Jong v. R., [1998] 3 CTC 2492, 98 DTC 1616

Margeson T.C.J.:

This appeal is in respect of an assessment for the taxation years 199] and 1993, notice of which was dated September 28, 1995, confirmed on May 7, 1996.

By the reassessment the Minister disallowed the Appellant’s capital gains deductions in those years. These deductions were claimed and set off against other income of the Appellant in his taxation years 1991 and 1993 as a result of a claimed “terminal loss. of $77,787”, on the disposition of a property, co-owned by the Appellant, in the year 1991.

The Minister treated the “terminal loss” as a loss from the disposition of a “rental property” and treated the amounts as investment expenses in the years in issue.

The Appellant claimed that the property in question was not a rental property and that the “terminal loss” on his disposition did not give rise to an “investment expense” within the definition in subsection 110.6(1) of the Income Tax Act (“the Act”) and within the meaning assigned by Regulation 1100(14) of the Income Tax Regulations.

Evidence

The Appellant was a medical doctor. He accepted all of the essential allegations of facts set out in the Reply to Notice of Appeal, (“the Reply”) except that there were eight other owners of the building, that he was a shareholder and director of St. Anthony’s Management Ltd. and that 100% of the income of the St. Anthony’s co-tenancy was from rental of the building and not 68% only as alleged in the Reply.

He said that St. Anthony’s Property Ltd. was the owner of the land and the parking lot and that he and the other co-tenants were shareholders of that company. St. Anthony’s Management Ltd. provided management services for the building but received no fee.

His primary interest was in his medical practice. He bought into the cotenancy in 1986 because one of the shares became available. He became a director of the co-tenancy as well as the other two entities. He was also a shareholder in each. He went to all of the meetings.

The co-tenancy agreement was introduced into evidence by consent as Exhibit A-3 and it provided that each of the co-tenants would pay rental to the co-tenancy in accordance with the size of their offices and each of them would share in the profits.

The agreement provided for the operation, by the co-tenancy, of a treatment centre located in the building. The Appellant said that he made use of the treatment centre for treating his patients as well as being on call there after office hours. The centre also paid rent to the co-tenancy.

For income tax purposes the Appellant claimed his own capital cost allowance for his share of the co-tenancy. All co-owners paid fees for the use of the treatment centre. The income for the year was allotted among the co- tenants as shown in Exhibit A-4.

The witness said that the co-tenants occupied about 39% of the total space in the building, the treatment centre occupied 1,022 square feet. The co-tenants and the treatment centre together occupied about 45% of the building in total. Other doctors occupied about 38% to 40% of the space.

In 1990 the co-tenants reorganized so that it would be easier to sell their shares. They incorporated a company called 389491 B.C. Ltd. to buy the building. The Appellant’s share was about $184,060.21. This gave rise to the claimed losses here.

The Appellant said that his interest in buying into the building was to have a say in how it was to be developed and run. He regarded its operation as part of his practice. He wanted it to remain a medical building and not to be turned into a shopping centre or otherwise.

The Appellant worked in the medical building 90% of the time and worked the other 10% in the hospital.

In cross-examination he admitted that Exhibit R-1, Tab 12, contained a modification of the sublease. These were the terms of his co-tenancy.

He agreed that it contained no mention of any special services that were to be provided to the tenants except the usual such as cleaning, some advertisement in the local paper and cleaning of the parking lot.

The building answered all of his needs and so he bought in. There were some changes of tenants after he moved in.

Most of the changes had taken place before he became a co-owner. It had been losing money before that.

He could not say if it were set up as a co-tenancy to enable the coowners to write off expenses against their professional income.

He identified his 1989 income tax return which showed a taxable dividend from St. Anthony’s Property Ltd. in 1989. He admitted that it was profitable in 1988, 1989 and 1990.

His suite at number 208 was shared with three other doctors since 1995 and before that there were only two others sharing it.

He confirmed the Minutes of a meeting of the Board of Directors of St. Anthony’s Property and Management Company Ltd. on March 14, 1979 which indicated that one of the purposes of the partnership was to enable the cost of the building to be deducted against personal income.

