St. Martin v. R., [1998] 4 CTC 2656

Bowie T.C.J.:

The appeals of Lucien St. Martin and his wife Ann Marie St. Martin were heard together on common evidence. They both appeal from reassessments for income tax for the taxation years 1992, 1993 and 1994. Mr. St. Martin was reassessed to disallow his claim to be entitled, in computing his income under section 3 of the Income Tax Act (the Act), to deduct the losses which he claimed to have sustained in each of those years in connection with a rental property owned by him and his wife in Florida, and in connection with a business which involved the buying and selling of sports cards. The Minister of National Revenue (the Minister) also disallowed his claim to be entitled to deduct an allowable business investment loss (ABIL) under paragraph 39(1)(c) of the Act in each of these three years.

Ann Marie St. Martin was reassessed to disallow her claims to losses in connection with the Florida property, and to disallow claims in each of the three years for losses incurred in connection with the rental by her to her husband of space in the basement of the family home, for use in connection with the sports card business. The family home is registered in her name.

The Minister’s position is that none of the Florida rental property, the sports card business, or the basement rental could have been said in the years under appeal to have had a reasonable expectation of profit, and that they were therefore not businesses, or sources of income, and that their losses therefore cannot be taken into account and offset against the employment incomes of the two Appellants. So far as the ABIL claim is concerned, the Minister’s position is that it has not been proven that Mr. St. Martin invested, by way of loan, shareholding or otherwise, in a small business corporation, or, if he did, that the investment was lost in the years claimed.

I shall deal first with the Florida property. It is owned jointly on a 50-50 basis by the Appellants, and so their claims are identical. In 1984 they purchased two units, one week each, of what is called an interval ownership property, sometimes known as a time share, in St. Petersburg, Florida. The premises they bought consist of a two bedroom, two bathroom unit, with kitchen, living and dining rooms. The common elements shared by all of the unit holders include a luxurious swimming pool, and other amenities. Their evidence was that they intended to rent out their two weeks of entitlement to use of the property to produce an income. According to their evidence, the constitutive documents for this project require that the property be sold at the end of 25 years, and the proceeds divided among the owners according to their respective shares. They foresaw, and still foresee, a very large appreciation of their investment over the 25-year period.

All did not go well in connection with the rentals, however. They had difficulty getting people to rent the property. Perhaps this is in some way connected with the fact that their two weeks of ownership are in midsummer. In any event, there has been constant difficulty obtaining tenants since the outset, although this has now been overcome, at least in part, by the return for the third year of a tenant for one of the two weeks. In the three years under appeal the gross rental income from the two units was $0.00, $800.00, and $1,100.00 respectively. Remarkably, they claimed against these amounts expenses totalling $9,192.79, $8,758.11 and $13,472.00. These claimed expenses were subsequently reduced by them by amounts of $2,237.00, $2,338.00 and $3,488.00, to produce revised claims for losses in the amounts of $6,955.00 for 1992, $5,620.00 for 1993, and $8,884.00 for 1994. Each of them claims half of these losses.

The largest single expense in connection with the property is for interest on the money borrowed to purchase the units. The units cost $9,000.00 each, a total of $18,000.00. The evidence is not clear as to the exact amount borrowed, but it appears to have been most if not all of the purchase price. It was raised by taking a second mortgage on the family home. The interest expenses for the three years under appeal are $4,800.00, $4,900.00 and $4,900.00 respectively. There are charges for maintenance and taxes payable each year of $780.00, $830.00 and $880.00. It was agreed by the Appellants that the most optimistic figure for a potential total rental income for the two weeks was $2,000.00. It is apparent at a glance, therefore, that if they were able to rent both units at the most favourable rate each year then the costs for interest, maintenance and taxes would amount to almost three times the gross revenues. The most casual observer can see that there is no potential here for anything but extremely large losses. The Appellants, in their evidence and argument, dealt with this by pointing out that they have made arrangements whereby they will pay off the mortgage loan by the year 2000. After that, they say, profits will be made. There are several reasons why this does not avail them.

