Date: 20020827
Docket: 2001-1801-IT-I,
2001-1802-IT-I
BETWEEN:
STELLA PINNOCK and
STAINTON PINNOCK,
Appellants,
and
HER MAJESTY THE QUEEN,
Respondent.
____________________________________________________________________
For the Appellants: The Appellants themselves
Counsel for the Respondent: A'Amer Ather
____________________________________________________________________
Reasons for Judgment
(Delivered orally from the Bench on
June 28, 2002, at Toronto, Ontario)
McArthur J.
[1] These appeals are from assessments made under the Income Tax Act for the 1996 and 1997 taxation years. The Appellants are husband and wife and their appeals and the replies thereto from the Minister of National Revenue are identical. Stella Pinnock carried the lead role in their joint presentation. An earlier request for adjournment was denied and the Appellants were prepared to proceed on June 24, 2002 under the Informal Procedure. They had been previously informed that federal tax and penalties is limited to $12,000 under the Informal Procedure and expenses are limited to $24,000. They had been further informed that a bump-up to the General Procedure would cost $300. I am told several letters and telephone calls from the Tax Court to the Appellants went unanswered. They are aware that their amounts under appeal exceed the Informal limitations. Presently, the Appellants are struggling through severe financial times and cannot afford a lawyer or an accountant or the bump-up fee. It would appear that they felt their best option was to proceed on their own under the Informal Procedure.
[2] The limitations that are referred to are set out in section 18.1 of the Tax Court of Canada Act, which states:
18(1) Every judgment that allows an appeal referred to in subsection 18(1) shall be deemed to include a statement that the aggregate of all amounts in issue not be reduced by more than $12,000 or that the amount of the loss in issue not be increased by more than $24,000, as the case may be.
[3] In 1996, the Minister disallowed expenses and interest of $7,805 and $31,818, respectively, and in 1997, disallowed expenses and interest of $18,589 and $37,778, respectively. The amounts are greater than the $12,000 in tax and $24,000 in loss, yet the Appellants elected to proceed under the Informal Procedure and limit their individual appeals. It would appear that the Appellants were unable to pay the $300 referred to as a "bump-up" fee.
[4] To further complicate the Appellants' proceedings, most of their relevant documentation was unavailable, having been retained or confiscated by the Ontario Ministry of Health and/or their former lawyers and accountants. The Appellant Stella is a social worker by profession and Stainton had a distinguished 34-year career with the Toronto Police Force.
[5] In 1974, the Appellants purchased, as equal partners, a boarding-house known as "Lauder Boarding Home" in Toronto, Ontario, and it is this partnership or business that claimed the losses which were disallowed and are now under appeal. It was very difficult to discern the relevant facts relied on by the Appellants. Exhibits A-1 to A-6 inclusive were presented in a disjointed fashion and are of little assistance. For example, Exhibit A-1 is a Guarantee to the Bank of Nova Scotia, signed by Stella only, guaranteeing a line of credit to 741290 Ontario Ltd. which carried on the business of Van Del Manor Nursing Home. No principal amount is mentioned and it is dated 1989. It was this business that ran afoul of the Ontario Ministry of Health and it was completely separate from the Lauder Boarding Home, other than the interest expense claimed which appears to be for money loaned by the Appellants to 741290.
[6] Exhibit A-2 is also dated 1989 and appears to be a list of guaranteed investment certificates in the aggregate amount of $155,000 to support a loan to 741290. Exhibit A-3 is a further list of securities lodged with Canada Trust and dated 1996, presumably used for the same purpose. Exhibit A-4 is a Canada Trust powerline monthly statement dated March 2000 to the Appellants, indicating a minimum payment due of $23,600. At that time, there was an account balance owing of $255,703. Exhibit A-5, I believe, is a bank statement dated February 1999 and I fail to see any relevance in this document. Exhibit A-6 is an additional Guarantee to the Bank of Nova Scotia also dated in 1989 and is similar to Exhibit A-1, with the exception that it has been duly executed by both Appellants.
