[OFFICIAL ENGLISH TRANSLATION]
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Reference: 2004TCC437 |
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Date: 20030615 |
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Dockets: 2002-4491(IT)I 2002-4615(IT)I |
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BETWEEN: |
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GÉRARD BARRETTE, DOMINIQUE BÉRARD, |
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Appellants, |
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and |
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HER MAJESTY THE QUEEN, |
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Respondent. |
REASONS FOR JUDGMENT
(Delivered orally at the hearing of August 20, 2003, at Montréal, Quebec, and amended for greater clarity.)
Archambault J.
[1] Mr. Dominique Bérard and Mr. Gérard Barrette are appealing from the assessments made by the Minister of National Revenue (the "Minister") for the 1998 taxation year. The Minister disallowed their claim for deductible business investment losses within the meaning of paragraph 38(c) of the Income Tax Act (the "Act"). The amount of the deduction disallowed is $51,344 (75% of a $68,459 loss) for Mr. Bérard, and $42,098 (75% of $56,131) for Mr. Barrette. The losses were incurred as a result of investments in Groupe Immobilier Diese Inc. ("Diese").
[2] The Minister disallowed the deductions because he considered the losses at issue to be capital losses, given that Diese was not a "small business corporation" within the meaning of subsection 248(1) of the Act. The Minister maintains that Diese operated a "specified investment business," according to the definition set out in subsection 125(7) of the Act. All its income was earned from property, and it did not employ more than five employees on a full-time basis throughout the taxation year at issue. The Appellants argue that Diese was a small business corporation, because its operations consisted of buying and selling real estate.
[3] At the outset of the hearing, the Appellant admitted to all the facts set out in the Replies to the Notice of Appeal prepared by the Respondent, except paragraph 4(i) of the Reply involving Mr. Barrette. The following are each of the relevant paragraphs of the Reply involving Mr. Bérard:
a) During the years at issue, the Appellant was a shareholder in Groupe Immobilier Diese Inc. (the "Corporation");
b) This Corporation was incorporated on April 13, 1989;
c) The Corporation's sole asset was a commercial building located at 2131 Sainte-Hélène Street, in the municipality of Longueuil;
d) The Corporation acquired this building on July 13, 1989, for the sum of $258,000;
e) The Corporation's sole income consisted of rental income;
f) The Corporation had no employees;
g) The Corporation was not associated with any other corporation;
h) The Corporation declared bankruptcy on February 3, 1999;
i) Between 1989 and 1998, the Appellant invested a total of $68,459 in this Corporation.
The following are the relevant paragraphs of the Reply involving Mr. Barrette:
a) During the years at issue, the Appellant was a shareholder in Groupe Immobilier Diese Inc. (the "Corporation");
b) This Corporation was incorporated on April 13, 1989;
c) The Corporation's sole asset was a commercial building located at 2131 Sainte-Hélène Street, in the municipality of Longueuil;
d) The Corporation acquired this building on July 13, 1989, for the sum of $258,000;
e) The Corporation's sole income consisted of rental income;
f) The Corporation had no employees;
g) The Corporation was not associated with any other corporation;
h) The Corporation declared bankruptcy on February 3, 1999;
i) Between 1989 and 1998, the Appellant invested a total of $39,605 in this Corporation.
Facts
[4] The Respondent submitted income tax returns for Diese for the 1992 to 1997 taxation years; each of the returns shows that the principal activity of this corporation is real estate rental. The real estate held by Diese is treated as a capital property in these returns and the attached financial statements. Moreover, capital cost allowances totalling $25,514 were claimed for the period of 1992 to 1994.
