Date: 20010226
Docket: A-213-99
OTTAWA, Ontario, Monday, February 26, 2001.
CORAM: STONE J.A.
EVANS J.A.
MALONE J.A.
BETWEEN:
CARL CARDELLA,
Appellant,
- and -
HER MAJESTY THE QUEEN,
Respondent.
JUDGMENT
The appeal is allowed in part and,
(1) to that extent the judgment of the Tax Court of Canada dated March 16, 1999 and the assessments of the appellant's income for the taxation years 1989, 1990 and 1991 with respect to his interest in Collegeway Associates Limited Partnership are set aside and the matter is referred back to the Minister of National Revenue for reassessment of that income for those taxation years in a manner consistent with the reasons for judgment herein;
(2) in all other respects, the said judgment is affirmed;
(3) no order as to costs.
"A.J. Stone"
J.A.
Date: 20010226
Docket: A-213-99
Neutral Citation: 2001 FCA 39
CORAM: STONE J.A.
EVANS J.A.
MALONE J.A.
BETWEEN:
CARL CARDELLA,
Appellant,
- and -
HER MAJESTY THE QUEEN,
Respondent.
Heard at Toronto, Ontario on Thursday, January 18, 2001 and Friday, January 19, 2001.
Judgment rendered at Ottawa, Ontario, on Monday, February 26, 2001.
REASONS FOR JUDGMENT BY: STONE J.A.
CONCURRED IN BY: EVANS J.A.
MALONE J.A.
Date: 20010226
Docket: A-213-99
Neutral Citation: 2001 FCA 39
CORAM: STONE J.A.
BETWEEN:
CARL CARDELLA,
Appellant,
- and -
HER MAJESTY THE QUEEN,
Respondent.
[1] This is an appeal from a judgment of the Tax Court of Canada dated March 16, 1999, which is now fully reported at 99 D.T.C. 631. At issue is whether the appellant is entitled to deduct from income pursuant to section 20 of the Income Tax Act certain interest and other expenses that were claimed by the appellant in the 1989, 1990 and 1991 taxation years as a limited partner of two partnerships established under the Limited Partnership Act, R.S.O. 1990, c. L-16.
Background
[2] The limited partnerships in issue are Gerrard Associates Limited Partnership ("Gerrard") and Collegeway Associates Limited Partnership ("Collegeway"), both of which were formed in the 1980s. During the taxation years in question Gerrard owned a 57 dwelling unit condominium project with 55 parking spaces at 86 Gerrard Street East in Toronto. Collegeway was the owner of a condominium project consisting of 105 dwelling units at 2079 The Collegeway in Mississauga, Ontario. The Gerrard partnership term was to run until December 31, 2018; the Collegeway term until December 31, 2099.
[3] The appellant, a physician, was not new to investing in real estate in the Toronto area. Although he had no training in real estate investment and had no business training, he claimed an "entrepreneurial spirit". According to the evidence, between 1981 and 1990 the appellant invested in at least 6 real estate transactions most of which turned out to be opportune. In the mid-1980s, the Toronto real estate market was rapidly accelerating. The appellant, who had some familiarity with the real estate market within the City and in Mississauga, regarded the opportunity of investing in Gerrard and Collegeway as ways of realizing further gains in his investment portfolio. He practised and taught medicine in the general area of the Gerrard property. His place of residence in Mississauga lay a short distance from the Collegeway property.
[4] Before investing in the partnerships the appellant was provided with promotional material. According to his testimony, he was aware that there was little likelihood of earning a share of partnership rental income. The size of the investment would be substantial over time even though a relatively small amount of cash would be paid initially. His capital contributions and financial payments would be funded by way of tax sheltered cash flow and income tax savings. The appellant testified that he took a long-term view of these investments, in the expectation that the condominium properties would appreciate in value such that at the end of the initial period of 10 years they could be sold and a gain realized that would more than offset any earlier losses. The promotional material included projections indicating that if the value of the condominium properties increased at an annual rate of more than 8% over the initial period of 10 years, the appellant's gains in the event of resale at the end of that period would more than offset his losses.
[5] In December 1988, the appellant purchased one unit of partnership interest in each of Gerrard and Collegeway at a purchase price of $231,283.00 and $171,000.00, respectively, paying $1,920.00 in cash in respect of his interest in Gerrard and $10,925.00 in respect of his interest in Collegeway. In each case, the balance of the purchase price was paid by way of promissory notes, "A", "B" and "C", the appellant thereby assuming a pro rata share of the debt obligations of each partnership. Notes "A" were refinanced by means of interest bearing mortgages in favour of arm's length lenders and were secured on the respective condominium properties. The parties agree with respect to Collegeway that the mortgage loan was amortized over a period of 25 years. At the time the appellant became a limited partner in Gerrard, the total debt related to the acquisition of the condominium property was projected to increase from $17,150,000 to approximately $24, 000,000 in a 10 year period. The Collegeway debt over the 10 year period was projected to increase from $17,150,000 to approximately $25,000,000. The promoters projected losses for tax purposes over the 10 year period at $393,053 per unit in Gerrard and approximately $187,000 per unit in Collegeway.