[7] A letter dated October 26, 2000 (Exhibit R-4) from Canada Customs and Revenue Agency to the Appellants' former solicitor is of assistance in understanding the situation herein, and I therefore include the entire document as follows:
Attention: Mr. Osborne G. Barnwell
October 26, 2000
Dear Sir:
Re: Mrs. Stella Pinnock
Notices of Objection for the 1997 and 1996 taxation years
This letter is in response to representations in your fax dated September 18, 2000 and the above Notices of Objection. The fax dated September 18, 2000 provided photocopies of Charge/Mortgage of Land
(1) Part of Lot 30 Concession 6 Town of Newcastle; Dated February 1990. Balance Due Date: February 14, 1991.
(2) Part of Lot 30 Concession 6 Town of Newcastle; Dated February 16, 1990. Balance Due Date: September 11, 1991.
(3) Lot 69, Plan 1766 City of North York; Dated August 17, 1989. Balance Due Date: August 17, 1990.
The Charge/Mortgage of Land are unsupported by any current documentation.
The fax dated September 18, 2000 states 'we respectfully ask that a meeting be arranged with you and the taxpayers so that they would have an opportunity to explain the circumstances surrounding the expenses claimed'. Considering the information provided, we are of the opinion that a meeting would not be an effective use of your clients' time at this time.
A review of the issues has now been completed and we wish to make the following summary and comments. The following are the issues raised in the Notices of Objection.
Taxation years |
1997 |
1996 |
Adjustments to Business Income |
|
|
|
"296 Lauder Group Home"
|
|
|
|
(1) Disallowed Insurance |
|
$ 2,423 |
|
(2) Disallowed Salaries |
$ 23,794 |
$ 12,201 |
|
(3) Disallowed Interest Expenses |
$ 6,216 |
|
|
(4) Disallowed Maintenance Expenses |
$ 2,935 |
|
|
(5) Disallowed Vehicle Expenses |
$ 4,235 |
$ 1,165 |
|
Total |
$ 37,180 |
$ 15,789 |
|
Total (on T7WC's) |
$ 37,177 |
$ 15,609 |
|
Adjusted: Partnership share at 50% |
$ 18,589 |
$ 7,805 |
|
|
|
|
|
(6) Deductions from Total Income |
|
|
|
Disallowed Carrying Charges and Interest Expenses |
$ 75,556 |
$ 72,651 |
|
Disallowed Split at 50% |
$ 37,778 |
$31,818 |
We wish to summarize and comment on all the issues that have been indicated in the Notices of Objection. Further, we will reply to specific concerns that have been indicated in the fax dated September 18, 2000.
(1) The auditor determined the expenses that were supported by receipts, vouchers or documents. Based on the review the expensed amounts that were determined to be undocumented and unreasonable in the circumstances were disallowed. The auditor's letter dated June 25, 1999, provided copies of a 'Statement of Adjustments along with working papers explaining the adjustments that had been proposed'.
Generally speaking, all ordinary commercial insurance premiums are deductible, e.g. fire insurance on plant and machinery used in the business, use and occupancy insurance. Our review of the disallowed insurance expense indicates no documentation of the amount and no evidence of actual bona fide payment.
(2) The auditor determined the expenses that were supported by receipts, vouchers or documents. Based on the review of the expensed amounts that were determined to be undocumented and unreasonable in the circumstances were disallowed. The auditor's letter dated June 25, 1999, provided copies of a 'Statement of Adjustments along with working papers explaining the adjustments that had been proposed'.
Generally, salaries paid to employees are deductible expenditures provided they are laid out to earn income of the business and they are reasonable. Our review of the disallowed salaries indicates no documentation of the amount or hours of work and no evidence of actual bona fide payment to the employees.
(3) The auditor determined the interest expenses were unsupported by receipts, vouchers or documents. Therefore, the allowable interest expenses were based on the outstanding principal as at December 31, 1996. The auditor's letter dated June 25, 1999 provided copies of a 'Statement of Adjustments along with working papers explaining the adjustments that had been proposed'.
Generally, interest expense paid are deductible expenditures provided they are laid out to earn income of the business and they are reasonable. Our review of the disallowed interest indicates no documentation of the amount and no evidence of actual bona fide payment.