[5] The analysis of these income tax returns and financial statements shows that Diese incurred a tax loss and an accounting loss for each year from 1991[1] to 1997. The accounting losses are as follows:
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1991 |
$23,589 |
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1992 |
$18,537 |
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1993 |
$13,386 |
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1994 |
$14,218 |
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1995 |
$9,857 |
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1996 |
$4,510 |
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1997 |
$1,035 |
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$85,132 |
[6] The Appellants explained the circumstances in which they invested in this corporation. Mr. Barrette's sister-in-law, Diane Beaudry, a residential and commercial real estate agent, identified a group of four individuals who were interested in investing in this corporation. She located the building that Diese acquired, and she negotiated its purchase. The building, located on Sainte-Hélène Street in Longueuil, was in good repair and did not need any renovation work, even though Mr. Bérard acknowledged that it had not been inspected by experts. At the time of purchase, the building was occupied by three tenants: a television and electronics repair business that paid a monthly rent of $1,100; a karate school that paid a monthly rent of $700; and, a non-profit organization that paid a monthly rent of $800.
[7] The promise to purchase proposed by Diese was accepted by the vendor on April 10, 1989. The agreed on price was $258,000. The purchase agreement was signed before a notary on July 12, 1989. The sum of $223,000 was paid (in part with a mortgage loan) and the balance of $35,000 was payable one year later, on July 12, 1990, and bore interest at a rate of 10%.
[8] Diese was incorporated three days after the promise to purchase was accepted, on April 13, 1989. The four shareholders, who each held 25% of the stock in Diese, were the Appellants, Ms. Beaudry, and a Mr. Roussel. The three men were all inspectors for the Régie du bâtiment. Each of the four shareholders' initial investment was $3,000.
[9] Diese filed a financial statement, dated June 6, 1989, and signed by Ms. Beaudry, with the Inspector General of Financial Institutions ("IGIF"). Ms. Beaudry described the nature of Diese's activities as buying, renovating and reselling real estate. During his testimony, Mr. Bérard confirmed that the intention of Diese and its shareholders was to purchase the Longueuil building and resell it at a profit in one year. At the end of the 1980s, the real estate industry was healthy; the market was fairly brisk. Real estate values were constantly on the rise, and, according to Ms. Beaudry, this building was expected to appreciate in value by $15,000 to $20,000. Mr. Bérard explained that Diese's financial statements had been prepared by an accountant-a CGA-who had also completed the income tax returns for Diese. This person described the principal activity of Diese as the rental of real estate.
[10] In 1990, the shareholders visited another building that Diese was considering purchasing. However, no offer had been made to the vendor because of the extensive renovations that would have been necessary in this building; this was not appealing to them.
[11] During his testimony, Mr. Bérard described the problems with the building at issue and Diese's unsuccessful attempts to sell it. Six months after the acquisition of the building in 1989, the non-profit organization vacated its premises, and despite all its efforts, Diese was unable to find another tenant before 1995. Moreover, Ms. Beaudry experienced financial difficulties in 1990, and she declared bankruptcy. She was unable to pay her share of the balance owing to the vendor of the building. According to Mr. Bérard, Ms. Beaudry attempted to sell the building at that time, with no success. The Appellants assumed her share of the debt, and the three remaining shareholders paid the outstanding $35,000 in July 1990.
[12] A second effort to sell the building was made on January 25, 1991. This one-year mandate was given to Ms. Verreault, another real estate agent. The mandate included an "MLS" listing, and the commission to be paid was 5%. The asking price for the building was $298,000. According to the listing, the balance owing on the mortgage was $188,850, the interest rate was 15½%, and the loan came due during the year.
[13] Over the two years that followed, the karate school changed ownership, and it paid its rent every other month only.
[14] The building was listed with a new agent on March 9, 1993. The property listing was valid until September 1993. The asking price was reduced to $240,000, then it was reduced again on March 28, 1993, to $235,000. The commission agreement was also changed: the 7% commission on the selling price that the vendor initially agreed to pay was changed to a $10,000 lump-sum payment. A 7% commission on a selling price of $235,000 would be $16,450. Obviously, where the building was to be sold for less than $142,857, the percentage to be paid would be greater than 7%.