First, we are dealing here with the years 1992, 1993 and 1994. The rearrangement of the financing was done in about 1996. There was no indication during the years under appeal that the mortgage interest would ever be brought down to a manageable amount. Second, no evidence was given to show just where the money to do this will come from, other than that they will increase their payments. No doubt the large refunds claimed by them in filing their income tax returns each year would be helpful, if they were entitled to them. For the reasons which follow I am of the opinion that they are not. Third, there are other expenses claimed by them for the cost of visiting the properties which, at least in the years under appeal, greatly exceeded the revenues. Mr. and Mrs. St. Martin would have me believe that these expenses for visiting the property were unusual in those years, and were required only because they had to be there each year to deal with numerous problems in connection with the management of the property which were interfering with its potential profitability. These expenses, they say, will not recur. I do not accept that as anything more than a self-serving statement of intent for the purposes of these appeals.

The most cursory examination of the expenses claimed by these Appellants for visiting the property reveals that they are largely personal living expenses of the Appellants and their three children, nothing more. They have charged for all the travel and living expenses of all the members of the family during their stay there. In 1993, remarkably, the claimed business expenses included the cost of a cruise for the whole family. Mr. St. Martin tried valiantly in his evidence to justify this on the basis that it was compensation for his wife and children for the fact that in 1992 they had all worked without pay to help him start up his sports card business. The cost of the children’s air fares and other expenses he justifies on the basis that they were too young to be left at home while he and his wife paid their annual visits to the property. It apparently did not occur to them that one of the Appellants could go to Florida to inspect the property and deal with the management difficulties, and the other stay at home with the children. I find on the evidence that these trips to Florida, to the extent that more than one family member went, are nothing but a very thinly disguised vacation to be enjoyed by the St. Martin family in each of the three years under appeal. Their enjoyment was no doubt enhanced by their belief, mistaken though it was, that their fellow taxpayers would be contributing a substantial subsidy towards the cost.

In Tonn v. R.,![1] the Federal Court of Appeal indicated that where there is a personal use element involved in a claimed rental loss case the Appellant will be called upon to justify objectively that the operation was in fact a business. Suspicious circumstances, the Court said, will lead to closer scrutiny. In Mohammad v. R.[2] the same Court said that where a rental property is purchased using high ratio financing, the cost of which renders profit in the early years unattainable, the taxpayer will have to show by cogent evidence that he intends to pay down the debt, and that he will have the resources to do so, if the claimed rental loss is to be sustained. Vague expectations of an ability to pay in the future are not enough; the Court said that the burden is to be discharged by showing that significant payments of principal have been made in the taxation years closely following the year of purchase. That has not been done here.

To summarize, these Appellants did not, in any of the years up to and including 1994, have any possibility, far less any reasonable expectation, of profit from the Florida property. I find that their intention and their expectation was that they would take vacations in Florida, which would be subsidized by the taxpayers of Canada, and that eventually the purchase money loan would be paid off, at least in part from the tax savings which they expected to realize by the losses they would claim. On this issue their appeals fail.

I turn next to the sports card business. In the spring of 1992 Mr. St. Martin lost his job with an insurance company. He received a lump sum severance payment from the company, however, and decided that he would begin a business. He testified that he researched the prospects of success in the business of buying and selling sports cards, and concluded that it was something at which he could make money. It was, he said, something that his sons had an interest in, but on cross-examination he denied that it was a hobby of his own. He stated categorically that he had not owned any sports cards since his university days. Having decided that he would enter into this business, he set about acquiring an inventory of sports cards to resell. The exhibits which he entered at the trial suggest to me that some of these may have been bought at wholesale, but that many of them were bought from retailers. He looked into the possibility of renting space in a strip mall near his home, but found that it would require him to enter into a three-year lease at a monthly rent far greater than he could afford. Instead, he agreed to pay his wife $90.00 or $100.00 per month to rent part of the basement of their home in which to carry out his sports card activities. The rent appears to have been struck by her, not on the basis of any examination of the market for similar space, but on the basis that this was about what he could afford to pay, at least initially. To sell the cards he travelled on week-ends to shows where he could rent a table to sell his stock to collectors. By the summer of 1992, Mr. St. Martin had obtained part-time work in the insurance field, and by the fall of 1992 he had a full-time job with an insurance company. His sports card business therefore soon became, at best, a part-time activity which he carried on in the evenings and week-ends.

