Date: 19990929
Docket: 98-1830-IT-I
BETWEEN:
GUY BISSON,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
Reasons for judgment
(Delivered orally from the bench at Montréal, Quebec, on August 26, 1999)
P.R. Dussault, J.T.C.C.
[1] These are appeals from assessments for the appellant’s 1993, 1994 and 1995 taxation years.
[2] In the assessments, the notices of which are dated May 20, 1997, the Minister of National Revenue (“the Minister”) disallowed the deduction of rental losses and carrying charges relating to a condominium located at 501–2330 Rue Ward in Ville St-Laurent, Quebec.
[3] The appellant purchased the condominium in 1991. The rental losses and carrying charges claimed for the years at issue are as follows:
|
Year |
Rental loss |
Carrying charges |
Total |
|
1993 |
$8,239 |
$9,545 |
$17,784 |
|
1994 |
$7,938 |
$9,533 |
$17,471 |
|
1995 |
$7,854 |
$10,335 |
$18,189 |
[4] In making the assessments, the Minister assumed the facts set out in subparagraphs (a) to (k) of paragraph 4 of the Reply to the Notice of Appeal. Those subparagraphs read as follows:
[TRANSLATION]
(a) Cousineau et Associés Inc., a developer, undertook to sell the immovable property located at 2330 Rue Ward in St-Laurent in undivided shares, as condominiums;
(b) according to the purchase contract, the appellant purchased the condominium on August 9, 1991, for $175,000, including $36,000 in cash, most of which would come from his line of credit;
(c) among other things, the main points made by the said developer to convince potential purchasers, including the appellant, were as follows:
(i) the value of immovable property has been increasing for 40 years, making it possible to anticipate significant potential profits on resale;
(ii) by reducing and deferring your income tax, you can accumulate capital;
(iii) in addition to the fact that it reduces income taxes, owning immovable property means that you own property whose value will increase over the years;
(iv) the cost of incidental expenses may be deducted if the condominium is rented out;
(v) an individual at a tax rate of 50 percent will save almost the equivalent of what he or she had to pay to purchase the property;
(vi) the property will also continue to provide the purchaser with the same tax benefits in subsequent years;
(vii) the right to purchase with little or no real investment of capital is obvious;
(viii) by purchasing the condominium through the credit facilities available in the marketplace, you can become the owner of property that will pay for itself through the rent you collect and the various tax deductions you obtain;
(ix) it added that some costs are an integral part of the purchase price and that those costs would be transferred from the contractor to the purchaser if the purchaser decided to rent out the condominium;
(x) it also stated, as an example, that a $125,000 purchase could be financed as follows without investing any capital:
Mortgage loan $78,000
Sale balance 7,000
Developer’s mortgage 15,000
Line of credit 25,000
$125,000
(d) the rental income and expenses for the condo reported by the appellant for the years under appeal break down as follows:
1993 1994 1995
Gross income $6,079 $6,787 $7,817
Expenses:
Property taxes $2,150 $2,135 $2,135
Profess. fees 1,884 2,925 3,210
Interest 10,284 9,665 10,326
14,318 14,725 15,671
Loss $(8,239) $(7,938) $(7,854)
Carrying charges claimed for the condominium:
$9,545 $9,533 $10,335
(e) since the year he purchased the condominium, the appellant has, as anticipated by the developer, incurred rental losses in respect of it;
(f) the gross income does not even cover the financing costs, let alone the other significant fixed charges, and this is before capital cost allowance is factored in;
(g) the appellant did no market research before purchasing the condominium;
(h) the appellant knew that the condominium he purchased was not profitable to operate, and the developer’s projections clearly showed this;
(i) the appellant did not take the necessary steps to remedy the situation so as to make it profitable to rent out his condominium;
(j) the appellant had no reasonable expectation of profit from the activity of renting immovable property during any of the 1993, 1994 and 1995 taxation years; and
(k) the expenses claimed by the appellant were not claimed for the purpose of gaining or producing income from property or a business but were rather the appellant’s personal or living expenses.
[5] The appellant said that he had no knowledge of subparagraph (c), denied subparagraphs (d), (f) and (h) to (k), and admitted subparagraphs (a), (b), (e) and (g).