[15] In July 1994, a rental mandate, valid until January 1995, was entrusted to La Capitale. Diese agreed to pay a 5% commission on rent payments.
[16] In 1994 or 1995, a leaky roof required Diese to pay $5,000 to $6,000 to replace it.
[17] Diese was finally successful in finding a new tenant in 1995 to replace the non-profit organization. The tenant signed a one-year lease, which, in fact, would only be renewed once. Given the difficult market conditions at the time, Diese was able to collect only $400 per month, or half the amount of the rent that the non-profit organization had paid. According to Mr. Bérard, this amount of rent was better than none at all. In order to have this lease signed, the shareholders had to fit-up the space themselves by removing some walls and repainting. The cost of the materials was approximately $1,000.
[18] A new rental mandate was signed with La Capitale in February 1996. This mandate was valid until August 1996, and the commission remained at 5%.
[19] According to Mr. Bérard, Diese lost its three tenants in 1997. Plans were made to convert the property from a commercial building to a residential building. However, because of the high cost of the conversion and the bank's refusal to finance the work required, the project was abandoned. Diese declared bankruptcy in February 1999. The building was sold for a derisory sum.
[20] Mr. Barrette acknowledged that he could not support a sum of $56,131 for his investment in Diese; the Minister determined that his investment was $39,605.
Analysis
[21] The only issue at bar in these appeals is whether Diese was a "small business corporation," and more specifically, whether its business was an "active business" or a "specified investment business." The expression "active business" is defined at subsection 248(1) of the Act as follows:
"active business", in relation to any business carried on by a taxpayer resident in Canada, means any business carried on by the taxpayer other than a specified investment business or a personal services business;
[22] According to the same section, the definition of a "specified investment business" is defined at subsection 125(7) of the Act, as follows:
"specified investment business" carried on by a corporation in a taxation year means a business (other than a business carried on by a credit union or a business of leasing property other than real property) the principal purpose of which is to derive income (including interest, dividends, rents and royalties) from property but, except where the corporation was a prescribed labour-sponsored venture capital corporation at any time in the year, does not include a business carried on by the corporation in the year where
(a) the corporation employs in the business throughout the year more than 5 full-time employees, or
[...]
[Emphasis mine.]
[23] The Respondent's position is, essentially, as follows. Because the only income declared by Diese was rental income, it was a specified investment business. It should also be noted that the Respondent's Reply to the Notices of Appeal does not indicate that the Minister considered that Diese's principal purpose was to earn income from property. Because the "principal purpose" of earning an income from property constitutes, in my opinion, an essential element to conclude that a specified investment business existed, and that the Minister did not consider this element, I informed counsel for the Respondent at the outset of this hearing that it was incumbent upon her to establish this fact. I have addressed this issue in Stein v. Canada, [1996] T. C. J. No. 685 (Q.L.), paragraphs 12 to 15, 96 DTC 1526, at page 1529, in which I cite important decisions with respect to burden of proof. More specifically, I cite the decision in M.N.R. v. Pillsbury Holdings Ltd., 64 DTC 5184, at page 5188, in which Cattanach J. of the Exchequer Court of Canada explains how a taxpayer must proceed to successfully challenge a tax assessment:
[. . .]
The respondent could have met the Minister's pleading that, in assessing the respondent, he assumed the facts set out in paragraph 6 of the Notice of Appeal by::
(a) challenging the Minister's allegation that he did assume those facts,
(b) assuming the onus of showing that one or more of the assumptions was wrong, or
(c) contending that, even if the assumptions were justified, they do not of themselves support the assessment.
(The Minister could, of course, as an alternative to relying on the facts he found or assumed in assessing the respondent, have alleged by his Notice of Appeal further or other facts that would support or help in supporting the assessment. If he had alleged such further or other facts, the onus would presumably have been on him to establish them.)
[. . .]
[Emphasis mine.]
