[OFFICIAL ENGLISH TRANSLATION]
97-1661(IT)I
BETWEEN:
BENOÎT NADEAU,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
Appeals heard on August 24, 1998, at Montréal, Quebec, by
the Honourable Judge Lucie Lamarre
Appearances
Agent for the Appellant: Virginie Falardeau, student-at-law
Counsel for the Respondent: Aziz Saheb-Ettaba
JUDGMENT
The appeals from the assessments made under the Income Tax Act for the 1992, 1993 and 1994 taxation years are dismissed.
Signed at Ottawa, Canada, this 9th day of September 1998.
|
"Lucie Lamarre" |
J.T.C.C.
Translation certified true
on this 9th day of July 2003.
Erich Klein, Revisor
[OFFICIAL ENGLISH TRANSLATION]
Date: 19980916
Docket: 97-1661(IT)I
BETWEEN:
BENOÎT NADEAU,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
REASONS FOR JUDGMENT
(Delivered orally at Montréal, Quebec, on August 24, 1998, and subsequently revised at Ottawa, Ontario, on September 16, 1998.)
Lamarre, J.T.C.C.
[1] The appellant is appealing from the assessments issued for the 1992, 1993 and 1994 taxation years by which the Minister of National Revenue ("Minister") denied him rental losses of $7,482, $5,903 and $8,593 respectively.
[2] In making the assessments, the Minister relied on the facts stated as follows in paragraph 15 of the reply to the notice of appeal:
[TRANSLATION]
(a) on June 30, 1989, the appellant acquired a property located at 9061 and 9063 Rue Bellerive in Montréal for the sum of $208,000;
(b) to pay for the purchase of that property, the appellant took out a mortgage of $173,400 at a rate of interest of 11¾ percent;
(c) at the time the appellant acquired the property, the building comprised three leased apartments which generated a total monthly income of $790;
(d) during the years in issue, two apartments were rented and the appellant lived in the main apartment;
(e) the property constantly produced rental losses and those rental losses take into account a personal portion of 33.33 percent:
(i) 1991 - $17 214
(ii) 1992 - $ 7,482
(iii) 1993 - $ 5,903
(iv) 1994 - $ 8,593;
(f) the gross rental income from the property (two rented apartments) was as follows for the years indicated:
(i) 1991 - $9,300
(ii) 1992 - $9,630
(iii) 1993 - $9,840
(iv) 1994 - $6,740;
(g) the gross annual rental income from the property was always negative as a result of the fixed costs corresponding to the years in issue:
TAXATION YEAR 1992 1993 1994
GROSS INCOME $ 9,630 $ 9,840 $ 6,740
FIXED COSTS 18,972 16,813 15,942
PERSONAL PORTION 6,324 5,604 5,314
DEFICIT $ 3,018 $ 1,369 $ 3,888
(h) the appellant did not show that he had taken concrete steps to improve the situation with regard to the rental losses from the property on Rue Bellerive in Montréal;
(i) the appellant had no expectation of making a profit from the property on Rue Bellerive in Montréal during the 1992, 1993 and 1994 taxation years;
(j) the rental expenses claimed annually in respect of the property on Rue Bellerive in Montréal were not incurred by the appellant for the purpose of earning income from a business or property.
[3] The agent for the appellant admitted subparagraphs (a), (b) and (f) and denied all the other facts set out. The appellant herself and Élisabeth Roy, a Revenue Canada appeals officer, testified.
[4] According to the contract of sale whereby the appellant purchased the property in question on June 30, 1989, the three apartments in the property were rented and together generated monthly income of $790, which would represent $9,480 a year if all three had been rented throughout the year. This therefore confirms the facts stated in subparagraph 15(c) of the reply to the notice of appeal, which were initially denied.
[5] At the time he bought the property, the appellant had been working for a number of years as an operations technician for a petrochemical plant in Varennes. His salary from that employment was $70,172 in 1989. It had been $34,562 in 1981. In 1994, the appellant received $77,917 and worked an average of 42 hours a week.
[6] The appellant purchased the property for $208,000, but the asking price had been $235,000. The municipal assessment evaluated the property at $190,365 for the 1987-1988 assessment roll.
[7] According to the listing, the duplex that the appellant purchased had been built in 1980; it had a view of the river and was located near a park and a bicycle path. The property and school taxes amounted to $4,000 and the electricity costs were $1,431 in 1988.
[8] To acquire the property, the appellant invested $38,000 of his own money and borrowed $173,400 from the Laurentian Trust of Canada at a rate of 11.75 percent. The appellant says he spoke to two other financial institutions before signing for that loan.
[9] On the basis of his own projections, the appellant thought he could make the property profitable by gradually increasing the rental income by five percent a year, which, according to him, was conservative since he had personally experienced rent increases that ranged from eight to fifteen percent in the preceding years.
[10] He anticipated maintenance expenses of approximately $2,000 a year as the property was relatively new. He also anticipated a very small increase in property taxes.