[6] Each limited partner was required to make monthly payments in respect of this indebtedness. In the case of Gerrard, this payment was limited to 42% of the subscriber's losses for tax purposes. In the case of Collegeway, the subscriber's payment was limited to 43% of such losses. A subscriber's losses for tax purposes included carrying costs of the promissory notes, an "arranging fee" and a "guarantee fee" relating to the losses suffered by Gerrard from rental operations. The arranging fee was paid for arranging financial institution loans for investors. The guarantee fee was paid for a guarantee payment of any cash flow deficiency in Gerrard.
[7] In 1997, the appellant ceased to make payments on the "A" note in Gerrard as a result of which his investment in that project terminated. The mortgage was foreclosed. However, the appellant continued his investment in Collegeway whose value, he thought, held up better than Gerrard. He testified to an intention of continuing that investment in the belief that Collegeway's real estate would ultimately appreciate in value and enable him to realize a net gain on the resale of the property.
The partnership agreements
[8] The terms and conditions governing the operation of each limited partnership are set forth in the partnership agreements. The Gerrard agreement, dated December 1, 1988, is titled "Restated Limited Partnership Agreement" (the "Gerrard agreement"). It describes the business of the partnership in Article 4.1 as follows:
4.1 Business. The business of the Limited Partnership is to carry on the business of participating in the real estate rental business in Ontario through the ownership of the Project with a view to profit and to engage in any and all activities related or coincidental to the ownership of the Project subject to the limitations set out in any contract related or coincidental thereto.
[9] The Collegeway "Limited Partnership Agreement", dated December 24, 1987 (the "Collegeway agreement"), contains a description of the partnership's business in Article 2.03, which reads:
2.03 Business
The business of the Partnership is to invest in, acquire, hold, maintain, operate, improve, and otherwise use the Properties for profit and to engage in any and all activities related or incidental thereto (collectively the "Business") but does not include the sale of the Property. The Partnership shall not undertake any action unrelated to those purposes without the prior consent of the partners given by Ordinary Resolution.
[10] Thus, Article 12.19(d) of the Gerrard agreement provides as follows:
12.19 Conditions to Action by Limited Partners. No action of the Limited Partners to:
...
(d) sell or otherwise dispose of the Property;
will be effective in any manner unless and until approved by Special Resolution and either:
(e) the Limited Partnership has received an opinion of counsel for the Limited Partnership that such action may be effected without subjecting the Limited Partners to liability as general partners under the Act; or
(f) a court of competent jurisdiction has entered a declaration, judgment or order to the like effect.
"Special Resolution" is defined in Article 1.1(dd) of the Gerrard agreement as follows:
1.1 Definitions. In this Agreement, except as otherwise expressly provided, the following words or expressions shall have the following meaning:
...
(dd) "Special Resolution" means a resolution approved by more than seventy-five percent (75%) of the votes cast by those of the Limited Partners who vote, and who are entitled to vote, in person or by proxy, at a duly constituted meeting of Partners, or at any adjournment thereof, called in accordance with this Agreement;
[11] Also, Article 16.01 of the Collegeway agreement provides as follows:
16.01 Limitation on Sale of Property
(a) Notwithstanding anything to the contrary contained in this Agreement, the General Partner shall not be entitled to sell, dispose, convey, demolish or alter all or substantially all of the Property without the prior consent of such action given by Special Resolution.
(b) The Limited Partners hereby expressly consent to be bound by the decision of the General Partner and the Limited Partners given by Special Resolution to effect any sale, exchange or other disposition, of the Property and hereby agree that any such action shall not be construed as an action which makes it impossible to carry on the ordinary course of business of the Partnership. In addition, notwithstanding anything contained herein to the contrary, the General Partner shall have the power and authority, without the prior consent of the Limited Partners, to convey the Property to a trust established by the Partnership, having the Partnership as its sole beneficiary, and having as a trustee, a corporation wholly owned by the Partnership; provided, however, that the General Partner shall not make such a conveyance on behalf of the Partnership unless it has received a legal opinion from tax counsel to the effect that for the purposes of Canadian Federal Income Taxes, the Partnership will continue to be treated as the owner of the Property.
"Special Resolution" is defined in Article 1.01 of that agreement as follows:
1.01 Definitions
...