[24] I added the following, at paragraph 15 page (Q.L.), 1529 (DTC):
[TRANSLATION]
More recently, the Federal Court of Appeal, in Pollock v. The Queen, 94 DTC 6050, described the onus on the Minister to defend his assessment where a taxpayer has successfully refuted some of the Minister's assumptions. At page 6053, Hugessen J. said the following:
Where, however, the Minister has pleaded no assumptions, or where some or all of the pleaded assumptions have been successfully rebutted, it remains open to the Minister, as defendant, to establish the correctness of his assessment if he can. In undertaking this task, the Minister bears the ordinary burden of any party to a lawsuit , namely to prove the facts which support his position unless those facts have already been put in evidence by his opponent.
[Emphasis mine.]
[25] In this case, the principal evidence-the only evidence-presented by the Respondent, is that all the gross income reported by Diese was rental income and that Diese had stated in its income tax returns that its principal activity was the rental of real estate.
[26] In her arguments, counsel for the Respondent cited a number of court decisions, namely Boulanger v. R., 2002 CarswellNat 1556, 2002 DTC 2016, Prosperous Investments Ltd v. Canada, [1992] T.C.J. No. 6 (Q.L.), Rogers v. Canada, [1997] T.C.J. No. 2 (Q.L.), Mayon Investments Inc. v. Canada, [1990] T.C.J. No. 1121 (Q.L.), Canadian Marconi v. Canada, [1986] 2 S.C.R. 522, [1986] S.C.J. No. 66 (Q.L.), Lee v. Canada, [1999] T.C.J. No. 249 (Q.L.), Martel v. Canada, [2002] T.C.J. No. 302 (Q.L.), and finally, Gascoigne v. Canada, [1996] T.C.J. No. 24 (Q.L.).
[27] In order to resolve the issue raised by these appeals, we must, in my opinion, rely on the wording of subsection 125(7) of the Act (reproduced above), which defines a specified investment business. The key words in this definition are "the principal purpose of which is to derive income...from property." I stress that the wording does not say that a specified investment business is a business for which income is earned mostly from property or in large part or mainly from property.
[28] It is important, therefore, to determine the principal purpose, which, obviously, depends on the true intention of the taxpayer. Among the decisions cited by counsel for the Respondent is Prosperous Investments, supra, in which my colleague, Bowman J., currently Associate Chief Justice, addressed this issue, as follows:
In determining the "principal purpose" of a business carried on by a corporation the stated object of the person who carries it on is not necessarily the only, or even the most important, criterion. Of critical importance is what the corporation in fact does and what its sources of income are.
[29] It is important to recall the facts of this decision, as reported by Bell J. in Rogers, supra, at paragraph 14:
Judge Bowman proceeded to analyze the taxpayer's financial statements in which he noted that the mortgage receivables and rent items made up well over fifty percent of the value of the company's assets. Furthermore, the principal portion of the revenues of the taxpayer was derived from rentals and interest and by far the preponderant part of the corporation's capital was devoted to rental properties and mortgages.
[30] It is my opinion that the remarks of Bowman J. essentially deal with the same principles as those applied in case law, where it is necessary to determine whether a property constitutes capital property or property that is part of the inventory to decide whether the gain resulting from the sale of this property is a capital gain or business income. There is no doubt that the taxpayer's intention is important in determining the nature of a property, but obviously the courts cannot render their decisions based solely on the taxpayer's statements. Case law has established indicators to verify the credibility of a taxpayer and to determine the plausibility of statements of intention made subsequent to the acquisition of the property.
[31] Although not an exhaustive list, these indicators include the nature of the property, the duration of possession, the circumstances surrounding the sale of the property, and the profession practiced by the taxpayer. Where the property is a rental property that generates rental income, this could be an indicator that it is a capital asset, whereas the purchase of a large number of vehicles or a large amount of soap would indicate that they are property that are part of the inventory.
