Tax Court of Canada Judgments

Date: 20000301

Docket: 98-3634-IT-I

BETWEEN:

YVES PERRAS,

Appellant,

and

HER MAJESTY THE QUEEN,

Respondent.

Reasons for Judgment

Lamarre, J.T.C.C.

[1] These are appeals filed under the informal procedure from assessments made by the Minister of National Revenue ("Minister") under the Income Tax Act ("Act") in respect of the appellant's 1993, 1994 and 1995 taxation years. In computing his income, the appellant declared a net business loss of $3,842 in 1993, nil income in 1994 and a net business income of $7,499 in 1995. In assessing the appellant, the Minister made the following adjustments to the appellant's business income:

	1993	1994	1995
Disallowed Business Expenses:
Insurance	$762	$0	$1,569
Taxes and dues	1,184	0	2,391
Light, heat, water and phone	1,426	0	1,913
Repairs and maintenance	0	593	1,828
Home office	0	2,607	411
Advertising and public relations	0	82	0
Automobile	203	753	394
Office	432	0	0
Office rental	0	0	4,992
Small tools	0 -----------	0 ------------	881 -----------
Total Business Expenses Disallowed	$4,007	$4,035	$14,379
Allowed Business Expenses:
Capital cost allowance	43 ----------	219 -----------	261 -----------
Net Business Expenses Disallowed	$3,964	$3,816	$14,118

[2] In assessing the appellant, the Minister relied on the following facts:

a) during the years under appeal, the Appellant was operating an electrical business under the name of Power Tech Electrique (the "Business"); (admitted)

b) the Business had a December 31^st year-end; (admitted)

c) the principal place of business was located at the Appellant's residence; (admitted)

Business-Use-of-Home Expenses:

d) the portion of the Appellant's residence used for business purposes was 18.9%;

e) in computing his business income for the 1994 and 1995 taxation years, the Appellant claimed business-use-of-home expenses in the amounts of $4,100 and $2,001 respectively, as detailed on the attached Schedule "A"; (admitted)

f) of the total home expenses claimed by the Appellant for the 1994 and 1995 taxation years, the amounts of $6,740.85 and $5,468.69 respectively were unsupported by documentary evidence (see Schedule "A" for the breakdown of these amounts);

g) the Appellant is not entitled to claim business-use-of-home expenses in excess of the amounts of $1,493.19 and $1,589.98 for the 1994 and 1995 taxation years respectively;

Expenses Relating to the Land:

h) on March 6, 1995, the Appellant entered into a lease agreement with his father, Rolland Perras, in regard to a parcel of land adjacent to his residence (the "Land"); (admitted)

i) the Land is a waterfront vacant lot of approximately 2 acres legally designated as Part 2 of Lot 7, Concession 5, Perras Promenade, Plan Registration 50R-6336 Part 2, in the Township of Russell, Ontario;

j) upon entering into this lease agreement, the Appellant's intention was to buy the Land after selling his actual residence and to build a new residence thereon, which would contain a larger office space for the Business;

k) at the time of signing the lease agreement, the fair market value of the Land was $35,000;(admitted)

l) the term of the lease was for the period from January 1, 1995 to December 31, 2007;(admitted)

m) the monthly lease payment was set at the amount of $347.26, based on an interest rate of 6.5%;

n) the present value of the minimum lease payments was equal to substantially all of the fair market value of the Land at the beginning of the lease;

o) the lease agreement contained a purchase option whereby the Appellant could buy the Land at the residual value equal to the balance of the principal remaining;

p) the lease with respect to the Land was capital in nature;

q) the portion of the Land used for business purposes during the 1995 taxation year was 1%;

r) in computing his business income for the 1995 taxation year, the Appellant claimed a total amount of $5,014.38 as Office Rental expenses, which represented 13 lease payments of $347.26, and an amount of $500 as a deposit on the Land;

s) the Appellant cannot claim the capital portion of the lease payments;

t) with respect to the Land, the Appellant also claimed the full amount of $1,163.38 in property taxes for the 1995 taxation year; (admitted)

u) the Appellant is entitled to claim only 1% of the current expenses relating to the Land, being $22.18 for the lease payments and $11.63 for the property taxes during the 1995 taxation year.

