Brenton v. R., [1998] 2 C.T.C. 2810, 98 D.T.C. 3393

Christie A.C.J.T.C.:

1 These appeals are governed by the informal procedure provided for under section 18 and following sections of the Tax Court of Canada Act. The years under review are 1992, 1993, 1994.

2 The Notice of Appeal reads:

The purpose of this letter is to formally file a Notice of Appeal to the NOTIFICATION OF CONFIRMATION BY THE MINISTER (copy attached) re. my income tax assessments for the 1992, 1993 and 1994 taxation years. Please note, I would like to choose the INFORMAL PROCEDURE.

I am enclosing a copy of a letter I sent to Revenue Canada on February 26, 1996, to which I received no reply. I am also enclosing my original Objection filed 18/09/95 by my representative, I. Graham Berg, C.A. These two documents together with notifications I have received from Revenue Canada (which I assume you have access to ... if not, I can provide them upon request) should provide all relevant facts and my reasons for appealing.

As stated in my letter dated February 26, 1996, I feel very strongly that I was obeying the law as it existed at that time and most definitely DID, contrary to the findings as noted in the NOTIFICATION OF CONFIRMATION BY THE MINISTER, make or incur the said expenditures to gain or produce income from a property. One can unfortunately not always predict the outcome of particular investments but that does not mean one did not have honourable intentions at the outset.

The Tax Office that dealt with my Notice of Objection is identified on a letter attached. I would like to request that my file be sent to and handled by a local Revenue Canada office. Relevant information can be forwarded to: Revenue Canada

• Appeals Division

• Room 830

• 220 4th Avenue S.E.

• Calgary, Alberta T2G 0L1

• ATTN: Jeff Wong

I trust this appeal will receive serious consideration.

You did not make or incur the $2,392.79, $10,540.91 and $7,125.55 expenditures for rental in the 1992, 1993 and 1994 years to gain or produce income from a business or property. The expenditures were ‘personal or living expenses’ as defined in subsection 248(1). You cannot deduct these expenditures from income according to paragraph 18(1)(h).

The purpose of this letter is to add to my Objection filed 18/09/95 by my representative, I. Graham Berg, C.A. That Notice of Objection indicated my reasons for purchasing the property at 4605 Donegal Drive, Unit 6 in Mississauga, Ontario and my reasons for claiming rental losses in 1992, 1993 and 1994. Since my Objection was filed last year, I have sold this property. Because of the difficulties I faced with obtaining renters, I was unable to turn a profit from this property. I found it increasingly difficult to cover the mortgage payments on my own, and based on Revenue Canada's ruling re. the disallowance of any losses, I felt obliged to sell. It was sold at a substantial loss to me ($19,750) excluding lawyer's fees, because of a drop in the townhouse/condo market.

Based on the reasons cited in my earlier Objection and on the above information, I am appealing to Revenue Canada to give this matter more attention. I realize that ignorance is no excuse but I claimed these losses very legitimately with no intent to abuse the system. My financial planner and accountant advised me throughout this process to ensure there was no wrong doing. He was stunned when I was reassessed, stating he knew of many other cases with larger losses for a lot longer periods of time than 3 years, with no reassessments.

I'd also like to address a telephone call that I made to Revenue Canada when I originally received my Notice of Assessment in August/95. The lady I spoke with indicated that Revenue Canada was attempting to change the rules re. rental properties and that is why I was being audited. I understand wanting to change the rules for the future but I don't understand penalizing someone for following the rules that exist today.

Please add this letter to my file and consider it in your review. I did legitimately incur the losses claimed and now must add to that the loss on sale of my home AND a tax bill in excess of $10,000. This is a huge setback and definitely VERY discouraging to an honest taxpayer who was just trying to start an investment portfolio!

Please advise if there are any other measures I can take to have my case reviewed prior to the normal 12-18 month waiting period.

Michelle Brenton Sin: 116-506-056

Notice of Objection - Attached Schedule

The property was purchased in 1992 intending to rent it out wholly as a start for an investment portfolio. The down payment was quite small but with the income I was earning in these years I intended applying a substantial amount in principal repayment annually so that in a short time the property could carry itself. To this end I obtained an open mortgage.