"Special Resolution" means a resolution consented to by the General Partner and confirmed without variation by:
(a) a resolution passed at a duly constituted meeting of Limited Partners by the affirmative vote of those Limited Partners representing not less than 66-2/3% of the total outstanding Voting Rights at such time; or
(b) a written resolution signed in one or more counterparts consented to in writing by Limited Partners representing not less than 66-2/3% of the total outstanding Voting Rights at such time;
[12] Both partnership agreements contemplated a possible dissolution prior to the expiration of the term with consequent liquidation of the partnership assets and distribution or sale thereof. Such provisions are contained in Article XIV of the Gerrard agreement and Article 14.00 of the Collegeway agreement.
[13] In subscribing for his units of limited partnership in each project, the appellant expressly bound himself to the terms of the respective limited partnership agreement.
[14] As part of the arrangements, the appellant was granted an option to purchase such number of dwelling units in each project as corresponded with the number of units of partnership interest held by him. The option could be exercised at any time in Gerrard and was open for exercise up to December 31, 2015 in Collegeway. As he owned one unit of partnership in each venture, the appellant had the option of purchasing one dwelling unit in each project. Neither option was exercised prior to the trial.
Deductions claimed
[15] In computing his income for each of the taxation years in issue, the appellant sought to deduct the following amounts from income:
|
Gerrard |
Year 1989 1990 1991 |
Interest $35,336 $39,567 $34,431 |
Arranging Fee $1,707 $1,707 $1,707 |
Guarantee Fee $1,319 $1,164 $1,164 |
||||
| Collegeway |
1989 1990 1991 |
$21,534 $23,235 $21,295 |
N/A N/A N/A |
N/A N/A N/A |
[16] These deductions were denied by the Minister of National Revenue (the "Minister") on the basis that the interest amounts were not borrowed money used for the purpose of gaining or producing income from a business within the meaning of paragraph 20(1)(c) of the Act, that the arranging fee was not deductible under paragraph 20(1)(e) of the Act and that the guarantee fee was not deductible under paragraph 20(1)(e.1) thereof.
[17] The appellant appealed to the Tax Court of Canada where it was heard on "An Agreement as to Certain Facts" as supplemented by viva voce evidence. In his amended pleading, the appellant alleged that in investing in the two ventures he was engaged in an adventure in the nature of a trade and accordingly that he had a source of income. The Minister pleaded that no reasonable expectation of profit existed.
The Tax Court judgment
[18] In dismissing the appeal, the learned Tax Court Judge rejected the appellant's contention that his investments in Gerrard and Collegeway amounted to an adventure in the nature of a trade on the basis of a claimed intention at the time of investing of turning a profit on the resale of the condominium properties after a period of 10 years. The Tax Court Judge acknowledged that a projection for gain on resale after 10 years had been used by the promoters to attract investors. However, he regarded the appellant's intention at the time of investing as of no relevance. In his view, it was the intention of the general partners that counts. Neither of the general partners was called to testify at trial. The Tax Court Judge noted that management and control of the projects remained in the hands of the general partners alone. He found direct evidence of intention in the partnership agreements which indicated that the properties were to be held to derive rental income. The Tax Court Judge also noted that the assumption of the promoters was that the condominium properties could be sold after 10 years "on capital accrual". He concluded that when gains on a resale were excluded from consideration the two partnerships could not be regarded as sources of income. He found support for that conclusion in this Court's decisions in Canada v. Mastri, 97 D.T.C. 5420 and Mohammad v. The Queen, 99 D.T.C. 5503.
Relevant statutory provisions
[19] The deductibility of interest in computing income from a business or property is provided for in paragraph 20(1)(c) of the Act. Subparagraph 20(1)(c)(i) and (ii) read as follows:
| 20. (1) Notwithstanding paragraphs 18(1)(a), (b) and (h) in computing a taxpayer's income for a taxation year from a business or property, there may be deducted such of the following amounts as are wholly applicable to that source or such part of the following amounts as may reasonably be regarded as applicable thereto: ... (c) an amount paid in the year or payable in respect of the year (depending upon the method regularly followed by the taxpayer in computing his income), pursuant to a legal obligation to pay interest on (i) borrowed money used for the purpose of earning income from a business or property (other than borrowed money used to acquire property the income from which would be exempt or to acquire a life insurance policy), (ii) an amount payable for property acquired for the purpose of gaining or producing income therefrom or for the purpose of gaining or producing income from a business (other than property the income from which would be exempt or property that is an interest in a life insurance policy), |
20. (1) Nonobstant les dispositions des alinéas 18(1)a), b) et h), lors du calcul du revenu tiré par un contribuable d'une entreprise ou d'un bien pour une année d'imposition, peuvent être déduites celles des sommes suivantes qui se rapportent entièrement à cette source de revenus ou la partie des sommes suivantes qui peut raisonnablement être considérée comme s'y rapportant: ... c) une somme payée dans l'année ou payable pour l'année (suivant la méthode habituellement utilisée par le contribuable dans le calcul de son revenu), en exécution d'une obligation légale de verser des intérêts sur (i) de l'argent emprunté et utilisé en vue de tirer un revenu d'une entreprise ou d'un bien (autre que l'argent emprunté et utilisé pour acquérir un bien dont le revenu serait exonéré d'impôt ou pour prendre une police d'assurance-vie), (ii) une somme payable pour un bien acquis en vue d'en tirer un revenu ou de tirer un revenu d'une entreprise (à l'exception d'un bien dont le revenu serait exonéré d'impôt ou à l'exception d'un bien représentant un intérêt dans une police d'assurance-vie), |
[20] Paragraphs 20(1)(e) and 20(1)(e.1) of the Act provide for the deduction of certain additional amounts. Those provisions are relied upon by the appellant as supporting the deduction of the "arranging" and "guarantee" fees. The respondent submits, however, that the deduction of those fees is prohibited by paragraph 18(1)(e) of the Act because the obligation to pay them was a "contingent liability".