The Minister has not accepted the expenses claimed by the Appellant in connection with this business as having been established. The pleadings put in issue whether the amounts were expended, and, if they were, whether they were proper business expenses. This is not surprising, considering the state of Mr. St. Martin’s records. He put into evidence a bundle of papers, principally photocopies of receipts of one kind or another. There are also some summaries of claims for G.S.T. rebates. There is nothing that could be called a set of books, however, or even an organized list of revenues and expenses. The Appellant explained that he was too busy to keep such records after September 1992, when he started to work full time again. The so-called records are a sorry lot indeed, and do nothing to convince me that Mr. St. Martin was in any sense in business.

Mr. St. Martin claimed in his evidence that he had created a business plan for the sports card business at the outset. He had with him in Court two boxes of documents, and he maintained that it had been in one of them at one time. He examined the auditor who was responsible for his reassessment, who denied ever having seen a business plan in the boxes of documents. Mr. St. Martin specifically disavowed making any suggestion that the business plan had been removed from his boxes of documents while they were in the possession of Revenue Canada officials. He produced no business plan, and I draw the inference that there never was one.

What I can glean from the evidence of Mr. St. Martin about the financial results of the sports card ‘business’ is this. Gross sales in 1992 were $1,030.00. of this amount $600.00 was from sales made by one of Mr. St. Martin’s sons, who was with him at a card show in a mall in Etobicoke, to a 12-year old boy from Mexico who was collecting José Canseco cards to resell there, where they are apparently in high demand. The expenses which he claims for that year are $1,162.00 for the cost of goods sold, and $6,211.00 for other expenses, being automobile, office expense, and rent paid to his wife in the amount of $1,080.00. For the years 1993 and 1994 the gross revenues total $428.00 and $320.00 respectively. The total expenses in those years amount to $5,224.00 and $2,586.00. Altogether Mr. St. Martin claims losses of $6,343.00, $5,181.00 and $2,655.00 for the three years. He attributes the poor financial results to a downturn in the sports card business, and says that by 1994 he had virtually stopped trying to sell his cards, but that he had by then amassed an inventory of some 500,000 cards, and will be ready to re-enter the field when sports card collecting comes back into vogue. He claims that many of his are vintage cards, and so have lasting intrinsic value. For now, however, he wishes to deduct business losses in the three years totalling about $14,000.00 from his other income under section 3 of the Act. $3,480.00 of that $14,000.00 results from the payment to his wife of rent for the basement of the family home.

Mrs. St. Martin, for her part, takes the position that she is entitled to deduct losses incurred by her in connection with the rental of the basement space to her husband. In filing her returns for 1992, 1993 and 1994 she has claimed losses in excess of $3,000.00 for each of the three years, a total of $10,035.00, said to arise from renting the “business office” to her husband. These losses are arrived at by totalling all of the expenses of the house, and allocating them in proportion to the rented space. In 1993 even the cable television, the telephone, and an amount for a guard dog were charged proportionately to the basement rental area. Prior to this arrangement with her husband beginning in 1992, Mrs. St. Martin had not rented out any space in the house. Her claim is predicated upon the theory that when she permitted her husband to use the basement to store and sort his sports cards, and he paid her an arbitrarily fixed rent of $90 to $100 for the privilege, the basement became, if not a business, then a source of income, the losses from which could be deducted by her from her salary as a teacher for the purpose of computing her income under section 3 of the Act.

