portion	9,376.79	7,754.90
of Expenses{*}
-Net Expenses	$19,009.62	$15,558.10
Net Rental Loss	$13,009.62	$ 9,558.10
Notes:

* the personal portion deducted, of total expenses reported

for the 1993 and 1994 taxation years, amounts to 33.3%.

(f) the Appellant has failed to provide any documentation to substantiate the claimed maintenance and repair expenditures for the 1993 and 1994 taxation years;

(g) the documentation provided by the Appellant to support her claimed interest expenses amounts shows that the Appellant has overstated the interest expense amounts in respect of the Property by $5,793.00 for the 1993 taxation year and by $1,903.00 for the 1994 taxation year;

(h) for the 1995 taxation year, the Appellant did not report any rental income or losses from the Property;

The space rented by the son and step son was two rooms and certain common areas. In 1993 the son was 21 years of age and the step son was 29 years of age. They both moved out some time in 1995 and there have been no tenants since that time.

Submissions of the Appellant

The Appellant submits that the claimed expenses and the fact of certain discrepancies referred to in paragraph 5(g) of the Reply are the fault of the tax preparer. The Appellant further complains of the fact that the Minister only reassessed on March 5, 1996 with respect to 1993 and 1994, that this is an undue delay and has resulted in her being responsible for large amounts of interest. She also believes on the merits that over time there was a reasonable expectation of profit.

Submissions of the Respondent

The Respondent submits that the rents declared fell far short of meeting the fixed expenses such as interest and real estate taxes, that there was a personal element in that the house was the principal residence of the Appellant and moreover was rented in part to a son and a step son.

Analysis and Decision

The most recent decisions of the Federal Court of Appeal dealing with rental losses, namely, Tonn, Mastri and Mohammad have established certain criteria as to when a reasonable expectation of profit exists.

In Tonn v. R., (1995), 96 D.T.C. 6001 (Fed. C.A.). Mr. Justice Linden, speaking for the court, said at page 6008:

The Moldowan test is stricter that the business purpose tests set out in subsection 9(1) and paragraph 18(1 )(a). As mentioned above, these tests stipulate that a taxpayer be subjectively motivated by profit when incurring an expenditure. The Moldowan test, however, also requires the presence of a profit motive, but, in addition, it must be objectively reasonable. In reality, in most situations, the objective Moldowan test and the subjective statutory tests will not yield many different results. A subjective intention is often determined by what may be reasonably inferred from the circumstances. Someone who claims a subjective intention that is foolish may not be believed. A taxpayer’s intention to produce profit normally has to be reasonable before a Court will accept it.

At pages 6009 and 6010 he said:

A closer look at‘this jurisprudence will illustrate that this is the approach now taken in most of the cases. The cases in which the “reasonable expectation of profit” test is employed can be placed into two groups. One group is comprised of the cases where the impugned activity has a strong personal element. These are the personal benefit and hobby type cases where a taxpayer has invested money into an activity from which that taxpayer derives personal satisfaction or psychological benefit. Such activities have included horse farms, Hawaii and Florida condominium rentals, ski chalet rentals, yacht operations, dog kennel operations, and so forth. Though these activities may in some ways be operated as businesses, the cases have generally found the main goal to be personal. Any desire for profit in such contexts is no more than a “pious wish” or “fanciful dream”. It is only a secondary motive for having set out on the venture. What is really going on here is that the taxpayer is seeking a tax subsidy by deducting the cost of what, in reality, is a personal expenditure.

At page 6011 he said:

The other group of cases consists of situations where the taxpayer’s motive for the activity lacks any element of personal benefit, and where the activity cannot be classified as a hobby. The activity, in these cases, seems to be operated in a commercial fashion and not as a veiled form of personal recreation. Usually these deductions are not challenged by the Department, and, therefore, they do not get appealed and are not reported very often in the law reports. The Courts still have a role, however, in deciding whether there exist less apparent factors which might suggest a different conclusion in cases such as these. The Courts are less likely to disallow these expenses, but they do so in appropriate circumstances.

At page 6012 he said:

When the cases are categorized into two groups as above, one cannot help observing that the hobby and personal benefit cases are rarely decided in the taxpayer’s favour. In contrast, where the activity is purely commercial, they rarely are challenged. If they are the Courts have been reluctant to second-guess the taxpayers, with the benefit of the doubt being given to them. I also note that in terms of sheer numbers, the hobby/personal-benefit cases vastly outnumber those of the commercial activity and variety, which are quite rare, indicating that taxpayers are challenged less often in such situations.

