Date: 20000407
Docket: 1999-300-IT-I
BETWEEN:
JEAN-MARIE LALANDE,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
Reasons for Judgment
Lamarre Proulx, J.T.C.C.
[1] This is an appeal under the informal procedure for the 1994, 1995 and 1996 taxation years. The point at issue is whether the appellant had a reasonable expectation of profit from the rental of a condominium purchased in 1983. From its purchase until its disposition in 1999, the property never produced a profit. The losses claimed for the years in issue are $5,149, $5,086 and $5,238.
[2] The appellant was the only person who testified in this case. Counsel for the respondent filed as Exhibit I-1 a book of documents with 21 tabs.
[3] The appellant is now retired. In 1984, he was an assistant deputy minister at the Ministère de la Fonction Publique (Civil Service Department) of Quebec. He explained that, in 1984, wishing to supplement his pension and at the same time take advantage of the government's rental property building incentive program known by the acronym MURB (multiple unit residential building program), he purchased a few properties, one of which was located on Richmond Road in Ottawa. He disposed of the others, which were located in Toronto, a few years after purchasing them. The appellant explained that, according to the advice of a colleague, a former Ottawa resident, it was advantageous to purchase MURBs and to purchase them from the builder Mastercraft for the following reasons: (a) to obtain the MURB designation, the properties had to be of high-quality construction and (b) Mastercraft was a recognized builder in the Ottawa area with expertise in rental apartment management. This colleague provided him with written information on the Richmond Road project. In addition, insisted the colleague, the appellant should consider the Ottawa area's economic future in the electronics field.
[4] The appellant referred to tab 19 of Exhibit I-1, which contains an analytical chart, prepared by the developer, showing the tax benefits of a $16,200 investment. It is presented as a tax savings incentive. The chart shows that net rental income was always negative from 1983 to 1991, and even more so after capital cost allowance.
[5] The appellant realized that this scenario brought out the tax benefits, but he said that, at the time, he had made his own projection up to the time he would reach retirement age. He stated that he had tried to reproduce those figures with his son-in-law's help. This worksheet was filed as Exhibit A-1. It shows positive net income starting in 1994: $397 for 1994, $1,026 for 1995 and $2,056 for 1996. For each of those years, the gross income hoped for was 15,087, $16,100 and $17,227. These figures were solely assumptions because, in actual fact, the property never generated gross rental income in the order of that stated in Exhibit A-1 and accordingly never produced net profits even in 1998.
[6] According to the documentary evidence, the rental losses claimed over the years were $15,497.81 (1984), $15,508 (1985), $13,592 (1986), $13,275 (1992) and $11,373 (1993). These losses included capital cost allowance.
[7] The appellant sold the property in 1999.
[8] The property was part of a pool of apartments collectively managed by a rental business. Tab 8 contains a letter from the appellant to Revenue Canada dated November 15, 1997, which reads in part:
[TRANSLATION]
The property was always part of a pool managed by a rental manager who paid himself out of the rental income and sent me the rest by monthly cheque . . . .
[9] The appellant thus never knew how much profit his own apartment generated except in 1998, when the property was managed on an individual basis. Mastercraft abandoned management of the apartments in 1987. After that, according to the appellant, the individual who handled the management was not up to the task. Legal action was instituted against Mastercraft in 1990 on grounds of defective construction. Tab 13 contains a report by Carleton Condominium Corporation No. 268 (Marina Bay). This report to the condominium owners states that 1992 was a good year. The various problems with the building had been resolved, although there were still some problems with the elevators that were to be solved in 1993.
[10] In 1997, the appellant withdrew his property from the rental pool and handed it over to a rental agent. The appellant testified that he did so in order to improve the rental results. From what the evidence showed, however, the rental income did not improve. The appellant's explanation for this was that the building had earned a bad reputation as a result of all the construction and rental management problems.
[11] Tab 10 of Exhibit I-1 contains the contract of purchase between the appellant and Mastercraft Development Corporation. Clause 6(f) states: "The building shall be a multiple unit residential building qualifying as Class 31 asset under Regulation 1100(14) of the Income Tax Act (Canada)." The contract of purchase was signed by the appellant on April 28, 1983. The vendor signed on September 13, 1983. Schedule J found at the end of tab 10 of Exhibit I-1 identifies the property purchased, its cost and the various elements of that cost. The total price of $107,999 was paid as follows: $2,500 cash, a mortgage of $91,799 and a promissory note for $13,700. This promissory note was given to Mastercraft Development Corporation and was to be paid not later than December 31, 1984. The appellant took out another loan to pay this promissory note.