10. The federal taxes in dispute are nil with respect to the assessments of the Appellant's 1993 and 1994 taxation years. (admitted)

Schedule "A"

Yves Perras v. Her Majesty the Queen

Business-Use-of-Home Expenses

	Claimed	Assessed	Disallowed
1994
Hydro	$1,968.96	$1,968.96
Insurance	459.00	459.00
Maintenance	2,159.36	592.54
Mortgage Interest	8,263.00	3,088.97
Property Taxes	1,791.00 -------------	1,791.00 -------------
Total Home Expenses	$14,641.32	$7,900.47	$6,740.85
Business portion	28.01% -------------	18.90% -------------
Business-Use-of-Home Expenses	$4,100.32	$1,493.19	$2,607.13
1995
Hydro	$2,315.14	$1,912.60
Insurance	563.00	648.10
Maintenance	2,315.46	1,828.04
Mortgage Interest	6,456.54	2,785.06
Property Taxes	2,231.15 -------------	1,238.80 ------------
Total Home Expenses	$13,881.29	$8,412.60	$5,468.69
Business portion	14.42% -------------	18.90% ------------
Business-Use-of-Home Expenses	$2,001.19	$1,589.98	$411.21

[3] At the hearing, the appellant abandoned his appeals for 1993 and 1994 as the assessments for those years are nil assessments. Moreover, the appellant is no longer challenging the assessed business-use-of-home expenses with respect to mortgage interest.

[4] The appellant was the only one to testify. He said that he took a business decision when he decided to lease his parents' land. He lives on land adjacent to the land in question. During the year in issue, he did not have enough space for a shop where he could store the voluminous materials (hydro poles and large wire) he needed for his business. He therefore used his parents' land to store it. For that purpose, the appellant and his father, Mr. Rolland Perras, signed a "Land Lease and Agreement" on March 6, 1995 which has been filed as Exhibit A-5. That agreement reads as follows:

LAND LEASE AND AGREEMENT

REGISTRATION: 50R-6336 PART 2

Lease Term January 1, 1995 to December 31, 2007

[. . .]

LAND LEASE AND AGREEMENT

THIS AGREEMENT made the 6 day of March 1995

BETWEEN MR. ROLLAND PERRAS

hereinafter called the Lessor

OF THE FIRST PART

AND

YVES PERRAS

hereinafter called the Lessee

OF THE SECOND PART

IN CONSIDERATION of the mutual covenants hereinafter contained, the parties hereto agree as follows:

1. LEASE. The Lessor agrees to lease to the Lessee, and the Lessee agrees to rent from the Lessor the land as described in Schedule "A" attached to and forming part of this agreement, subject to the terms and conditions hereof, which schedules so attached form a part of this agreement.

2. TERM. The term of this lease shall be 144 months (12 years) from the date of transfer being January 1, 1995. Lessee agrees to maintain the land in the condition from which it was original delivered, on expiration, or cancellation of the lease, or for any other reason required by the terms of this agreement. Should the Lessee fail to maintain the land, the Lessor shall e (sic) entitled to recover from the Lessee.

3. LEASE CHARGES. The monthly lease for the land shall be as set out in Schedule "A". The lease term commences on January 1, 1995 and ends on December 31, 2007. The monthly payments will be $347.26, payable to Mr. Rolland Perras. A pro-rated amount of lease from the date of delivery and all other payments shall be due and payable on deliver (sic) and all other payments shall be due and payable in advance on the 1st day of each and every month during the term. In addition, a security deposit of $500.00 shall e (sic) paid by the Lessee on delivery. Such deposit may be applied by the Lessor in its absolute discretion to cover lease charges or other charges as may legally be the responsibility of the Lessee. Any portion of the security deposit not so applied shall be returned to the Lessee upon expiration of the term of this lease or at such earlier date as this lease may be otherwise terminated.

4. OFFICIAL FEES AND TAXES. The Lessee must pay all official fees and taxes including but not limited to any personal property, sales, income and excise taxes imposed by any government authority when due. This includes municipal taxes and registration fees.

5. PROHIBITIONS. There are no prohibitions on the term of this lease, subject to it being maintained in the same condition as on delivery.