[6] The appellant works for the Bombardier company. In 1986, he purchased a six-unit apartment building in Valcourt, Quebec. In 1991, he decided to purchase again, but this time in Ville St-Laurent because of the potential represented by the Canadair company for a real estate investment in that municipality.
[7] The condominium was purchased on August 9, 1991, for $175,000. The appellant admitted that 100 percent of the purchase price was financed, partly through a line of credit with a credit union in Valcourt. The documents adduced in evidence, including the appellant’s 1993 to 1998 tax returns, show that during the years at issue interest was paid on two mortgage loans, the balance of the developer’s sale price and the line of credit. The total interest paid was $12,629, $11,998 and $13,461 for 1993, 1994 and 1995, respectively.
[8] According to the documents submitted by the appellant and prepared by the developer for the management company that managed the property, the anticipated gross rent for the condominium was $1,100 a month or $13,200 a year. It can thus be seen that interest expenses alone represented 95.3 percent, 90.6 percent and 101.6 percent of the anticipated gross yearly income for 1993, 1994 and 1995, respectively.
[9] In actual fact, the appellant made no reference to gross income in his tax returns for those years. He referred only to an operating profit of $6,079, $6,787 and $7,817 for each year respectively. Property taxes, professional fees, interest on the first and second mortgages and interest paid to the developer were then subtracted from that yearly profit, resulting in losses of $8,239, $7,938 and $7,854 for the three years at issue. The interest paid on the line of credit and the carrying charges payable to the developer were claimed separately in the schedule to the return relating to investment income.
[10] According to the appellant, the information was presented that way on the basis of documents and information obtained from the developer or the management company. I will simply note here that such a presentation is totally unacceptable and obviously intended to conceal some of the facts. First of all, it is impossible to determine the nature and amount of the expenses deducted from gross income to arrive at the yearly operating profit indicated. Second, the fact that the interest paid on the line of credit and the carrying charges paid to the developer were deducted in a separate schedule under a heading totally separate from the interest and other expenses claimed against the operating profit indicated for the condominium had the effect of artificially showing a much smaller loss than was incurred in respect of the condominium each year.
[11] To finish up on this question, I will simply add that the statement of rental income and expenses for 1993 to 1998 and the forecast income statement for 1999 and 2000 adduced in evidence (Exhibit A-3) also show, for the years at issue (1993, 1994 and 1995), only the operating profit under “income” and not gross income as is the case for subsequent years. First of all, the document gives the impression that gross income increased substantially every year, whereas in fact 1996 gross income was $11,553, lower than the anticipated gross yearly income of $13,200 for the years at issue. Of course, as noted above, the real gross income for those years is unknown. Second, one cannot help but notice a similar document — which was presumably attached to the appellant’s 1996 tax return but a photocopy of which is found with his 1995 return (see Exhibit I-1) — in which a real income of nil is given for 1993 and 1994. Since the same document shows outlays of $8,239 and $7,938 for those two years, the loss indicated for each year respectively is equal to those amounts. Thus, two completely different methods were used to arrive at the amount of the loss claimed for each year. This approach is suspicious, to say the least. It goes to show that it is always possible to get the numbers to “work out”.
[12] To close on this point, I will merely add that the statement of income and expenses is presented clearly and unambiguously only in the returns filed for 1996 and later years.
[13] In his testimony, the appellant said that he also financed the purchase of the Valcourt apartment building in 1986, although he admitted that he did not finance 100 percent of the price in that case. He said that he paid $13,000 in cash and borrowed on the security of a first mortgage and a second mortgage. However, the second mortgage was repaid a year and a half later upon the maturity of certain term deposits held by the appellant.
[14] With regard to the Ville St-Laurent condominium, the appellant said that he also had the necessary funds to make a cash payment but was advised to borrow on his line of credit all the same. He also admitted that he read the promotional documents before purchasing the condominium (Exhibit I-2). The documents have a great deal to say about the benefits of 100-percent financing, the anticipated tax losses and the even greater tax savings that can be achieved through such financing. The appellant also admitted that, in deciding to purchase the condominium, he was influenced by the potential capital gain of about $35,000 referred to in the forecasts established by the developer.