Issues
[21] The specific errors of the Tax Court Judge as argued by the appellant may be summarized as follows:
a) failure to find that the appellant was engaged in an adventure in the nature of a trade with respect to his interests in the partnerships;
b) failure to find that the appellant otherwise had a reasonable expectation of profit and therefore a source of income;
c) failure to place the onus of proving that the appellant's partnership interests were not sources of income on the respondent and to find that the respondent had failed to discharge that onus.
Analysis
[22] I shall deal with each of these issues in turn.
Adventure in the nature of a trade
[23] The appellant submits that his investments in the partnerships consisted of "an adventure or concern in the nature of a trade" with a view to profit making and was thus a "business" as that term is defined in section 248 of the Act. "An adventure or concern in the nature of a trade" is not defined by the Act. It is a common law concept whose meaning has been developed in Canadian jurisprudence.
[24] There are two prongs to the appellant's argument. First, he contends that his intention from the outset was to profit on a resale of the condominium properties and indeed that this was his sole motivation for investing because, as forecast by the promoters, he could not earn rental income in the initial 10 year period. That fact, it is contended, reinforces the appellant's intention of seeking a return on resale of the properties rather than on rental income. Although prospective investors were told by the promoters that their annual payments would be "funded through tax-sheltered cash flow and income tax savings", in fact the appellant did not and could not realize any such saving. Second, the option to purchase a dwelling unit in each of the partnership properties allowed the appellant to trade in those units, again supporting the argument that he was engaged in an adventure in the nature of a trade.
[25] The Tax Court Judge rejected these arguments. After quoting from the well known judgment of Lord Justice Clerk of the Scottish Court of Exchequer in Californian Copper Syndicate (Limited and Reduced) v. Harris, [1904] 5 T.C. 159, at 165-166, where a distinction was drawn between a transaction of a business nature or of a capital nature, the Tax Court Judge went on to recite the following passage from the judgment of Noël J. in Racine, Demers and Nolin v. Minister of National Revenue, 65 D.T.C. 5098 (Ex. Ct.), at 5103 with respect to taxpayer intention:
To give to a transaction which involves the acquisition of capital the double character of also being at the same time an adventure in the nature of trade, the purchaser must have in his mind, at the moment of the purchase, the possibility of reselling as an operating motivation for acquisition; that is to say that he must have had in mind that upon a certain type of circumstances arising he had hopes of being able to resell it at a profit instead of using the thing purchased for purposes of capital. Generally speaking, a decision that such a motivation exists will have to be based on inferences flowing from circumstances surrounding the transaction rather than on direct evidence of what the purchaser had in mind.
[26] The courts have consistently emphasized that, in determining whether a transaction was intended as an adventure in the nature of a trade, regard must be had to the surrounding circumstances: Happy Valley Farms Ltd. v. The Queen, 86 D.T.C. 6421 (F.C.T.D.), at 6424. The taxpayer's intention as a factor of utmost importance was stressed by the Supreme Court of Canada in Friesen v. Canada, [1995] 3 S.C.R. 103. In that case, Major J. summarized certain important factors to be considered in determining whether a transaction in real estate is an adventure in the nature of a trade. He listed those factors at paragraph 17:
(i) The taxpayer's intention with respect to the real estate at the time of purchase and the feasibility of that intention and the extent to which it was carried out. An intention to sell the property for a profit will make it more likely to be characterized as an adventure in the nature of trade.
(ii) The nature of the business, profession, calling or trade of the taxpayer and associates. The more closely a taxpayer's business or occupation is related to real estate transactions, the more likely it is that the income will be considered business income rather than capital gain.
(iii) The nature of the property and the use made of it by the taxpayer.
(iv) The extent to which borrowed money was used to finance the transaction and the length of time that the real estate was held by the taxpayer. Transactions involving borrowed money and rapid resale are more likely to be adventures in the nature of trade.