6. DEFAULT. If the Lessee shall fail to pay the monthly instalments to be paid hereunder as and when the same fall due and such default continues for then (sic) (10) days, or if the Lessee shall fail to observe or perform any of the other terms or provisions of this lease agreement and such failure continues for then (sic) (10) days, or if the Lessee shall commit an act of bankruptcy or make a bulk sale of its assets or take or permit to be taken any proceedings in insolvency, bankruptcy, receivership or liquidation in respect of the Lessee, or if the Lessee shall fail to provide the Lessor with satisfactory evidence of payment of fees and taxes when so required, then, upon the happening of any of these events, the Lessee shall be deemed to have repudiated this lease and the Lessor may, at its option, elect to accept such repudiation in which event the Lessor shall be entitled to reclaim the land and terminate the lease.

7. LATE CHARGES. Time is of the essence with this lease. If any payment is not paid within 10 days of its due date, a late charge of 2 percent (24 percent per month) of that payment will be imposed.

8. CANCELLATION. The Lessee shall be entitled to terminate this lease prior to the expiration of the term herein provided upon payment to the Lessor of all amounts herein provided to be paid by the Lessee to the Lessor up to the date of cancellation; and

a. payment to the Lessor of an amount equal to the cancellation charge specified in the table of cancellation appearing on Schedule "A" attached hereto, plus any charges to return the property to delivery status;

b. paying to the Lessor the retail fair market value which such land would have had at the date of such payment (being the balance of the principal payments on the lease).

9. It is understood and agreed that except as otherwise specifically provided herein, the Lessee shall bear all risk of loss or damage to the land during the currency of this lease, and in the event of damage shall either repair or restore the land to its fair market value.

10. LIABILITY. It is understood and agreed that the Lessor shall not be liable or accountable to the Lessee for any loss or damage of any nature or kind sustained by the Lessee directly or indirectly resulting from acts of God.

11. NO ABATEMENTS. The monthly lease and other charges shall be paid when due for the full term of the lease without notice or demand, without counterclaim, set off, reduction, abatement deferment or any other kind of defence for any cause.

12. CONSTRUCTION OF AGREEMENT. This agreement shall be construed according to the laws of the province of Ontario.

13. ASSIGNMENT AND SUBLET. This agreement or any interest herein may not be assigned or sublet by the Lessee without the prior written consent of the Lessor. The Lessor alone, will decide the credit worthiness and suitability of any proposed sub-Lessee. An administration fee of $200.00 will be levied upon the lessee for these checks and for the preparation and signing of the appropriate sublease and proof of capacity. The original security deposit will remain with the Lessor.

14. WAIVER. The failure of either party hereto in any one or more instances to insist upon performance of any terms, covenants or conditions of this lease, to exercise any right or privilege in this agreement conferred, or the waiver of any breach of any of the terms, covenants or conditions of this agreement, shall not be construed as thereafter waiving any such terms, covenants, conditions, rights or privileges, but the same shall continue and remain in full force and effect the same as if no such forbearance or waiver had occurred.

15. BUY BACK PROVISION. At the end of the original term of the lease, the residual value of the land will be the balance of the principal remaining. The Lessee acknowledges and agrees that the provisions of this clause are for the benefit of the lessor an (sic) that the same shall not apply until the expiration of the original term of the lease an (sic) that the same do not nor shall they be taken as granting to the lessee and (sic) interest in the land unless and until the original term shall have expired and that the same will be null and void in the event of termination of this lease. The buyback provision of the lease must be exercised on the last day of the lease term. If the Lessor agrees to an early retirement of the lease and invokes the buyback provision, the buyback amount will be the balance of the principal payments on the lease.

ROLLAND PERRAS AND YVES PERRAS LEASE/PURCHASE AGREEMENT AND PAYMENT OPTIONS SCHEDULE "A"

LOT DESCRIPTION: PART 2 OF LOT 7 CONCESSION 5, PERRAS PROMENADE

PLAN REGISTRATION 50R-6336 PART 2

Mr. Yves Perras wishes to enter into a lease/purchase agreement with Mr. Rolland Perras on the land described above. The lease is set up for 12 years in order to arrive at reasonable monthly payment. The lease is set up such that when Yves Perras sells his house prior to the termination of this agreement, the entire balance of the lease/purchase can be paid off.