[32] Given the principles relevant to interpreting the Act, and given the facts relevant to this case, it must be concluded in this case that the Respondent did not discharge its duty to establish that Diese's principal goal was to earn income from rental properties. Conversely, the Appellants established that Diese's principal goal was real estate speculation. The facts in support of the conclusion that the building on Sainte-Hélène Street in Longueuil was acquired in the context of a real estate buying and selling business are as follows. Diese purchased its building for the purpose of reselling it quickly, at a profit. Moreover, where a corporation owns a building, the courts tend to conclude more easily that the activity of such a corporation constitutes "a business carried on" rather than a "project involving a risk" or an "adventure in the nature of trade." It should also be noted that Diese had taken steps to acquire a second building.
[33] It is my opinion that, clearly, the two Appellants were led into an adventure in the nature of trade with risk by a real estate agent, Mr. Barrette's sister-in-law. Because of her profession and her experience, this person had the knowledge required to speculate in real estate. Given their professional experience as building inspectors, the Appellants did not have the knowledge required for speculation, nor did they have the knowledge required for commercial leasing. They relied on Ms. Beaudry, who was the veritable instigator of this project and the person who directed it, at least at the outset. Her intention is significant for the purpose of determining the intention of Diese in the pursuit of this project. Thus, Ms. Beaudry's intention was made clear at the very beginning, when she stated, in her financial statement to the IGIF in June 1989, that the activities of Diese would consist of buying, renovating, and selling real estate. Given her profession as a real estate agent and her knowledge of taxation,[2] Ms. Beaudry was well aware of the consequences of this statement. Given this statement, Diese could not have treated gains in its real estate operations as capital gains. Where the intention of Diese had been to acquire long-term real estate investments, Ms. Beaudry would not have provided this description of the business.
[34] It is a fact that the financial statements of Diese indicate that its principal activity was real estate rental, but obviously this indication does not correspond with that expressed in the financial statement. It is likely that Ms. Beaudry was no longer a shareholder of Diese when the accountant prepared these financial statements, and I am not persuaded that the Appellants understood the scope of this indication and the impact it might have. I am persuaded that if the accountant had been properly apprised of the true intention of Diese, he would not have described its principal activity as he did. He would not have entered the building in the statement as a capital asset, and he would not have claimed a capital cost allowance. It is my opinion that the financial statement prepared by the joint shareholder who located the building, negotiated its purchase, and played a leadership role in Diese has a more significant probative value than the simple description made by the accountant in the financial statements.
[35] It should be recalled that the market conditions in 1989 encouraged speculation, owing to the constant increase in the value of real estate, a trend that had been occurring for a number of years-nearly two decades. The fact that Diese never made a profit from the rental of its building, and that it accumulated a loss of more than $85,000 in seven years, does not help the Respondent discharge its duty to demonstrate that this corporation's principal goal was to earn income from property.
[36] My conclusion is the same where I analyze the actions of Diese. Did it act in a manner that is consistent with the indications made in the financial statements sent to the IGIF? Did it attempt to sell the building in question quickly? The evidence showed that there were a number of attempts to sell. Firstly, Ms. Beaudry tried to sell it. Unfortunately, the details are somewhat vague in this respect because the Appellants did not have the relevant documents with them and because Ms. Beaudry did not testify. In his testimony, Mr. Bérard stated that Ms. Beaudry did attempt to sell the building before the shareholders were obligated to pay the balance of the purchase price, that is, in the first twelve months following the purchase. This step is consistent with the schedule anticipated at the outset.
[37] In January 1991, another attempt was made to sell the building. Documents were filed to establish the fact that a mandate had been assigned to sell the building for $298,000, or $40,000 more than the initial purchase price of the building. In 1993, the price was reduced twice, and despite all of its efforts, Diese was unable to sell the building. In this situation, the initial plan failed because of economic conditions and real estate market conditions. It is a known fact that the real estate market, particularly in the Montréal area, collapsed in the 1990s. The loss of a tenant, resulting in a five- or six-year vacancy of a unit, obviously did not help sell the building.