For the following reasons I could not follow this intended plan:

• 1. One of the renters I had lined-up backed out and a replacement at a reasonable rent could not be found.

• 2. The rents of previous years on which I had budgeted could not be realized because of a drop in the market.

• 3. The maintenance and repairs were far greater than I had been lead to believe or budgeted for.

Because of this I was forced to move out of my apartment as I could not afford the rent and short fall on the rental property. I also was unable to make the reductions intended on the mortgage.

In view of the above I have since put the property up for sale as it was always greater than my needs. I am moving out and if I cannot sell it for a reasonable amount, I shall attempt to rent the whole property until such time as I can.

It was always intended that this be an investment property and only became my residence as a result of the change in the rental market and other cost miscalculations.

3 The opening paragraph and paragraphs 1 to 9 inclusive of the Reply to the Notice of Appeal read:

In reply to the Notice of Appeal for the 1992, 1993 and 1994 Taxation Years, the Deputy Attorney General of Canada says:

A. Statement of Facts

1. With respect to the first unnumbered paragraph of the Notice of Appeal he admits that the Minister of National Revenue (herein the Minister) issued a Notification of Confirmation dated June 28, 1996 for the 1992, 1993 and 1994 Taxation Years.

2. With respect to the second unnumbered paragraph, he denies that the Appellant did not receive a reply to the February 26, 1996 letter. He further states that the stated purpose of the letter was to add to the Appellant's Objection. In response to the Objection the Minister confirmed the reassessments on June 28, 1996 and also responded by letter dated June 4, 1996. He can discern no further facts in the remainder of the paragraph to admit or deny.

3. With respect to the third unnumbered paragraph of the Notice of Appeal, he denies that the expenditures were incurred for the purpose of gaining and producing income from business or property.

4. He can discern no further facts to admit or deny in the Notice of Appeal.

5. The income tax returns were initially assessed as follows:

1992:	24 June 1993
1993:	25 April 1994
1994:	24 April 1995

6. In computing income for the 1992, 1993 and 1994 Taxation Years, the Appellant deducted net rental losses in the following amounts, as detailed in Schedules 1, 2 and 3 attached herein:

1992:	$ 2,392
1993:	$10,540
1994:	$ 715

7. In reassessing the Appellant for the 1992, 1993 and 1994 Taxation Years, the Minister disallowed the deduction of the losses.

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

• (a) The Appellant reported the following T4 income from employment:

  1992:	$59,910
  1993:	$67,311
  1994:	$79,320

• (b) From 1992 to 1994 the Appellant reported the following losses from renting out part of her principal residence (herein ‘the Residence’):

  Taxation	Gross	Net
  Year	Income	Expenses	Income (Loss)
  1992	nil	$ 2,392	($ 2,392)
  1993	$3,000	$13,540	($10,540)
  1994	$6,000	$13,125	($ 7,125)

• (c) The Residence was a three bedroom condominium unit.

• (d) The Appellant rented out one bedroom and the shared use of the remainder of the Residence charging $500 per month to her friend, Anne Weremi commencing in July 1993. The Appellant used the larger master bedroom and the third bedroom was unoccupied.

• (e) Anne Weremi was the tenant for seven months in 1993 and 12 months in 1994.

• (f) At all material times to this Appeal, the Appellant had no other tenants.

• (g) The address of the Residence was:

  • 4605 Donegal Drive, unit 6

  • Mississauga, Ontario

  • L5M 4X7

• (h) The Residence was purchased in October 1992 and was sold in 1995.

• (i) The Appellant purchased the residence for $186,000 and obtained a first mortgage of $161,262.

• (j) Expenses claimed in 1992 and up to June 30, 1993 were prior to any renting of the Residence.

• (k) The Appellant allocated the household expenses (property taxes, maintenance and repairs, interest, insurance, utilities, condo fees, cable, telephone etc.) as follows:

  rental expenses	67%
  personal expenses	33%

• (l) At all material times to this Appeal, the Appellant did not advertise and did not claim any advertisement expenses.

• (m) The rent charged of $500 a month could not reasonably be expected to earn a profit but did minimally defray costs such as telephone, utilities, condo fees, interest and maintenance and repairs (as detailed in Schedules 1, 2 and 3 attached herein).