lam mindful of the edict of the Federal Court of Appeal in the Tonn^[3] case to the effect that embryonic businesses must be allowed some time to grow to profitability, and that neither the Minister nor the Courts should be quick to second guess the judgment of people who are trying to start a business. This, in my view, is not a case where the taxpayer has attempted to start a genuine business which had some prospect, even a remote one, of success. Sports cards may not have been a hobby of Mr. St. Martin, but they seem to have been of great interest to his sons, who went with him to the shows, and otherwise took part in the activity. This operation has none of the hallmarks of a business about it. No plan, no books of account, no revenues to speak of. I agree with Bowman J, who said earlier this year in Kaye

v. R.\[4]

One cannot view the reasonableness of the expectation of profit in isolation. One must ask “Would a reasonable person, looking at a particular activity and applying ordinary standards of commercial common sense, say ‘yes, this is a business’?” In answering this question the hypothetical reasonable person would look at such things as capitalization, knowledge of the participant and time spent. He or she would also consider whether the person claiming to be in business has gone about it in an orderly, businesslike way and in the way that a business person would normally be expected to do.

below,[5] he said

...Simply put, if you want to be treated as carrying on a business, you should act like a businessman.

Applying that test to the so-called sports card business, I conclude that it fails. It was not and never could become a business. The spin-off from it, Mrs. St. Martin’s claim for rental losses, can best be described as an exercise in avarice. In fairness to her, though, I must say that I believe her evidence to the effect that her husband prepared her income tax returns, and that she simply signed what he put in front of her. The avarice is his, not hers.

There remains the claim for an ABIL. This is based upon certain amounts which Mr. St. Martin said he invested in an insurance brokerage firm run by a Mr. Wayne Bullard. It was called Allrite Insurance Broker, and later Associated Insurance Brokers. Mr. St. Martin had some cash on hand in the spring of 1992, arising out of his severance from his employer. Mr. Bullard, I think it is fair to say, set out to relieve him of it. He came up with a scheme whereby the Appellant, and perhaps some other investors, would provide short term funds to clients of the insurance brokerage who needed cash to pay their premiums falling due. The return would be 10%, or so it was said. Mr. St. Martin advanced cash to Mr. Bullard in furtherance of this scheme. Remarkably, the terms were not reduced to writing, even in the most informal way. Exactly what amounts he advanced is not clear to me, but it appears to have been somewhere between $20,000.00 and $25,000.00, between 1992 and 1994. Some of this was recovered by repay- ments made, and ultimately through litigation, but much of it was lost. Mr. Bullard has since been imprisoned, I am told. The Appellant takes the position that he made the advances to Mr. Bullard’s company, which, he says is a corporation, and that they were in the nature of an investment in that corporation.

The claim for an ABIL cannot succeed. Quite apart from the difficulties of proof of the amounts of the loans, the purpose for which they were made, and the point at which they became unrecoverable, the insurmountable problem with this claim is that the evidence, such as it is, leads me to conclude that if any loans were made, they were made to Mr. Bullard in his personal capacity.

First, the documentary evidence relating to this issue consists of a pile of papers in a folder. From those papers it seems clear that neither Allrite Insurance Broker nor Associated Insurance Brokers was incorporated. They seem to have been names under which Mr. Bullard carried on business in his personal capacity. In any event, the cheques written by the Appellant, to the extent that they are to be found at all in the evidence, are made out to Mr. Bullard personally. According to the Appellant’s evidence some of the money was handed over by him to Mr. Bullard in cash. To the extent that there are cheques by way of repayment (many of them were returned NSF by the bank), they are drawn on Mr. Bullard’s personal account. I find that any loan which was made by the Appellant in his dealings with Mr. Bullard was made to Mr. Bullard, and not to a corporation. To qualify as a business investment loss under paragraph 39(1)(c) of the Act, a bad debt must have arisen from a loan to a corporation which meets the other requirements of the Act. Loans to an individual cannot qualify.

The appeals of both Appellants for the taxation years 1992, 1993 and 1994 are dismissed.

Appeal dismissed.