[15] The promotional documents do in fact refer to a cumulative net operating income based on the market value of a typical condominium as determined using an inflation rate ranging from three to eight percent from 1992 to 1995 (Exhibit I-2). The same document also presents what is called a “forecast statement of losses for tax purposes” from 1990 to 1995 inclusive, a period of six years. A similar document applicable to a 3-bedroom condominium, which is the size of the condominium purchased by the appellant, shows anticipated losses of $17,222, $16,725 and $14,853 for the fourth, fifth and sixth years of operation, or 1993, 1994 and 1995, respectively (Exhibit I-1). Based on those forecast losses, the appellant applied for a reduction in withholding taxes for the three years in question (Exhibit I-3, pages 2-4). A similar reduction was also requested for 1996 based on an anticipated authorized deduction of $7,938 (Exhibit I-3, page 5). The level and extent of the losses were thus anticipated by the developer from the outset and were in fact about the same as those claimed by the appellant for the years at issue and even for 1996.
[16] With regard to 1996, it should be added that the interest paid was $10,526, or 91 percent of the reported gross rental income of $11,553.
[17] In his testimony, the appellant said a number of times that he was dissatisfied with the management company’s management of his condominium and with the services of its financial advisor at the time, inter alia because of the trouble he had obtaining satisfactory answers to his questions.
[18] He said that he tried to take over the management of his condominium in 1994 but was unable to do so. He referred to a number of steps he took, which were unsuccessful until 1997 when, with a notary’s help, he was finally able to oust both the management company and its financial advisor from the management of the condominium. An initial letter was sent to Michel Guilbert of Planiservice Estrie Inc. on May 27, 1997, to revoke the mandate (Exhibit I-4). A second revocation of the power of attorney given to the same individual was signed before a notary on September 16, 1997.
[19] On this point, counsel for the respondent noted that the appellant does not seem to have reacted to the situation until after receiving the notices of assessment dated May 20, 1997. However, the appellant said that this was merely a coincidence and that he had begun taking steps well before then.
[20] I note that the appellant, in his testimony, did not talk about a specific plan or even about any intention he may have had of reducing his level of indebtedness in relation to the condominium within a relatively short time after purchasing it in August 1991. Nor did he show that he had such a plan or intention during the years at issue. In fact, the interest paid on the many loans he took out to purchase the condominium remained extremely high — more than 90 percent of gross income — throughout the years at issue and even during the following year, 1996, and thus over a period of six years including the year of purchase.
[21] In actual fact, during the years at issue the appellant merely continued to act in accordance with the plan and forecasts established by the developer based on the assumption of 100-percent financing and maximum use of the tax losses generated in anticipation of a potential capital gain, and thus a positive “cumulative net income” that might be as high as several tens of thousands of dollars according to the forecasts made in the promotional documents (Exhibit I-2).
[22] The appellant’s agent argued that the appellant had a reasonable expectation of profit in respect of the Ville St-Laurent condominium but that some problems arose, especially with the management of the condominium, which was being handled by third parties. The appellant took steps to take over the management thereof in 1996, and a profit can be expected in 1999 and 2000. The appellant’s agent further argued that there has been an “appreciation” in the condominium’s value and that the appellant intends to keep it. The appellant’s agent also referred to the matter of the capital cost allowance that could not be claimed in respect of the Valcourt property because of the losses claimed in respect of the Ville St-Laurent condominium, citing subsection 1100(11) of the Income Tax Regulations.
[23] Finally, the appellant’s agent stressed the fact that 100-percent financing is possible when purchasing immovable property. He argued that this does not matter if the purchaser then rearranges things in order to repay the loans, as the appellant did, it might be added, with the Valcourt property.
[24] Counsel for the respondent began by arguing that the interest expenses are not deductible because the taxpayer’s goal was to realize a capital gain and not to gain or produce income from a business or property (Ludco Enterprises Limited et al. v. The Queen, 98 DTC 6045, F.C.T.D.).
[25] Counsel for the respondent then argued that the appellant had no reasonable expectation of profit during the years at issue, mainly because of the level of financing for the condominium’s purchase. According to her, the purchase was planned so as to realize a capital gain and it was anticipated from the outset in the promotional documents that losses would be incurred.
[26] In support of her argument that the appellant had no reasonable expectation of profit during the years at issue, counsel for the respondent referred to the principles established in Moldowan v. The Queen ([1978] 1 S.C.R. 480, 77 DTC 5213, S.C.C.), Tonn v. Canada ([1996] 2 F.C. 73, 96 DTC 6001, F.C.A.), Mastri v. Canada ([1998] 1 F.C. 66, 97 DTC 5420, F.C.A.) and Mohammad v. The Queen ([1998] 1 F.C. 165, 97 DTC 5503, F.C.A.), as set out in the decision I rendered in Jean-Paul Audet v. Her Majesty the Queen (unreported decision of February 4, 1999, reasons revised on February 26, 1999, file No. 97-2417(IT)G).