Reference may usefully be made to a discussion of the subject in R.E. Beam and S.N. Laiken, "Adventure or Concern in the Nature of Trade: Badges of Trade as the Key Indicator of Taxpayer Intention", (1996) 44 Can. Tax J. 888.
[27] While I agree that it is the intention of the appellant at the time of investing that is relevant, the facts found at trial do not support the feasibility of such an intention. As we have seen, the appellant could only give effect to such intention within the legal framework of the limited partnership agreements, both of which significantly circumscribed the ability of a limited partner to bring about a resale. In each case the passage of a special resolution was required. Such a resolution in Gerrard needed to be approved by more than 75% of the votes cast by the limited partners voting therefor. In Collegeway, the affirmative vote of not less than 66_% of the limited partners was required together with the consent of the general partner. No evidence was led at trial that these onerous requirements could be met at any time after expiry of the initial 10 year period. Nor was there evidence that the appellant stood to make a profit if and when the properties were eventually sold.
[28] The appellant submits, in any event, that particular dwelling units could be bought and sold by him pursuant to the options which he held. The Tax Court Judge did not deal explicitly with this question. However, the evidence at trial is clear that it was never within the appellant's contemplation to proceed in that fashion. He testified as follows in re-examination:[1]
Q. And was it ever contemplated that the projects would involve the sale or that the projects could be disposed of either en bloc or through the sale of individual units?
A. My understanding was that it was likely going to be en bloc, but in Collegeway, for example, I did receive offers on my unit. I have recently. So there probably is a mechanism whereby I could have sold my unit even though it was part of the whole, but I decided not to do that, but my understanding was generally that I guess that you could have disposed of the unit singly –
Q. What I meant was, was it ever contemplated by the general partner, along with the limited partners, to dispose of the project by selling individual condominium units?
A. No. No. That wasn't what was presented to me.
Q. It was an en bloc sale?
A. It was more of an en bloc sale.
The appellant also testified that in selecting real estate investments he shied away from purchasing his own property and from managing it himself because too much of his time would be required and because he lacked sufficient managerial expertise.[2]
Reasonable expectation of profit
[29] The second and third issues may be conveniently addressed together. I shall begin with the issue of onus.
[30] The appellant submits that the onus was on the respondent to prove that the limited partnership interests were not sources of income and that he failed to discharge that onus. As indicated by his "Notice of Appeal", the appellant seemed to have well understood the Minister's position, for throughout the pleading he alleged that the reasonable expectation of profit test had no application in the circumstances. The Minister, in his "Reply", pleaded by way of assumptions that the appellant had no reasonable expectation of profit from his interests in either Gerrard or Collegeway. At the trial itself, the appellant attempted to establish a reasonable expectation of profit on the basis that he was engaged in an adventure in the nature of a trade. That stance was not explicitly pleaded. In the end, the Tax Court Judge decided that no such adventure was proven.
[31] The appellant relies on the case law with respect to onus of proof in tax litigation as it was recently summarized by L'Heureux-Dubé J. in Hickman Motors Ltd. v. Canada, [1997] 2 S.C.R. 336, where she stated at paragraphs 92-93 of her concurring reasons:
It is trite law that in taxation the standard of proof is the civil balance of probabilities: Dobieco Ltd. v. Minister of National Revenue, [1966] S.C.R. 95, and that within balance of probabilities, there can be varying degrees of proof required in order to discharge the onus, depending on the subject matter: Continental Insurance Co. v. Dalton Cartage Co., [1982] 1 S.C.R. 164; Pallan v. M.N.R., 90 D.T.C. 1102 (T.C.C.), at p. 1106. The Minister, in making assessments, proceeds on assumptions (Bayridge Estates Ltd. v. M.N.R., 59 D.T.C. 1098 (Ex. Ct.), at p. 1101) and the initial onus is on the taxpayer to "demolish" the Minister's assumptions in the assessment (Johnston v. Minister of National Revenue, [1948] S.C.R. 486; Kennedy v. M.N.R., 73 D.T.C. 5359 (F.C.A.), at p. 5361). The initial burden is only to "demolish" the exact assumptions made by the Minister but no more: First Fund Genesis Corp. v. The Queen, 90 D.T.C. 6337 (F.C.T.D.), at p. 6340.
This initial onus of "demolishing" the Minister's exact assumptions is met where the appellant makes out at least a prima facie case: Kamin v. M.N.R., 93 D.T.C. 62 (T.C.C.); Goodwin v. M.N.R., 82 D.T.C. 1679 (T.R.B.). In the case at bar, the appellant adduced evidence which met not only a prima facie standard, but also, in my view, even a higher one. In my view, the appellant "demolished" the following assumptions as follows: (a) the assumption of "two businesses", by adducing clear evidence of only one business; (b) the assumption of "no income", by adducing clear evidence of income. The law is settled that unchallenged and uncontradicted evidence "demolishes" the Minister's assumptions: see for example MacIsaac v. M.N.R., 74 D.T.C. 6380 (F.C.A.), at p. 6381; Zink v. M.N.R., 87 D.T.C. 652 (T.C.C.). As stated above, all of the appellant's evidence in the case at bar remained unchallenged and uncontradicted. Accordingly, in my view, the assumptions of "two businesses" and "no income" have been "demolished" by the appellant.