[12] According to the sales prospectus filed as Exhibit A-3, the purpose of the purchase was as follows: "The objective of investing in multi-unit residential income property is to earn cash income, to realize capital appreciation and to provide an opportunity for income tax deferrals." At pages 10 and 11 of the prospectus, attractive rental income is not among the 15 reasons "Why you should invest in Marina Bay". Those reasons are given as being "tax shelter, return of investment, capital appreciation, strong market for condominiums, retroactive tax refunds, etc." At page 13, the guarantees enumerated include a "Revenue Guarantee", which reads as follows: "During the first two years after the Transfer Date, Mastercraft shall also provide a Revenue Guarantee that will ensure that the monthly rental revenue for each unit shall not be less than the scheduled rent. In the event that monthly rental revenue exceeds the guaranteed rent, the excess shall accrue to the benefit of the investor."
[13] Tab 9 contains the [TRANSLATION] "Rental Property Questionnaire". To question 4, [TRANSLATION] For what purpose was the property originally purchased? the answer is: [TRANSLATION] To supplement my retirement because it was class 31 property with tax benefits. The purpose of this program was to improve Canada's building inventory. To question 5, [TRANSLATION] When did you begin renting the property? Please state the month and the year, the answer is: [TRANSLATION] I don't know because the property was part of a pool. To question 9, [TRANSLATION] How do you determine the rental cost for each unit? the answer is: [TRANSLATION] These costs are established by the manager. To question 10, [TRANSLATION] If during a given period of time the unit was not rented, please state whether it was available for rental. If not, please explain why not, the answer is: [TRANSLATION] It was the manager's duty to find a tenant.
Argument
[14] Counsel for the appellant emphasized the reasons for the purchase. The appellant wanted to supplement his pension income. Consequently, the purpose of the purchase was to generate good rental income. The tax consequences were a plus, but not an end in themselves. In addition, the appellant had conducted serious analyses and research. If he encountered difficulties, they were the sort of unforeseeable and acceptable problems that arise when one has no personal interest in the property leased. Counsel also argued that the property was a MURB for which, until 1994, there was even an exception regarding the use of capital cost allowance to increase or create a rental loss under subsection 1100(14) of the Income Tax Regulations (the "Regulations"), and that the rental losses claimed were thus in accordance with the spirit of the Regulations.
[15] Counsel for the respondent referred to the Supreme Court of Canada's decision in Moldowan v. The Queen, [1978] 1 S.C.R. 480, at page 485:
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. . . .
She referred as well to the Federal Court of Appeal's judgment in Tonn v. Canada, [1996] 2 F.C. 73, at pages 103 and 104:
[39] . . . Though I do not support the use in the Nichol case of the word "patently", I otherwise agree that the Moldowan test should be applied sparingly where a taxpayer's "business judgment" is involved, where no personal element is in evidence, and where the extent of the deductions claimed are not on their face questionable. However, where circumstances suggest that a personal or other-than-business motivation existed, or where the expectation of profit was so unreasonable as to raise a suspicion, the taxpayer will be called upon to justify objectively that the operation was in fact a business. Suspicious circumstances, therefore, will more often lead to closer scrutiny than those that are in no way suspect.
Counsel also referred to the decision of the Federal Court of Appeal in Mastri v. Canada, [1998] 1 F.C. 66, at pages 74, 75 and 76:
[9] First, it was decided in Moldowan that in order to have a source of income a taxpayer must have a reasonable expectation of profit. Second, "whether a taxpayer has a reasonable expectation of profit is an objective determination to be made from all of the facts" (supra, at pages 485-486). If as a matter of fact a taxpayer is found not to have a reasonable expectation of profit then there is no source of income and, therefore, no basis upon which the taxpayer is able to calculate a rental loss. There is no doubt that, post-Moldowan, this Court has followed and applied that decision: see Landry (C.) v. Canada, [1995] 2 C.T.C. 3 (F.C.A.); Poetker v. Minister of National Revenue, [1996] 1 C.T.C. 202 (F.C.A.); and Hugill (R.) v. Canada, [1995] 2 C.T.C. 16 (F.C.A.). The only remaining issue is whether Tonn departs from that jurisprudence by postulating that the reasonable expectation of profit test remains irrelevant to the question of deductibility of losses until such time as it can be established that the case involves an inappropriate deduction of tax, the presence of a strong personal element or suspicious circumstances. . . .
. . .
[10] In my respectful view, neither of the above passages support the legal proposition espoused by both the Minister and the taxpayers. It is simply unreasonable to posit that the Court intended to establish a rule of law to the effect that, even though there was no reasonable expectation of profit, losses are deductible from other income sources unless, for example, the income earning activity involved a personal element. The reference to the Moldowan test being applied "sparingly" is not intended as a rule of law, but as a common-sense guideline for the judges of the Tax Court. In other words, the term "sparingly" was meant to convey the understanding that in cases, for example, where there is no personal element the judge should apply the reasonable expectation of profit test less assiduously than he or she might do if such a factor were present. . . .