[27] First of all, I would point out that the decision in Jean-Paul Audet is currently under appeal to the Federal Court of Appeal.
[28] Second, I agree that the principles and tests set out in Moldowan, Tonn, Mastri and Mohammad, as I summarized them in Jean-Paul Audet, are also applicable to the circumstances of this case. I do not think it necessary to reproduce in extenso the comments of Robertson J.A. in Mohammad to which I referred at length. It is clear that the case at bar corresponds to the situation he dealt with in paragraphs 7 to 12 of his decision. I consider it sufficient to refer here to paragraph 11 of his decision, which reads as follows:
[11] The above analysis is to the effect that there can be no reasonable expectation of profit so long as no significant payments are made against the principal amount of the indebtedness. This inevitably leads to the question of whether a rental loss can be claimed even though no such payment(s) were made in the taxation years under review. I say yes, but not without qualification. The taxpayer must establish to the satisfaction of the Tax Court that he or she had a realistic plan to reduce the principal amount of the borrowed monies. As every homeowner soon learns, virtually all of the monthly mortgage payment goes toward the payment of interest during the first five years of a twenty to twenty-five year amortized mortgage loan. It is simply unrealistic to expect the Canadian tax system to subsidize the acquisition of rental properties for indefinite periods. Taxpayers intent on financing the purchase of a rental property to the extent that there can be no profit, notwithstanding full realization of anticipated rental revenue, should not expect favourable tax treatment in the absence of convincing objective evidence of their intention and financial ability to pay down a meaningful portion of the purchase-money indebtedness within a few years of the property’s acquisition. If because of the level of financing a property is unable to generate sufficient profits which can be applied against the outstanding indebtedness, then the taxpayer must look to other sources of income in order to do so. If a taxpayer’s other sources of income, e.g. employment income, are insufficient to permit him or her to pay down purchase-money obligations then the taxpayer may well have to bear the full cost of the rental loss. Certainly, vague expectations that an infusion of cash was expected from Aunt Beatrice or Uncle Bernie will not satisfy the taxpayer’s burden of proof. In practice, the taxpayer will discharge that burden by showing that significant payments were in fact made against the principal indebtedness in the taxation years closely following the year of purchase.
[29] In my view, this has not been proved in the case at bar — on the contrary. Interest expenses remained extremely high and more or less steady throughout the period from 1991 to 1996 inclusive, a six-year period the last year of which is after the period at issue. The 100-percent financing was maintained during all of those years even though the appellant said that he initially had the necessary funds to avoid using the line of credit. The evidence in no way shows that the appellant was somehow prevented from repaying at least his line of credit during the years at issue, despite the problems he says he encountered as regards the management of the condominium.
[30] The obvious conclusion is that the appellant acted in full accordance with the developer’s plan and forecasts. The objective of the plan was to maximize operating losses and then offset them through an increase in value so that the investor could obtain a sizeable positive cumulative net income after a certain number of years. During the first five or six years, the main goal was not to make a profit but rather to increase the loss through 100-percent financing in order to make the most of tax savings in respect of income from another source. Such an approach in no way meets the requirements set out by Robertson J.A. in Mohammad. Even if the substantial carrying charges payable over a five-year period are disregarded, the interest payable and paid by the appellant during the years at issue was so high in relation to gross income that it was absolutely impossible for him to make any profit during those years, since the obligation to pay the other substantial fixed charges, namely property taxes, condominium fees and insurance, cannot be ignored.
[31] In the circumstances, I feel that the appellant has not shown that he had a reasonable expectation of profit in respect of the Ville St-Laurent condominium during the years at issue.
[32] As a result of the foregoing, the appeals for the 1993, 1994 and 1995 taxation years are dismissed.
Signed at Ottawa, Canada, this 29th day of September 1999.
“P.R. Dussault”
J.T.C.C.
[OFFICIAL ENGLISH TRANSLATION]
Translation certified true on this 29th day of December 1999.
Stephen Balogh, Revisor