• (n) Expenses claimed for gas grill, furniture and garage door opener, if found to be incurred for the purpose of gaining or producing income from business or property are capital in nature and not deductible as current expenses.

• (o) Maintenance and Repair expenses claimed in 1993 in the amount of $515.09 were not proven.

• (p) At all material times to the Appeal, the Appellant's rental of part of her Residence did not provide the Appellant with a source of income.

• (q) The Appellant did not have a profit or a reasonable expectation of profit from the renting part of her Residence during the 1992, 1993 and 1994 Taxation Years.

• (r) The expenses claimed in relation to the renting part of her principal Residence were personal or living expenses of the Appellant and were not incurred for the purpose of gaining and producing income from business or property.

• (s) Alternatively if the Court finds that the expenses were incurred for the purpose of gaining or producing income, the expenses and the Appellant's delineation of the household expenses between personal and rental were not reasonable in the circumstances.

B. Issues to be Decided

• 9. The issue is whether the Appellant had a reasonable expectation of profit from the renting of part of her Residence in the 1992, 1993 and 1994 Taxation Years and whether the Minister properly denied the rental expenses claimed.

Schedule 1 Michelle Brenton

Statement of Income and Expenses October 15, 1992 - December 31, 1992

Gross rental income		0
less Expenses:
Property taxes	$ 333.13
Maintenance and repairs	961.43
Interest	574.60
Insurance	10.13
Light, heat, water	300.17
Condo fees	1,217.54
Total expenses claimed		$2,392.79
Net loss claimed		($2,392.79)

Note: 1. No tenant until July 1993.

2. Client claimed 2/3 of household expenses as rental expenses from purchase date to December 31, 1992.

Schedule 2 Michelle Brenton

Statement of Income and Expenses 1993

Gross rental income ($500 × 6 months)	$ 3,000.00
less Expenses for a 12 month period:
Property taxes	$1,634.80
Maintenance and repairs	2,025.61
Interest	7,118.00
Light, heat, water	968.70
Telephone	389.41
Cable	186.85
Condo fees	1,217.54
Total expenses claimed		$13,540.91
Net loss claimed		($10,540.91)

Note: 1. No tenant until July 1993.

2. Appellant claimed 2/3 of household expenses for full year.

Schedule 3 Michelle Brenton

Statement of Income and Expenses 1994

Gross rental income ($500 × 12 months)	$ 6,000
less Expenses for a 12 month period:
Property taxes	$1,661.06
Maintenance and repairs	1,054.15
Interest	7,621.32
Telephone	349.09
Cable	217.84
Light, heat, water	1,008.30
Condo fees	1,213.78
Total expenses claimed		$13,125.55
Net loss claimed		($ 7,125.55)

Notes:

Note: 1. Claimed2/3of household expenses as rental expenses.

4 Schedules 1, 2, 3 show the deductions by way of rental losses claimed by the appellant in computing her income. Exhibits R-1, R-2, R-3 are statements of real estate rentals included in the appellant's returns of income for the years under review. They show that in 1992 total expenses were $500.00 and the amount allocated to personal use was $167.00. The same figures for 1993 are $2,451.00 and $816.00 and for 1994 they are $11,426.00 and $3,805.00. Translated into percentages this means that in each year the amount allocated to personnel use was 33.3% of total expenses and the balance of 66.7% was allocated to renting. At trial the appellant readily conceded that 50-50 would have been a more reasonable distribution.

5 Tonn v. R. (1995), 96 D.T.C. 6001 (Fed. C.A.)is a decision of the Federal Court of Appeal relied on by the appellant. The issue in that case was also the deductibility of rental losses. It purported to explain the true meaning and intent of the reasons for judgment of Dickson J. (as he then was), speaking for the Supreme Court of Canada, in Moldowan v. R. (1977), 77 D.T.C. 5213 (S.C.C.). I note in passing that Moldowan is by far the most frequently cited case in Canadian jurisprudence in respect of litigation pertaining to the taxation of income. In order to deduct losses, whether they be in relation to property or business, there must be a source of income. In Moldowan, Dickson J. said at page 5215: “Although originally disputed, it is now accepted that in order to have a ‘source of income’ the taxpayer must have profit or a reasonable expectation of profit.” Later he added at the same page: “In my view, whether a taxpayer has a reasonable expectation of profit is an objective determination to be made from all of the facts.”