At the time of sale of the building the terms were basically the same. The other doctors there did not solicit his patients nor did he solicit theirs. No co-tenant had any interest in the other co-tenants’ business or in the other businesses in the building.

Argument of the Appellant

In argument counsel said that the real issue is whether or not the loss arising from the medical building where the Appellant practices medicine constituted an “investment expense” under subsection 110.6(1) of the Act.

His position was that if you interpreted the term “property” in subsection 110.6(1) as broadly as in section 240(1) then almost everything would be included. However, subsection 9(3) limits the application of the section because it says that “income from a property does not include a capital gain from the disposition of the property and a loss from a property does not include a capital loss on its disposition”.

This only makes sense because a loss from a property is not an expense. Here it was a terminal loss arising from a disposition of the property. Subparagraph 110.6(1)(e)(1) does not apply.

The second issue is under subparagraph 110.6(1 )(e)(ii). The question here is, was the Appellant’s interest in the co-tenancy, an interest in a rental property?

Counsel argued that this was not a rental property.

The act of renting here was just a sideline of carrying on a medical practice in the building. The co-tenants occupied 39% of the office rental space. The total revenue of the co-tenants and treatment centre amounted to over 50% of the total income from the building.

When determining whether this was primarily a rental property the Court should look at the co-tenants as a group and not at the individual co- tenant. This was a fully integrated medical centre.

Further, the Court should look at Regulations 1100(14.1) and 1100(14.2) in deciding whether the payments here were received as isolated acts of rentals or were they received as an integral part of the medical practice operation. Here, the rentals represented 50% of the total income of the medical business and this was not just a passive rental property.

Further, Regulations 1100(14), (14.1) and (14.2) clarify that what was received was not “an amount from a rental business”.

The basic test of whether something is rental property or not is whether the property is used by the taxpayer principally for the purpose of gaining or producing gross revenue that is rent.

Using the total rent paid by the co-tenants plus the rent from the treatment centre, the general test of “principally” being 50% is met. The principal purpose of the building is to provide a place for the doctors to carry on their medical practice, not to earn investment income.

Under Regulation 1100(14.1) amounts paid by someone other than the owner to use or occupy the premises are considered to be rent. But because of Regulation 1100(14.2) this does not apply where a property is owned by a person who is personally active on a continuous basis throughout the year in a business in which the property is used. See paragraphs 6 and 7 of Interpretation Bulletin IT-195R4.

The other tenants were necessary to the “synergy” required for a successful operation of the medical building but this does change the fact that the Appellant taxpayer was involved in the continuous operation of his own practice and treatment centre in the building.

The fact that the disposition of the property “which was capital property to the taxpayer” gave rise to a terminal loss, does not alter the above analysis that only expenses should be added to the CNIL account and that only expenses from passive property (as opposed to property used in an active business) should be included.

The appeal should be allowed.

Argument of the Respondent

In argument counsel for the Respondent said that the Appellant was carrying on the same business for five years before he became a co-tenant of the property. Later he became a partner in the companies that owned the land and the building. There was no change in his medical practice. His medical practice was carried on in less than 10% of the rental space which was a shared space.

One hundred per cent of the income of the co-tenancy was from rentals.

Counsel argued that the loss claimed by the Appellant was an “investment expense” because it represented a loss from property or a loss from renting or leasing a rental property.

There is a presumption that the earning of rent by a landowner is not “the conduct of a business”. See Walsh v. Minister of National Revenue (1965), 65 D.T.C. 5293 (Can. Ex. Ct.) at page 5296.

Regulation 1100(14) defines “rental property” as:

(a) a building owned by the taxpayer or the partnership, whether owned jointly with another person or otherwise

if, in the taxation year in respect of which the expression is being applied, the property was used by the taxpayer or the partnership principally for the purpose of gaining or producing gross revenue that is rent ...

Regulation 1100(14.1) expands that definition of rent and Regulation 1100(14.2) says that Regulation 1100(14.1) does not apply in certain circumstances.