[32] The appellant submits that he discharged the initial onus by making out a prima facie case that his source of income stemmed from an adventure in the nature of a trade and, therefore, that the onus shifted to the Minister to prove the assumption that no such source of income existed. The respondent maintains that the onus remained on the appellant to establish an "adventure in the nature of a trade" because it was he who raised that issue at trial.
[33] This is far too fine an argument, in my view. Given the respondent's pleaded assumption the appellant needed to show, if he could, that he had a source of income from either the rental operations or from an adventure in the nature of a trade. If he succeeded in doing so by way of a prima facie case, the Minister's assumption would be "demolished" and the onus of proof would then shift to the Minister who would be obliged to establish the correctness of his assumption.
[34] I turn next to the appellant's submission that he had a reasonable expectation of profit from rental operations. This argument requires a consideration of the test of "reasonable expectation of profit" as it was articulated in Moldowan v. The Queen, [1978] 1 S.C.R. 480.
[35] Moldowan, supra, arose under former subsection 13(1) which corresponds to subsection 31(1) of the Act. The taxpayer, a businessman, engaged in horseracing activities. The issue before the Supreme Court was whether the taxpayer's chief source of income was farming as a combination of farming and some other source of income. If it was, it would fall outside of the restricted farm loss rules. No issue was raised that the taxpayer' farming activities constituted a hobby or that the expenses should be denied because they were "personal and living expenses" within the meaning of the Act. Nor was it argued that the taxpayer had no source of income.
[36] Dickson J. (as he then was) proceeded to articulate the reasonable expectation of profit test when he stated, at 485-486:
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. [[1972] C.T.C. 151]. See also s. 139(1)(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. If the taxpayer in operating his farm is merely indulging in a hobby, with no reasonable expectation of profit, he is disentitled to claim any deduction at all in respect of expenses incurred.
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 [(1974), 74 D.T.C. 6193)]. One would not expect a farmer who purchased a productive going operation to suffer the same start-up losses as the man who begins a tree farm on raw land.
[37] While the foregoing passage is, strictly speaking, obiter dictum, it is not lightly to be ignored by lower courts considering that it seems to represent the considered opinion of the Supreme Court: Sellers v. The Queen, [1980] 1 S.C.R. 527. See also Re Miller and the Queen (1985), 141 D.L.R. (3d) 330 (Ont. C.A.), at 339; Black v. Law Society of Alberta (1986), 27 D.L.R. (4th) 527 (Alta. C.A.), at 537; Consolidated-Bathurst Limited v. The Queen, [1987] 2 F.C. 3 (C.A.), at 15ff; Scarff v. Wilson et al (1988), 55 D.L.R. (4th) 247 (B.C. C.A.), at 258, reversed on other grounds (1988), 61 D.L.R. (4th) 749 (S.C.C.). Compare Clark v. Canadian National Railway Co. (1985), 17 D.L.R. (4th) 58 (N.B. C.A.), at 66-67.
[38] The application of the test in particular cases by both the Tax Court of Canada and this Court has been much criticized by members of the tax bar in Canada. See e.g. J.R. Owen, "The Reasonable Expectation of Profit Test: Is There a Better Approach?", (1996) 44 Can. Tax J. 979, no. 4; B.S. Nichols, "Chants and Ritual Incantations: Rethinking the Reasonable Expectation of Profit Test", Report of the Proceedings of the Forty-Eight Conference, vol. 1 (Toronto: Canadian Tax Foundation, 1997) 28:1; T.E. McDonnell, "Rental Losses Denied – Confusion Compounded," (2000) 48 Can. Tax J. 444. For a recent discussion of issues pending determination by the Supreme Court of Canada in Walls and Buvyer v. The Queen, 2000 D.T.C. 6025 (F.C.A.) and Stewart v. The Queen, 2000 D.T.C. 6163 (F.C.A.), see R. Taylor, "Applicability of the Moldowan Test to Source of Income Determination Questions Where no Element of Personal Benefit to Taxpayer", (2000) 8 Tax Litigation No. 2 509.
[39] Office, employment, business and property are identified as sources of income in section 3 of the Act, while rules for determining a taxpayer's income from a business or property appear in section 9.