(4) The auditor determined the expenses that were supported by receipts, vouchers, or documents. Based on the review expensed amounts which were determined to be undocumented and unreasonable in the circumstances were disallowed. The auditor's letter dated June 25, 1999 provided copies of a 'Statement of Adjustments along with working papers explaining the adjustments which had been proposed'.
Generally, maintenance expenses paid are deductible expenditures provided they are laid out to earn income of the business and they are reasonable. Our review of the disallowed maintenance indicates no documentation of the amount and no evidence of actual bona fide payment.
(5) The auditor determined the expenses which were supported by receipts, vouchers or documents. Based on the review the expensed amounts which were determined to be undocumented and unreasonable in the circumstances were disallowed. The auditor's letter dated June 2, 1999 provided copies of a 'Statement of Adjustments along with working papers explaining the adjustments which had been proposed'.
Generally, vehicle expenses paid are deductible expenditures provided they are laid out to earn income of the business and they are reasonable. Our review of the disallowed vehicle indicates no travel log book for the expenses and no adjustment for personal portion. The taxpayer has not supplied any supporting documents. However, the auditor estimated a reasonable amount attributable to the business.
The disallowed expenses are in accordance with Section 67, Subsection 9(1), Paragraph 18(1)(a) and 18(1)(h) of the Income Tax Act.
The first test of deductibility is contained in subsection 9(1) which states that:
subject to this Part, a taxpayer's income for a taxation year from a business or property is his profit therefrom for the year.
Sections 18 and 19 prohibit the deduction of specified expenditures through the use of the words 'no deduction shall be made'. However, the rules in sections 18 and 19 actually establish general principles or test of deductibility under the Act. If an expenditure is not prohibited by a rule in section 18 or 19, that is, if an expenditure passes the set of sequential tests in these provisions, the expenditure is deductible.
To pass the test of deductibility in paragraph 18(1)(a) an expense or outlay must:
(a) be made or incurred by the taxpayer for the purpose of gaining, producing or maintaining income; and
(b) be expected to generate income related to the taxpayer's business or property.
The meaning of 'for the purpose of gaining or producing income' has been at issue in many cases.
A business is not permitted to deduct undocumented expenses whose existence and purpose it failed to demonstrate. In the case of Expofood (Canada) Ltd., v. MNR, (TCC) 85 DTC 42, the taxpayer offered no evidence as to the existence, amount or purpose of these expenses.
Expense deductions unsupported by any records, receipts or vouchers will generally be disallowed, unless supported by other evidence. Records, vouchers and receipts have been at issue in many cases.
Section 67 of the Income Tax Act places a limitation on the amount of an outlay or expense that may be deducted. To be deductible, the nature and amount of the expenditure must be reasonable in the circumstances.
(6) Deductions from Total Income
Carrying charges and Interest Expense $75,556 $72,651
Split at 50% $37,778 $31,818
The auditor's letter dated June 25, 1999 provided copies of a 'Statement of Adjustments along with working papers explaining the adjustments that had been proposed'.
The deduction of interest on borrowed money is limited to the amount of interest paid or payable or a reasonable amount in respect thereof. Interest Deduction is profiled in Paragraph 20(1)(c) of the Income Tax Act.
Interest is deductible under the following conditions:
(1) it must have been paid or payable in respect of the year pursuant to a legal obligation to pay interest; and
(2) the borrowed money must have been used for the purpose of earning income from a business or property or the interest must have been on an amount payable for property acquired for the purpose of gaining or producing income from the property or from a business.
A series of cases in the 1980's stressed the link between a source of income and the related interest expense.
In the case of The Queen v. Bronfman Trust, 87 DTC 5059, the question of income-producing capability was addressed in the Supreme Court of Canada decision.
In the case of The Queen v. Bronfman Trust, 87 DTC 5059, the position taken by Revenue Canada was confirmed, where the Supreme Court of Canada held what was important was the use of the borrowed funds. In this case, the Supreme Court, in its examination, was not able to trace the funds borrowed directly to an income-earning source (eligible use source) and, hence, denied the deduction of the related interest. In order for interest on borrowed funds to be deductible, the taxpayer must still trace the funds borrowed to an income-producing purpose.