These sections do not help the Appellant here.

Counsel for the Appellant argued that “a terminal loss was not a loss from a property under section 9(3)”. This subsection does not apply here because a terminal loss is not a capital loss. A terminal loss is covered by subsection 20( 16) of the Act.

Therefore, the Appellant is left with only one argument and that being that the property was used in the medical practice of the Appellant or in a separate undertaking by Dr. Jong.

Here however, the amounts received were income from a property and not income from a business. He referred to Walsh, supra, Schulman v. Minister of National Revenue (1966), 66 D.T.C. 206 (Can. Tax App. Bd. , Wert- man v. Minister of National Revenue (1964), 64 D.T.C. 5158 (Can. Ex. Ct.), Gendron c. Ministre du Revenu national (1989), 89 D.T.C. 582 (Eng.) (T.C.C.) and Smithers Plaza Ltd. v. Minister of National Revenue (1975), 75 D.T.C. 137 (T.R.B.) as cases showing a distinction between income from a business and income from a property.

The Appellant might be taken out of the presumption that the earning of rent by a landowner is not income from a business if he could show that there was a range of services that the property owner supplied to the tenant, beyond the ordinary as discussed in Wertman, supra, and Walsh, supra.

The presumption is not rebutted in the case at bar because Dr. Jong said that no special services were provided apart from the normal services provided by a landlord to a tenant.

Further, the relationship was set up as though each were operating his business separately and not as though a business was being carried on there and in which the different co-tenants were partners.

This can be shown by the fact that a management company was formed to run the building.

The owners of the building organized themselves as a co-tenancy and not as a partnership or a corporation. Therefore, it is the use of the building by the Appellant that will determine whether or not it was a rental property.

Here one must consider two factors in determining whether the property was used principally for a given purpose. (1) The proportion of time that the property is used for that purpose. (2) The proportion or amount of space used for that purpose. See Interpretation Bulletin IT-195R4.

Factor number one is not important because the office was used at the same time whether it was for the purpose of operating a business or for obtaining rental income. The space used by the Appellant for business was only 10% of the total space and it was shared.

The test under Regulation 1100(14) as to whether property is a rental property is a qualitative and quantitative one. See Gulf Canada Resources Ltd. v. R., (1993), 93 D.T.C. 5345 (Fed. T.D.) at page 5348.

If more than 50% is used for rental, that is an indication that the property is used mainly for rental and it will be a rental property. Here, 90% of the space was used for rental. Therefore the presumption is that it was used mainly for rental.

Under the qualitative branch of the test, regard must be had to the main purpose of the owner in using the property.

In this case, unlike Gulf Canada, supra, the Appellant was a tenant before he became a co-owner. Therefore, he must show that his main purpose in becoming an owner was for a business purpose and not for producing rent.

There was little or no relationship between the Appellant’s business and the business carried out in the building. The presumption is that the owner was using the rental premises principally for the purpose of producing rent and it is a “rental property”.

It is not enough that the Appellant was carrying out the same type of business as others in the building.

This case is unlike the situation where a gas company leases a building to a business who carries on continuously selling and promoting the lessor’s products. In the case at bar the other doctors were not carrying on Dr. Jong’s business. There was no change in his business when he became a co- owner except that he received profits and his belief that he could write off any loss from the building from his professional income.

The benefit of having other tenants, who were medical or dental services related, were “only spin-off benefits”. This made the building more desirable for the tenants.

The main purpose of the building was to produce gross rental income.

The only income from the treatment centre was rental income therefore that argument need not be addressed.

The appeal should be dismissed.

Rebuttal

In rebuttal, counsel for the Appellant argued that the cases on business income that were referred to by counsel for the Respondent were decided before subsection 110.6(1) became part of the statute.

The dividend income that the Appellant received for several years was from the company that owned the land and not from the company that ran the building.

It is necessary to look at the business of all of the owners and not just that of the Appellant.

Regulation 1100(14.l)(a) makes the payments by the co-owners other than rental payments because they were co-owners.