[11] As for the interest expense, he projected that it would decline from $19,434 in 1990 to $10,005 in 1994. He expected to bring this about by repaying $6,000 to $8,000 a year on the principal of the loan; in addition, he was counting on a drop in interest rates in future years.
[12] Given these projections, the appellant felt he could make a profit in 1994. In actual fact, the appellant did not pay down the principal during the years in issue other than through his regular payments. The evidence revealed, however, that he invested a total of $12,350 in his RRSP during those same years.
[13] As to interest rates, the appellant renewed his mortgage in 1991, paying a penalty of approximately $6,500 in order to lower the interest rate to 8.5 percent. In 1993, he again renewed his mortgage, bringing the rate down to 5.75 percent.
[14] If we disregard the personal portion, the interest expenses were thus $17,412 in 1991 (higher because of the penalty), $9,398 in 1992, $7,885 in 1993 and $7,267 in 1994. Those expenses increased to $13,548 in 1995 and fell to $11,537 in 1996. In 1997, the appellant was able to renegotiate a mortgage at 3.8 percent, and the interest for that year was $6,921.
[15] Maintenance expenses turned out to be higher than expected, ranging between $3,500 and $4,000 a year. The appellant said he had to replace countertops and toilets, redo the ceramic work and so on.
[16] With respect to the rental income, the appellant was not able to increase it by five percent annually. Between 1990 and 1993, income increased from $7,020 to $9,840, declining to $6,740 in 1994.
[17] The appellant gave as explanations for this the exodus to the suburbs and supply and demand. Furthermore, in 1994, the upper apartment, for which the rental was highest, was vacant for nine months. Although the appellant had been informed that the tenant was leaving the premises on January 1, 1994, paying two months' rent, the appellant was unable to find another tenant before November of that year.
[18] The appellant did not see fit to place advertisements in the newspapers because, he said, that was not an effective method; he merely posted announcements in convenience stores and other businesses and put a sign in the window of the apartment.
[19] The appellant himself lived in the ground floor apartment until January 1, 1995. He also used the garage, the laundry room and the reading room in the basement.
[20] The appellant tried unsuccessfully to sell the property in question in 1992, when he realized that it would take time before he could make a profit. He ultimately sold it at a loss in 1998.
[21] From 1989 to 1996, the appellant had nothing but losses, which declined from $15,101 in 1990 to $4,436 in 1996. In 1997, he made a profit of $848, although that was without taking into account capital cost allowance.
[22] Starting in 1995, the rental income was appreciably higher since the appellant rented the three apartments.
[23] Counsel for the respondent argued that the appellant had no expectation of profit during the years in issue and that there was accordingly no source of income that could entitle him to claim losses.
[24] The burden is on the appellant to prove objectively that he had a reasonable expectation of making a profit during the years in issue and that the rental activity constituted a business. The factors by which "objective reasonability" might be demonstrated were proposed by the Supreme Court of Canada in Moldowan v. The Queen, [1978] 1 S.C.R. 480, and cited by the Federal Court of Appeal in Enno Tonn v. The Queen, [1996] 2 F.C. 73.
[25] Among the criteria are the following: the profit and loss experience in past years, the taxpayer's training, the taxpayer's intended course of action and the capability of the venture as capitalized to show a profit after charging capital cost allowance.
[26] These criteria must be applied sparingly where personal motives are absent. It is my view that here the appellant derived in part a personal benefit from his investment.
[27] On analyzing these various criteria, one sees that the property generated only losses for as long as the appellant held it, except in 1997, when there was a slight profit which did not take capital cost allowance into account. The property was subsequently sold at a loss in 1998.
[28] The fact that the appellant did not repay any principal amount greatly restricted his ability to make the rental operation profitable. On this point I refer to Zahid Mohammad v. The Queen, [1998] 1 F.C. 165, in which Robertson J.A. wrote as follows at page 173:
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.
[29] I believe this is a case where circumstances suggest that a personal or non-business motivation existed, or that the expectation of profit was so unreasonable as to raise a suspicion.
[30] I find on the evidence that the appellant has not shown objectively that the activity in question constituted a business. Indeed, from the very outset, the rental income was such that no profit could be expected if such high interest expenses were to be added to the property and school taxes and the insurance and heating expenses.
[31] The appellant was counting on factors beyond his control to make the property profitable, those factors being: a significant decline in interest rates, which were liable to fluctuate constantly; no increase in property taxes, which in fact rose appreciably; a pay increase over the years, which proved not to be as large as expected; and a rise in rental income that did not occur.
[32] Having chosen to invest his savings in an RRSP rather than in the reduction of the principal amount of the loan, the appellant cannot objectively claim that he hoped to make a profit from the property. In fact, he was relying on other factors-much too risky and beyond his control-to make his rental activity profitable.
[33] Accordingly, the appellant cannot claim that during the years in issue he was carrying on a rental business that might entitle him to deduct the rental losses. The appeals are therefore dismissed.
Signed at Ottawa, Canada, this 16th day of September 1998.
|
"Lucie Lamarre" |
J.T.C.C.
Translation certified true
on this 9th day of July 2003.
Erich Klein, Revisor