Conclusion:
The appeal officer has reviewed the facts, the evidence and the jurisprudence of the disallowed items. All amounts reassessed can reasonably be regarded as unsupported and unreasonable amounts.
Based on our review, we are of the opinion that the disallowed amounts are in accordance with the following: Section 67, Subsection 9(1), Paragraph 18(1)(a), 18(1)(h) and 20(1)(c) of the Income Tax Act.
We trust our comments will be of assistance. We will defer any processing action for thirty (30) days to allow your submission of any additional information or explanation you may wish to have us consider. If we do not receive your reply within that time, we will proceed with the confirmation of the reassessments as explained above.
Delivery of the information should be to Canada Customs and Revenue Agency, 5001 Yonge Street, Appeals Division 11th floor, Section 430-2 to the attention of C. McAuley.
Please contact the appeal officer at the telephone number indicated if you have any questions.
Your co-operation is appreciated.
Yours truly,
C. McAuley, CMA
Appeal Officer"
cc: Mrs. Stella Pinnock
[8] Mr. Tom Kung, who performed the audit in these appeals for CCRA testified on behalf of the Respondent. Statements of fact contained on pages 3, 4 and 5 of the Appellants' Notice of Appeal were read in part by Mrs. Pinnock as follows:
In 1998 the taxpayer and her spouse, Stainton Pinnock, and two other shareholders began a business known as 'Val-Del Manor Nursing Home'. Unfortunately from the commencement of the business, they began to experience financial problems. The business was licensed under the Nursing Homes Act of Ontario which was administered by the Ministry of Health.
Under that Act and Regulations, the Ministry of Health subsidized the residence of the nursing home. ...
... Records which have been kept at the business and which supported the fact that advances had been made by the Appellants over the years were contained in the boxes. Request of the Ministry for the return of the records have been ignored. Unfortunately, due to severe financial problems, the Appellant and her spouse have not been able to afford to undertake a motion to the Ontario Court to force the delivery of the records.
... In order to carry on the nursing home business, a second mortgage was taken out on the Orono Farm. In support of this, a statement showing the amount of interest paid was submitted to the Agency. However, the amount was not allowed. Other similar supports were submitted but were ignored by the Agency.
The Lauder Boarding Home was a for-profit operation. Both the Appellant and her spouse operated the business in partnership. The business involved providing accommodations to certain individuals such as those without shelter and who were funded by social services agencies. In order to carry on its business, the boarding home had to hire workers. The turn-over of the worker pool was very high. The Appellant and her spouse experienced great difficulty in attracting long-term employees. Certain employees, who were hired, demanded they be paid in cash. In order to carry on a viable business, the Appellants had little choice. The wages disallowed were with respect to the amounts paid to those employees.
[9] The Appellants continue to struggle with their investments, particularly with 741290 Ontario Ltd. They rely on the Supreme Court of Canada decision in Stewart v. the Queen, [2002] S.C.J. No. 46. They submit that all the expenses claimed as set out in their 1996 and 1997 income tax returns under the heading "Statement of Business Activities" (Exhibits R-2 and R-3) should be allowed because they are accurate and were set out by their former chartered accountant.
Analysis:
[10] The issue in these appeals is the allowability of those expenses claimed for the operation of the Lauder Boarding Home in excess of the amounts allowed by the Minister. It is the Respondent's position that the expenses are to be disallowed because they are unsupported by receipts. The second issue is whether the Appellants are entitled to claim interest on loans taken out at various times to invest in 741290 Ontario Ltd. The Respondent relied in part on a partial financial statement (Exhibit R-1) which indicated that no advances were made to 741290. Without doubt, the Appellants' books and records were all but non-existent. I accept their submissions that their bookkeeping records were in the possession of the Ontario Ministry of Health and with their previous lawyers and accountants. They cannot afford to undertake legal remedies to force delivery of these records. They are unfamiliar with subpoenas and other legal processes. They are left at a tremendous disadvantage. I have no doubt that they have had substantial business losses over the years that they cannot substantiate with documentation. In the past, they relied on accountants. They are now left with little more than their oral testimony which includes general statements such as the statement of: "Business activities in our 1996/1997 returns must be correct because they are prepared by a chartered accountant".