Mr. Rolland Perras declares the entire lease payment (12 months) for personal income tax purposes and Yves Perras could claim the entire lease payment (for 12 months) as an expense for his personal income tax. The capital gain on the sale/lease of the land is calculated for tax purposes spread between the term of the lease. For GST purposes, to ensure the total income from the sale of the land does not exceed $30,000 in one year, which requires a charge of GST, the lease method ensures that the income from the sale does not require GST charges. The calculations, and payments are indicated below.

LOAN TERMS	SELECTED
LOAN AMOUNT	35,000
ANNUAL INTEREST RATE (%)	6.5
AMORTIZATION LENGTH (YEARS)	12
NUMBER OF PAYMENTS PER YEAR	12
COMPOUNDING PERIODS PER YEAR	1
MONTHLY LEASE PAYMENT ON THE FIRST DAY	$347.26
TOTAL INTEREST OVER DURATION	$15,005.81

[5] The appellant said that two-thirds of that land was a slope prone to flooding in springtime. According to him, only one third of the land is usable space, and this is where he put his business materials.

[6] The value attributed to the land by the municipality is $35,000. When the appellant signed the above-cited agreement, he started paying the property taxes and all other fees related to the land.

[7] The appellant terminated the lease sometime in 1997 when he closed his business. He met his father in his accountant's office and his father agreed not to charge any penalty. An undated Land Lease Cancellation Agreement was signed by the appellant and his parents. This document has been filed in evidence as Exhibit A-2 and reads as follows:

1. The land lease agreement signed between Mr. Rolland Perras and Mr. Yves Perras for POWERTECH ELECTRIC for the period January 1, 1995 to December 31, 2007 for the land Registration 50R-6336 Part 2 is hereby cancelled, in accordance with Section 6 of the said lease.

2. Given that the land was leased for the purposes of storage and construction of an electrical shop for POWERTECH ELECTRIC, and the said business was sold and subsequently closed on February 15, 1997; and the signed lease has been determined to be illegal and void, the lease is cancelled. In recognition that only Mr. Rolland Perras signed the lease when the land is owned equally by Mr. and Mrs. Rolland and Lilliane Perras the following clause amends and corrects the Section 2 of the initial lease:

"The term of this lease shall be for the period January 1, 1995 to February 28, 1997. The title to the property remains in the hands of Rolland and Lilliane Perras. No option to purchase is exercised."

3. All security deposits and fees paid to the date of the termination of the lease remain with the lessor.

The appellant acknowledged that this document had been prepared after the respondent's audit but he said that it was also after his business closed.

[8] The appellant also filed in evidence a reminder notice for property taxes in arrears with respect to the land in question. That notice was issued on January 6, 2000 by the Township of Russell (Exhibit A-3) and was filed by the appellant to show that his parents are still the owners of the land.

[9] The appellant said that the land has a total area of 2.26 acres, that is, 102,802 square feet. The auditor established that the appellant used only 900 square feet for storage, which is one per cent of the total area.

[10] The appellant submits that he is entitled to deduct the whole of the rental payments for the land as they were incurred solely for a business purpose. The respondent submits that the agreement signed between the appellant and his father was not a lease but a disguised sale. The respondent therefore submits that the appellant cannot deduct the capital portion of the "lease payments". As for the balance, the respondent submits that the appellant can claim only one per cent as the appellant used only one per cent of the land for business purposes.

[11] The appellant replied that if he had wanted to buy it in 1995, he would be the owner of the land today, which is not the case. Furthermore, he said that had he not cancelled the lease, he would have paid approximately $15,000 in total by the end of the lease. This would have left a balance of at least $20,000 to be paid in order to acquire the land. He submits that this cannot be considered as a negligible residual value to be paid upon exercising the option to purchase. In the circumstances, the appellant is of the view that one cannot speak of a disguised sale. He also said that it was more convenient for him to lease the land than to buy it.

[12] The appellant also challenges the one per cent business use of the land. He claims that the whole property was leased for business purposes but that only one-third was usable. He says that he had to pay for the value of the whole property.

[13] With respect to the car expenses, the appellant acknowledged that he did not keep a logbook and that he was already being allowed 100 per cent of the expenses for his van.

[14] With respect to the business-use-of-home expenses, the appellant said that at home he used an office and a workbench and that he used his basement and garage for storage. He said that he had measured the space used for business purposes with the auditor and that he does not understand how the auditor arrived at 18.9 per cent for use-of-home expenses. According to him, two-thirds of the garage was used for storage while the auditor determined that only one-half was used for that purpose.