At page 6013 he said:

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.

At page 6015 he said:

The property was not a vacation site. The house was not used to give free or subsidized housing to relatives or friends. They made an honest error in judgment and lost money instead of earning it. It is not for the Department (or the Court) to penalize them for this, using the reasonable expectation of the profit test, without giving the enterprise a reasonable length of time to prove itself capable of yielding profits.

After the decision in Zonn, the Federal Court of Appeal in Mastri v. R., (1997), 97 D.T.C. 5420 (Fed. C.A.) stated that there was no doubt that Zonn was correctly decided. The decision of the Tax Court of Canada was reversed on the basis that it was an error in law to say that just because there was no personal element involved an unchallenged finding of fact that there was no reasonable expectation of profit was not sufficient grounds for disallowing the loss. The error of the Tax Court of Canada appears to have been in the interpretation that it put on Tonn that the absence of a personal element superseded the finding of no reasonable expectation of profit. In fact, the finding of the Tax Court of Canada that there was no personal element appears to have been suspect since the taxpayers bought the house to be used as their personal residence and in fact, after one year, they moved into it.

In Mohammad v. R., (1997), 97 D.T.C. 5503 (Fed. C.A.) it was held to be an error in law to reduce the amount of interest deductible by an arbitrary amount under section 67. In Mohammadthere was 100% financing. At page 5506 Robertson J.A. said:

The above analysis is to the effect that there can be no reasonable expectation of profit so long as no significant payments are made against the principal amount of the indebtedness. This inevitably leads to the question of whether a rental loss can be claimed even though no such payment(s) were made in the taxation years under review. I say yes, but not without qualification. The taxpayer must establish to the satisfaction of the Tax Court that he or she had a realistic plan to reduce the principal amount of the borrowed monies. As every homeowner soon learns, virtually all of the monthly mortgage payment goes toward the payment of interest during the first five years of a twenty to twenty-five year amortized mortgage loan. It is simply unrealistic to expect the Canadian tax system to subsidize the acquisition of rental properties for indefinite periods. Taxpayers intent on financing the purchase of a rental property to the extent that there can be no profit, notwithstanding full realization of anticipated rental revenue, should not expect favourable tax treatment in the absence of convincing objective evidence of their intention and financial ability to pay down a meaningful portion of the purchase-money indebtedness within a few years of the property’s acquisition. If because of the level of financing a property is unable to generate sufficient profits which can be applied against the outstanding indebtedness then the taxpayer must look to other sources of income in order to do so. If a taxpayer’s other sources of income, e.g., employment income, are insufficient to permit him or her to pay down purchase-money obligations then the taxpayer may well have to bear the full cost of the rental loss. Certainly, vague expectations that an infusion of cash was expected from Aunt Beatrice or Uncle Bernie will not satisfy the taxpayer’s burden of proof. In practice, the taxpayer will discharge that burden by showing that significant payments were in fact made against the principal indebtedness in the taxation years closely following the year of purchase.

Based upon all of the facts of this case and relying on the criteria set forth by the Federal Court of Appeal whose decisions are binding on me, I find, without difficulty, that the Appellant did not have a reasonable expectation of profit in the years in question. My principal reasons are that the rents clearly could not meet the fixed costs of mortgage interest and real estate taxes and there were personal elements present of principal residence and renting to relatives. The Appellant has the burden of proof. In this case it was an extremely difficult one and the onus has not been discharged.

The Appellant also complained about the lateness of the reassessment and the resultant interest charges. As I have no authority to waive or reduce interest, I can only recommend that the Appellant apply to the Minister of National Revenue for application of the fairness package in this regard. The Appellant also complains about the behaviour and bad advice of the tax preparer. This is only too common in cases of this nature where tax preparers represent that rental losses can be claimed as deductions from employment income thereby reducing the amount of tax a taxpayer must pay. The difficulty is that the tax preparers do not always explain the full significance of the deduction and the fact that the rental operation must have a reasonable expectation to truly qualify for rental loss deductions.

In conclusion, applying the criteria of the Federal Court of Appeal as described above I find that there was no reasonable expectation of profit and consequently the appeals must be dismissed.

Appeal dismissed.