[11] I find the Appellants to be an honest, hardworking couple who find themselves in their 60s and desperately struggling with serious financial difficulties. They have been funding losses of 741290 Ontario Ltd. for over 10 years. I accept their evidence that they borrowed several hundred thousand dollars on the security of their home, their farm, and the Lauder Boarding Home, all of which they owned jointly. They advanced all or most of the proceeds of these loans to invest in 741290 Ontario Ltd.
[12] The Minister's position in disallowing the interest carrying charges is that they were unsubstantiated, and the 1997 balance sheet of 741290, carrying on the nursing home business, indicated that the advances from shareholder was nil. Three pages of this document were placed in evidence. It appears the entire document was at least nine pages. The Appellants' interest payments of $31,818 in 1996 and $37,778 in 1997 are the amounts claimed. They both stated in evidence that they paid these amounts in interest for the purposes of earning income from the Lauder Boarding Home and from 741290 which operated the nursing home. I believe them, and I cannot totally disregard their evidence because they lacked documentation. The Appellants could not explain the nil advances on the 1997 balance sheet. There was an entry signifying advances from shareholders in 1996 of $38,747. Without the accountant's explanations, these entries are hardly conclusive.
[13] The third page of this statement submitted reflected mortgages payable by 741290 Ontario Ltd. of $1,742,897 in 1997 and $1,751,143 in 1996. There appear to be four mortgages registered against the nursing home property as at March 31, 1996. It would appear from the four pages of the financial statements that the corporation was liable for mortgages totalling $2,151,639. A reference was made to "Note 5" which was not, however, included in the Exhibit R-1 filed in evidence by the Respondent. This evidence is of little assistance, although one could speculate that in addition to the mortgages totalling $1,751,143 registered against the nursing home property, there was an additional $400,000 in mortgage financing for which 741290 Ontario Ltd. was liable. This would tie into the Appellants' evidence that they granted mortgages on their three other properties owned personally for the benefit of 741290 and that it was liable for the interest payable thereon. The single page for 741290's 1996 balance sheet further reflects bank indebtedness as at March 31, 1996 of $347,842. Without any details or explanation, this is of limited assistance except it indicated that 741290 was in debt with many mortgages and with the bank in 1996 and 1997.
[14] Based on the Appellants' evidence and the corroborating evidence, I somewhat arbitrarily conclude that each of the Appellants is entitled to claim a total of $24,000 for interest expense in each of the years 1996 and 1997. I believe this to be a common-sense conclusion. I have no doubt that they paid substantial interest and are entitled to relief pursuant to paragraph 20(1)(c) of the Act. The interest amounts claimed in excess of $24,000 by each Appellant is disallowed. I believe the Minister was justified in disallowing the general expenses. For the reasons given by Respondent's counsel, I find that the general expenses of $7,805 in 1996 and $18,589 in 1997 are disallowed. Because of the expense limitations under the Informal Procedure, it does not serve a useful purpose to analyze these disallowed expenses.
[15] In conclusion, the appeals are allowed for the purposes of permitting the Appellants to each claim a total of $24,000 for interest or carrying charges in each of 1996 and 1997, and the assessments are referred back to the Minister for reconsideration and reassessment.
Signed at Ottawa, Canada, this 27th day of August, 2002.
|
"C.H. McArthur" |
J.T.C.C.
COURT FILE NOS.: 2001-1801(IT)I and 2001-1802(IT)I
STYLE OF CAUSE: Stella Pinnock and Stainton Pinnock
and Her Majesty the Queen
PLACE OF HEARING: Toronto, Ontario
DATE OF HEARING: June 24, 2002
REASONS FOR JUDGMENT BY: The Honourable Judge C.H. McArthur
DATE OF JUDGMENT: July 11, 2002
APPEARANCES:
For the Appellants: The Appellants themselves
Counsel for the Respondent: A'Amer Ather
COUNSEL OF RECORD:
For the Appellant:
Name: N/A
Firm: N/A
For the Respondent: Morris Rosenberg
Deputy Attorney General of Canada
Ottawa, Canada