Analysis

Expenses Related to the Land

[15] Counsel for the respondent relied on the decision in Viceroy Rubber and Plastics Limited v. M.N.R., 93 DTC 347 (T.C.C.) in submitting that the lease payments made by the appellant to his father under the agreement in the year in issue were in substance payments for the purchase of capital property. As Judge Brulé said in that decision, the Act does not provide for a determination of when a payment is on account of a purchase transaction or on account of a lease transaction. Consequently, said Judge Brulé, this determination must be made on consideration of the following (at page 350):

(1) the terms of the agreement between the parties and

(2) the factual circumstances surrounding the making and execution of that agreement.

A transaction is considered a sale rather than a lease where any one of the following situations applies:

(a) the lessee following the payment of specific rental costs, automatically acquires title to the property;

(b) the lessee is required to purchase the property from the lessor during or upon termination of the lease agreement or is required to guarantee that the lessor will receive the entire option price from the lessee or a third party;

(c) the lessee has the right during or upon the expiry of the lease to acquire the property at a price which at the commencement of the lease is substantially less than the probable fair market value of the property when the lessee is permitted to acquire the property; or

(d) the lessee has the right during or upon the expiry of the lease to acquire the property at a cost and pursuant to terms and conditions which at the commencement of the lease are such that no reasonable person would fail to exercise the option to purchase. (See Interpretation Bulletin No. IT-233R dated February 11, 1983 at clause 3.)

When it is determined that the lease is one of sale, the lessee must treat the transaction as an acquisition of an asset and an assumption of a liability as at the commencement of the lease. It is important to note that where certain obligations (i.e., taxes, insurance, etc.) incidental to ownership of property become the responsibility of the lessee, this fact will not in and of itself determine conclusively whether the transaction is one of sale but will only corroborate support that the transaction is perhaps a sale.

Judge Brulé also referred to the case of Tri-Star Leasing (London) Inc. v. M.N.R., 92 DTC 1786 (T.C.C.), where Judge Sarchuk held at page 1790:

In order to determine the nature of the agreement before me it is necessary to look at the language of the contract itself, its purpose and the circumstances surrounding the conclusion of the contract. To that extent it is appropriate to look to the common intent of the parties in addition to looking at the manner in which the contract is framed.

[16] Judge Brulé also pointed out in Viceroy Robber and Plastics Limited, supra, at page 352 that "in determining the true character of a contract as one of lease or sale, the Courts have examined closely the unique provisions within the documents themselves. Particular attention has been given to option to purchase clauses within the contracts".

[17] In Kamsel Leasing Inc. v. M.N.R., [1993] T.C.J. No. 12 (Q.L.), Judge Sarchuk said at page 7:

In the present appeal there is sufficient evidence upon which I can conclude that a lessee had the right at the expiration of the lease to acquire the property at a price which at the inception of the lease could be said to be substantially less than the probable fair market value of the property at the time of permitted acquisition. It is equally fair to state that the option permitted a lessee to acquire the property at a price which at the inception of the lease was such that no reasonable person would fail to exercise, and indeed the evidence was that a substantial percentage of the lessees exercised the option. These two findings I am constrained to note mirror the circumstances under which, according to IT-233R, Revenue Canada would consider a transaction to be a sale rather than a lease.

[18] In the present case, the Land Lease and Agreement (Exhibit A-5) includes a buyback provision (paragraph 15) which states that at the end of the original lease, the residual value of the land will be the balance of the principal remaining. Schedule A to Exhibit A-5, forms part of the Land Lease and Agreement. I am of the view that this Schedule A, which is entitled "Lease/Purchase Agreement and Payment Options", shows what the intention of the parties was at the time the agreement was signed. Payments were calculated in such a way as to attract a lesser tax burden for both parties. The calculations in Schedule A show a loan amount of $35,000 to which an annual interest rate of 6.5 per cent is applied over an amortization period of 12 years. The monthly lease payments were established at $347.26 and the total interest over the duration of the lease is shown as being $15,005.81.