[40] The rigour of the reasonable expectation of profit test in cases involving no personal element was somewhat tempered by this Court in Tonn v. The Queen, [1996] 2 F.C. 73 (F.C.A.). See also Labrèche v. Ministre du revenu national, 99 D.T.C. 5083 (F.C.A.); Walls, supra; The Queen v. Milewski, 2000 D.T.C. 6559 (F.C.A.). Compare Mastri, supra, and Kuhlmann v. The Queen, 98 D.T.C. 6652 (F.C.A.). The Supreme Court of Canada has not had the occasion to consider the purpose and application of the test since it was articulated in Moldowan, supra.
[41] In Hickman Motors, supra, the test was alluded to in the concurring reasons of L'Heureux-Dubé J. where it was determined that the taxpayer was entitled to deduct capital cost allowance pursuant to paragraph 20(1)(a) of the Act and the regulations. L'Heureux-Dubé J. pointed out that the "purpose" test in paragraph 20(1)(a) of the Act and the regulations was not to be affected by applying the reasonable expectation of profit test. As she put it at paragraphs 69-72:
[...] Where a business does not have a profit, however, it must have a "reasonable expectation of profit", to be determined by an application of the Moldowan test (see Krishna, supra, at p. 261). In a nutshell, the "reasonable expectation of profit" test is principally directed at differentiating between a "business" and a "personal pursuit such as a hobby, etc.", whereas the "purpose of producing income" test is directed at determining whether an asset is appropriately used in the business.
The "reasonable expectation of profit" test questions whether there is a business, whereas the "purpose of producing income" test presupposes a business and questions the usage of a piece of business-owned property. The "reasonable expectation of profit" test looks at the historical and anticipated results of several years of operations, and asks: "will the revenue of this operation ever be greater than its expenses, such that a profit will occur?" The "purpose of producing income" test looks at an item of property and asks: "does it produce revenue, or is it at least used for that purpose?" These two tests address very different issues. Both tests could be applied separately to the same taxpayer at the same time.
Most of the "reasonable expectation of profit" criteria would be repugnant to the "purpose of producing income" test. For instance, the "profit and loss experience in past years" criterion is irrelevant to the "purpose of producing income" test for CCA, because a business may very well include items of property used only for a short-term period. Similarly, the "taxpayer's training" criterion is irrelevant to the "purpose of producing income" for CCA, because some items of property may require no particular training other than the general knowledge possessed by anyone.
In my view, the words and scheme of the ITA support an application of the "reasonable expectation of profit" criteria to ascertain whether a taxpayer is carrying on a business or a hobby, but not to determine the deductibility of CCA per se. See also generally John R. Owen, "The Reasonable Expectation of Profit Test: Is There a Better Approach?" (1996), 44 Can. Tax J. 979. With respect, mechanically transferring the "reasonable expectation of profit" criteria into the "purpose of producing income" requirement in Regulation 1102(1)(c) for CCA purposes is incorrect in law. In doing so, both the Trial Division and the Court of Appeal erred in law.
[42] No "personal element" is present in the case at bar. The appellant made no use of any dwelling unit and indeed purchased none of his own. He limited his participation in the investments to that of a limited partner, pure and simple. I do not question that the partnerships were engaged in serious activities i.e. the acquisition and rental of a large numbers of dwelling units. The manner in which the acquisitions and operations were financed were business decisions and were, thus, matters of business judgment. There is no suggestion of male fides. It is not denied that the ventures were largely funded by "tax sheltered cash flow and income tax savings". That alone is not significant unless it could be established as being the sole purpose of the ventures: Walls, supra. The promoters projected at the outset that the period of the first 10 years would result in heavy losses. The parties agreed that at no time in the taxation years in issue would the income allocated to the appellant from either Gerrard or Collegeway be sufficient to meet the interest expenses, the arranging fee and the guarantee fee claimed in respect of Gerrard or the interest claimed in respect of Collegeway. As we have seen, the appellant's investment in Gerrard was lost in 1997 when the mortgage secured by the condominium property was foreclosed.
[43] The appellant relies on this Court's decisions in Walls, supra, and Milewski, supra, both of which were rendered subsequent to the judgment under appeal. Milewski, supra, involved an appeal from the Tax Court of Canada in a case whose facts bear some similarity to the facts of the present case, particularly with respect to Collegeway. In that case, the partnership earned income in its second and third years of rental operations and it was admitted that the venture was carried on with a reasonable expectation of profit. The question at issue was whether the taxpayer was entitled to deduct interest expenses laid out to acquire his investment in the limited partnership even though the expenses exceeded his share of the partnership's income. This Court determined that he could. At trial,[3] Bowman J.T.C.C. (as he then was) was of the view, at paragraph 26, that the reasonable expectation of profit doctrine "has no application to this obviously viable business" and that "[t]o use it to restrict the deduction of interest that is specifically permitted by paragraph 20(1)(c) ignores not only the plain meaning of that paragraph, but the highest pronouncements as to the purpose of the interest deduction: Tennant v. The Queen, 96 DTC 1621 at 1625 (S.C.C.)". Both the majority and the minority judgments in this Court upheld the decision at trial.