Regulation 1100(14.2)(Z?) makes the payments by the treatment centre to the co-tenancy other than rent because Dr. Jong was an active participant in the treatment centre throughout the year. This operation was ancillary to his own medical practice and that of the other tenants who were co-owners.

The Court must look to the businesses of all of the co-owners and of the treatment centre. When you deduct the amount paid by the treatment centre and the co-owners, than the amount of rental paid was less than 50%.

Dr. Jong’s stands in the same position as that of the co-tenant that he replaced.

The case of Verge v. Minister of National Revenue (1981), 81 D.T.C. 330 (T.R.B.) can be distinguished from the case at bar because there the Appellant tried to deduct capital cost allowance before the building had even been constructed.

The loss in the case at bar was a capital loss but under subsection 20(16) it is treated differently because it is a terminal loss.

Subsection 9(3) is not determinative either way. The use has to be looked at in the light of what the drafters of section 110.6 had in mind.

Analysis and decision

The Court accepts the argument of counsel for the Respondent that subsection 9(3) does not apply to the case at bar and offers no consolation to the Appellant. What was involved here was a terminal loss under subsection 20(16) of the Act.

The Court does not accept the argument of counsel for the Appellant that Regulations 1100(14), (14.1) and (14.2) show that what was received by the Appellant was not an amount received from a “rental property”.

The analysis of these regulations by counsel for the Respondent would appear to be a fair interpretation of what they mean. These regulations do not assist the Appellant here. What was received was from a rental property and the property was not used “by the lessee to carry on the business of selling, or promoting the sale of, taxpayers or partnerships goods or services under Regulation 1100(14)”.

Under the case of Walsh, supra, a prima facie case is made out that the amount received from the property was from rental and not from a business unless the Appellant can show that the range of services provided by the landlord was such that the payment received can be regarded as substantial payment for the services.

The evidence in this case does not establish that situation.

The evidence does indicate that each co-owner and tenant were operating separate businesses apart from the operation of the building by the coowner.

The Court considers the use of the building and in that consideration the percentage of the space that was used by the Appellant. That amounted to very little, about 10% and that was shared by the Appellant and two others.

The Court is satisfied that what should be considered here is the use of the space by the Appellant and not the Appellant together with the other coowners because they had nothing whatsoever to do with the business of the Appellant.

It is true that the operation of the building included the running of the treatment centre but that does not rebut the prima facie case made out above because the Appellant and all other co-owners paid for their use of it.

Using the qualitative and quantitative tests as referred to in Gulf Canada Resources Ltd. v. R., supra, the Court is satisfied that vis-à-vis the Appellant, as much as 90% of the space was used for rental purposes and the presumption is that the building was used primarily for rental purposes.

The Court is satisfied that the Appellant was using the property principally for the purpose of producing rent despite his acknowledgement that he had an interest in how the building was to be run, what it was to be used for and despite the fact that he was involved in a business similar to other co- tenants. There was no real relationship between the Appellant’s business and that of the other tenants, apart from the treatment centre, which income was solely rental income in any event.

The Court is not satisfied that the activity of the Appellant in using the treatment centre throughout the year and the activity of the other co-owners in doing the same thing, changes the income received from rental income to business income.

The Court does not accept the argument that the income of the Appellant, the other co-owners and the treatment centre should be deducted from the total rentals received to determine the percentage of income that was rental.

In spite of the argument put forth by counsel for the Appellant that the Court must look at the use of the property in light of what the drafters of section 110.6 had in mind, that is, that under section 110.6, only passive real estate expenses should be included in this section, the Court finds that the amount in issue during the relevant years was a loss from property or a loss from renting or leasing real property under subparagraphs 110.6(1 )(e)(i) and 110.6(1 )(e)(ii) of the Income Tax Act and was properly characterized by the Minister as an investment expense pursuant to subsection 110.6(1) of the Act in the assessment in issue this case.

The appeal is dismissed and the Minister’s assessment is affirmed.

The Minister will have costs of his action to be taxed.

Appeal dismissed.