[19] If the lease had not been cancelled in 1997, the appellant would have paid by the end of the lease an amount of $50,005.44 ($347.26 x 144 months). This total amount would have included $15,005.81 in interest, leaving a balance paid of $34,999.63 on the land itself. These calculations show that the Minister was right in saying that the residual value was negligible at the end of the lease and the appellant is wrong when he says that that residual value would have been around $20,000.

[20] Furthermore, the principal test, according to The Canadian Institute of Chartered Accountants Handbook ("CICA"), for determining whether a transaction is a lease or a sale is whether the transaction conveys all the benefits and risks of ownership to the lessee (see CICA at page 1155, paragraph 3065.05):

Benefits may be represented by the expectation of profitable operation over the property's economic life and of gain from appreciation in value or realization of a residual value. Risks include possibilities of losses from idle capacity or technological obsolescence and of variations in return due to changing economic conditions.

[21] In the present case, the agreement clearly stipulates, in my view, that the benefits and risks of ownership were transferred from Mr. Rolland Perras to the appellant at the time the agreement was signed in 1995.

[22] The appellant could acquire ownership of the land at the end of the lease on very favourable terms. Moreover, the appellant had to pay all fees and taxes on the land (Exhibit A-5, paragraph 4). The appellant had to bear all risk of loss or damage to the land during the currency of the lease, and in the event of damage, had to repair or restore the land to its fair market value (Exhibit A-5, paragraph 9). The appellant was also liable for any loss or damage of any kind resulting from acts of God (Exhibit A-5, paragraph 10).

[23] Accordingly, the arrangement between the appellant and his father appeared in essence to amount to a deferred purchase, pursuant to the terms of which the appellant was paying for capital property by way of instalments over a twelve-year period, even though, legally, the agreement exhibited the form of a lease. In this respect, in interpreting a contract, it is the intent of the parties that governs, whatever the name they may have given it. (See Thibault v. Auger, (1950) S.C. 340 (Superior Court of Quebec), and Grand Toys Ltd. v. M.N.R., 90 DTC 1059 (T.C.C.)).

[24] Finally, although title to the property remained in the name of Mr. Rolland Perras, this factor in itself does not determine the proper characterization of the transaction in question at the time it was agreed upon. (See Viceroy Rubber and Plastics Limited, supra, page 354). I am also of the view that the fact that the parties decided to cancel the lease when the appellant's business closed (after the respondent's audit) is not a factor that should change the proper characterization at the time they signed the agreement in 1995.

[25] I therefore conclude that the agreement bears the characteristics of a sale and, consequently, the appellant was not entitled to deduct the capital portion of the monthly payments made in the year 1995.

[26] With respect to the portion of the land devoted to business use, the respondent's auditor determined that 900 square feet were used by the appellant for storage on a lot with a total area of 102,802 square feet; this represented one per cent of the land. The appellant acknowledged that at the time of the signing of the agreement in 1995, he had anticipated the possibility of selling his house and eventually building on the land in question. This eventuality was even contemplated in Schedule A of the Land Lease and Agreement (Exhibit A-5). I therefore find that the appellant intended to use the land for personal purposes also. The appellant has not convinced me that the Minister was not justified in allowing only one per cent business use of the land. The appellant is therefore not entitled to deduct more than one per cent of the non-capital portion of the monthly payments and of the property taxes with respect to the land, as determined in the assessment.

Business-Use-Of-Home Expenses

[27] With respect to the business-use-of-home expenses, the appellant acknowledged that the respondent's auditor measured with him the portion of the house used for business purposes. Except for his testimony, which was not convincing, the appellant has presented no further evidence that would lead me to change the percentage of home expenses attributed to business purposes by the auditor. Indeed, that percentage does not seem to be unreasonable. I therefore conclude that the appellant has not demonstrated on the balance of probabilities that the Minister erred in assessing the business-use-of-home expenses at 18.9 per cent. Nor has the appellant shown that the Minister erred in disallowing some of the business-use-of-home expenses on the basis that they were unsupported by documentary evidence. The appellant was therefore not entitled to claim business-use-of-home expenses in excess of $1,589.98 for the 1995 taxation year.

[28] For all these reasons, the appeals for the 1993 and 1994 taxation years are quashed and the appeal for the 1995 taxation year is dismissed.

Signed at Ottawa, Canada, this 1st day of March 2000.

"Lucie Lamarre"

J.T.C.C.