[44] I now turn to consider whether, having regard to the facts and to recent jurisprudence, Gerrard or Collegeway had a reasonable expectation of profit. In my view, it is difficult to see that realizing a profit from rental operations motivated the partners in Gerrard. The objective indicators would suggest otherwise. That partnership was burdened by a heavy debt load from the very beginning, a load which was projected to remain undiminished throughout the first 10 years of operations. Indeed, no profit was realized from Gerrard's inception until it finally fell under the weight of its own debt load in 1997, when the mortgage was foreclosed. In my view, the appellant has failed to demolish the Minister's assumption that there was no reasonable expectation of profit and, therefore, no business source of income existed. It follows, in my view, that the interest and other expenses claimed in respect of Gerrard cannot be deducted under subsection 20(1) of the Act.
[45] In my view, Collegeway presents a somewhat different factual situation. Its debt load, while considerable, was amortized over a period of 25 years. Unlike Gerrard, Collegeway did enjoy a profit in two of the three years here in issue, a share of which the Minister included in the appellant's income for the 1990 and 1991 taxation years. While at the outset the appellant looked to the possibility of realizing an eventual gain on the sale of the real property, that alone cannot alter the fact that in taking up a unit of partnership interest in Collegeway the appellant became a limited partner in common with his co-partners with a view to profit from the "business" described in Article 2.03 of the partnership's constating document.
[46] This is not to suggest that this description should be taken as conclusively establishing that the business therein described did in fact exist. But, it seems to me, it is at this point that the reasonable expectation of profit test has particular relevance. As was noted by L'Heureux-Dubé in the passage I have quoted from her concurring reasons in Hickman Motors, supra: "The ‘reasonable expectation of profit' test questions whether there is a business..." Much the same point was made by Bowman J.T.C.C. (as he then was) in Allen, supra, at paragraph 25 where he stated that the test "operates at the liminal stage of questioning the existence of a business." In my view, a business as described in Article 2.03 did exist in Collegeway even though it carried a considerable debt load. As I have stated, Collegeway was intended to be a long-term operation as is indicated by its constating document and the fact that its mortgage loan was amortized over a period of 25 years. I note in this connection that in Milewski, supra, in upholding the judgment of Judge Bowman in Allen, supra, Rothstein J.A. agreed at paragraph 8 that a 25 year amortization period was "not unusual...for long-term investments in real estate."
[47] As detailed earlier in these reasons, the Collegeway units were priced at $171,000.00 with $10,925.00 paid in cash and the balance secured by a series of notes. Projected cumulative deductions per partner for tax purposes over 10 years were said to be approximately $187,000.00. Over that period, any cash deficiencies from rentals which failed to cover the operating costs of the partnership and the interest costs of the limited partners were to be paid by one of the promoters and added to one of the notes.
[48] In the result, I am satisfied that a reasonable expectation of profit did exist in Collegeway. It had enjoyed a profit in its early years of operation and there was no convincing evidence that it would not be profitable in the future. In my view, therefore, the appellant has made out a prima facie case that a reasonable expectation of profit did exist and that the Minister has failed to establish that his assumption to the contrary was correct. It seems to me that the foregoing conclusion is consistent with the approach of the Court in Walls, supra and Milewski, supra.
[49] The only other question is whether the interest expenses claimed are eligible to be deducted under paragraph 20(1)(c) of the Act on the basis of the case law: Bronfman Trust v. The Queen, [1987] 1 S.C.R. 32; Tennant v. The Queen, [1996] 1 S.C.R. 305; Shell Canada Ltd. v. The Queen, [1999] 3 S.C.R. 622. I did not understand the respondent to argue that the interest expenses would not be properly deductible if a business and a source of income did exist but rather that they are not deductible because, on the application of the reasonable expectation of profit test, no business in Collegeway existed. Having concluded that a business did exist in Collegeway, it must follow, in my view, that the interest expenses are properly deductible under paragraph 20(1)(c).
[50] I would allow the appeal in part, set aside the judgment of the Tax Court of Canada dated March 16, 1999 and refer the matter back to the Minister for re-assessment, in a manner consistent with these reasons, of the appellant's income for the taxation years 1989, 1990 and 1991 with respect to his interests in Collegeway. I would otherwise affirm the judgment below. As success has been divided, I would make no order as to costs.
"A.J. Stone"
J.A.
"I agree.
John M. Evans, J.A."
"I agree.
Brian D. Malone, J.A."
[1] Transcript of Proceedings, January 11 and 12, 1999, at 70-71.
[2] Ibid., at 60.
[3] Allen and Milewski v. The Queen, 99 D.T.C. 968 (T.C.C.).