6 In Tonn Linden J.A., who delivered the judgment of the Court, said at page 6009:

It seems to me that for most cases where the department desires to challenge the reasonableness of a taxpayer's transactions, they need simply refer to section 67. This section provides that an expense may be deducted only to the extent that it is reasonable in the circumstances. They need not resort to the more heavy-handed Moldowan test.

The primary use of Moldowan as an objective test, therefore, is the prevention of inappropriate reductions in tax; it is not intended as a vehicle for the wholesale judicial second-guessing of business judgments.

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 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.

7 In Brill v. R. (1996), 96 D.T.C. 6572 (Fed. C.A.)Linden J.A. said at page 6578:

In applying Moldowan, it is not whether profit is earned, but whether it could reasonably be earned. As long as the business has a reasonable chance of earning profit in the year or in the near future, the interest is deductible, whether or not there actually was a profit earned in a given taxation year. That is the lesson of the Tonn case, which only seeks to restate and clarify the application of the principle of Moldowan. Thus, where as here, if no profit is possible in the year or in the near future, no deduction can be allowed (at least as long as Moldowan continues to govern cases such as these).

8 Mastri v. R. is another decision of the Federal Court of Appeal dealing with rental losses. It is reported in(1997), 97 D.T.C. 5420 (Fed. C.A.)at page 5421. In this case counsel for the Minister took the position that Tonn was wrongly decided and urged the differently constituted panel that dealt with Mastri to “overrule” Tonn or “at the very least ‘clarify’ what was decided in Tonn”. I must say as an aside that it has been a mystery to me why the Attorney General did not seek leave to appeal Tonn to the Supreme Court of Canada when there was still time to do so. In any event, the invitation to overrule was declined. But Robertson J.A., who delivered the judgment of the Court, did acknowledge that confusion had arisen about what was actually decided by Tonn. He said this at page 5243 with reference to that judgment:

It is simply unreasonable to posit that the Court intended to establish a rule of law to the effect that, even though there was no reasonable expectation of profit, losses are deductible from other income sources unless for example the income earning activity involved a personal element. The reference to the Moldowan test being applied ‘sparingly’ is not intended as a rule of law, but as a common-sense guideline for the judges of the Tax Court. In other words, the term ‘sparingly’ was meant to convey the understanding that in cases, for example, where there is no personal element the judge should apply the reasonable expectation of profit test less assiduously than he or she might do if such a factor were present. It is in this sense that the Court in Tonn cautioned against ‘second-guessing’ the business decisions of taxpayers.

In summary, the decision of this Court in Tonn does not purport to alter the law as stated in Moldowan. Tonn simply affirms the common-sense understanding that it is not the place of the courts to second-guess the business acumen of a taxpayer whose commercial venture turns out to be less profitable than anticipated.

9 Turning now to the relationship between rental income and the expenses allocated to renting which gives rise to the losses sought to be deducted. In 1992 there was no income and the expenses were $2,393.00. The same figures for 1993 are $3,000.00 and $13,541.00. For 1994 they are $6,000.00 and $13,126.00. This means that in the years when there was rental income it constituted 22% and 46% respectively of the rental expenses in those years. In 1993 income was only 42% of the mortgage interest alone. That percentage for 1994 was 83. That is to say that, even when there was rental income in each of the 12 months in 1994, it was insufficient to cover interest alone.

10 Bearing in mind what has been said in the authorities cited and its relationship to the whole of the evidence, I am of the opinion that a reasonable expectation of profit did not exist with respect to the appellant's rental activities as structured in 1992, 1993, 1994 or in the near future if the appellant had carried on those activities.

11 At trial the appellant made reference two or three times to start-up costs. They relate to a start-up period which has been described as “a grace period for emerging operations”. But such a period would not commence until the appellant's rental undertaking was so structured, organized and financed that it could be found to be reasonably capable of yielding a profit in due course. In this regard I refer to Watt v. R. (1997), 97 D.T.C. 5459 (Fed. C.A.), a recent decision of the Federal Court of Appeal.

12 In the light of what I have said here this morning these appeals cannot succeed. Accordingly judgment shall issue dismissing them.