. . .
[12] In summary, the decision of this Court in Tonn does not purport to alter the law as stated in Moldowan. Tonn simply affirms the common-sense understanding that it is not the place of the courts to second-guess the business acumen of a taxpayer whose commercial venture turns out to be less profitable than anticipated. . . .
The Federal Court of Appeal's decision in Mohammad v. Canada, [1998] 1 F.C. 165, at pages 173 and 175, was likewise cited:
[7] Frequently, taxpayers acquire a residential property for rental purposes by financing the entire purchase price. Typically, the taxpayer is engaged in unrelated full-time employment. Too frequently, the amount of yearly interest payable on the loan greatly exceeds the rental income that might reasonably have been earned. This is true irrespective of any unanticipated downturn in the rental market or the occurrence of other events impacting negatively on the profitability of the rental venture, e.g. maintenance and non-capital repairs. In many cases, the interest component is so large that a rental loss arises even before other permissible rental expenses are factored into the profit and loss statement. The facts are such that one does not have to possess the experience of a real estate market analyst to grasp the reality that a profit cannot be realized until such time as the interest expense is reduced by paying down the principal amount of the indebtedness. Bluntly stated, these are cases where the taxpayer is unable, prima facie, to satisfy the reasonable expectation doctrine. These are not cases where the Tax Court is being asked to second-guess the business acumen of a taxpayer whose commercial or investment venture turns out to be less profitable than anticipated. Rather these are cases where, from the outset, taxpayers are aware that they are going to realize a loss and that they will have to rely on other income sources to meet their debt obligations relating to the rental property.
. . .
[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. . . .
Conclusion
[16] First I shall speak briefly about the MURB program by referring to the passage dealing with the purpose of the legislation in the Federal Court of Appeal's decision in Vaillancourt v. The Queen, [1991] 3 F.C. 663 (91 DTC 5352), at pages 677-678 (DTC, page 5358):
Purpose of legislation and budget speech
In the budget speech he made on November 18, 1974, the Minister of Finance said the following:
For reasons already discussed, I am particularly anxious to provide a quick and strong incentive to the construction of new rental housing units. I therefore propose to relax for a period the rule whereby capital cost allowances on rental construction could not be charged against income from other sources.
Specifically, in respect of new, multiple-unit residential buildings for rent, started between tonight and December 31, 1975, the capital cost allowance rule will not apply. This means that an owner of an eligible rental unit will be permitted to deduct capital cost allowance against any source of income at any time. I am confident that this measure will attract a significant amount of private equity capital into the construction of new rental housing. [My emphasis.]
Although these observations do not have the decisive scope claimed for them by counsel for the appellant, they illustrate quite clearly the Government's intention to encourage the construction of multiple-unit residential buildings and to induce taxpayers to invest in such buildings in return for significant depreciation potential. . . .
[17] The purpose of the MURB program was to promote the construction of residential rental properties. Nowhere do we read that its purpose was to alter the conditions for the applicability of section 9 and paragraph 18(1)(a) of the Act or the principles developed by the Supreme Court of Canada in Moldowan, supra, and commented on in the Federal Court of Appeal decisions cited above. According to this case law, in order to have a source of income one must have a profit in view or at least one must have a reasonable expectation of profit.
[18] It should be kept in mind in the instant case that the developer's forecasts at the outset were that there would be no net profit, even before capital cost allowance and on the basis of a guaranteed rental income. If we disregard the entire advertising aspect, which goes back to 1983 and consider the appellant's conduct, we are forced to recognize that the appellant had incurred significant rental losses since 1983. Since the years in issue are 1994, 1995 and 1996, there was ample time to turn the situation around. It is easy to understand that the reason expenses always greatly exceeded gross rental income was because the amount of the purchase price was almost entirely borrowed. The appellant did not put in place the necessary capital structure to deal with normal rental problems. He did not correct the problem of insufficient capital. The only corrective action he suggests he took was to withdraw the rental property from the rental pool and hand it over to a rental agent. This occurred after the years in issue and, as the evidence showed, had no effect on the usual negative income.
[19] In my opinion, the evidence clearly showed that the rental property in question was not a source of income for the appellant: its purpose was not to generate a rental profit nor a reasonable expectation of such profit.
[20] Accordingly, the appeal is dismissed.
Signed at Ottawa, Canada, this 7th day of April 2000.
"Louise Lamarre Proulx"
J.T.C.C.
[OFFICIAL ENGLISH TRANSLATION]