[38] The evidence provided by the Respondent did not show that Diese had changed its business. The rental of real estate continued, in my opinion, while awaiting improvements in the real estate market. The fact in this appeal are similar to those in Stein, supra. The following is a part of the summary of this decision, found at page 1526 DTC:
The evidence clearly established that the taxpayer had not acquired the condominium for the purpose of earning rental income. He acquired it for speculative purposes, not intending to resell it quickly at a profit. Any rental income received, therefore, was only intended to mitigate his carrying charges, since the taxpayer's intention to rent was only ancillary to his overall purposes. Nor did the taxpayer ever have any expectation of profit from renting. Accordingly the Minister was correct in disallowing the taxpayer's attempt to deduct rental losses in computing his income for 1986 and 1987. On the facts, moreover, when the taxpayer acquired the condominium, he did indeed have a reasonable expectation of profit on subsequent resale. And even though such expectation was thwarted by the recession, the taxpayer's intention throughout had always been to resell. The property, therefore, was inventory, so that the taxpayer was required to capitalize, rather than to deduct, any running expenses incurred by him during 1986 and 1987.
[39] This was a case in which the Minister had disallowed the deduction of losses on the basis-too often wrongly claimed-that there was no reasonable expectation of profit. It is my conclusion that the Minister drew the same incorrect conclusion in this case. It cannot be concluded that a taxpayer ceased to operate the type of business in question simply because the business was not operated in the manner planned and because a taxpayer is saddled with a speculative property that he cannot sell.
[40] Before concluding, I would like to mention that I have read the decisions presented to me by counsel for the Respondent attentively. The issue in this case is question of fact, or, at the very least, a combined question of fact and of law. Each case must be considered on its own merits. I do not feel it is useful to comment on each of these decisions and distinguish them from this one. I will, however, comment on Boulanger, in which Lamarre J. wrote, at paragraph 28:
[. . .]
I therefore reject the appellants' argument that the mere intention to operate a business is sufficient to qualify the Corporation as a small business corporation for the purposes of deducting a BIL.
[41] It is important to place this statement in its context. Clearly, the mere intention to wish to operate a business is not sufficient to operate a business. Action is required. That case involved a project which, in the opinion of Lamarre J., had not advanced past the stage of preparing to establish a business. In paragraph 34, she says:
I agree with counsel for the respondent that the elements essential to the project's implementation collapsed even before the project saw the light of day. The Corporation did not obtain the necessary financing to start its project, and the Corporation was unable to conduct any major transaction with respect to the type of business it was supposed to carry on.
[42] In this case, the intent was to group a number of automobile dealerships together at one single site. Further in paragraph 34, she adds:
No sufficient organizational structure was established that could enable the Corporation to commence activities relating to the operation itself, such as looking for suppliers, developing markets for products, and looking for the necessary labour. All this simply did not exist and, in that sense, it is hard to conceive, as stated in Samson et Frères Ltée, supra, that a business had begun even before those essential elements relating to the structure of such a business were brought together.
[43] At paragraph 35, in fine, she writes:
It is difficult to claim that the Corporation actively operated an automotive centre in 1996, when the only building constructed on the land purchased for that purpose did not even belong to the Corporation (see on the subject Goren, supra). In my view, the Corporation was, to all intents and purposes, merely an inactive corporation without the capital needed to implement the automotive services project it intended one day to operate.
[44] It is my opinion that this decision illustrates very well the fact that the words of a judge should not be cited out of context; they must be connected to the facts relevant to the decision.
[45] In this case, the operation of Diese's business had obviously started. This corporation had acquired a building for the purpose of reselling it at a profit; it had secured a loan to fund the purchase, and, in the following months and years, attempted to sell the building without success.
[46] For all these reasons, the appeals of the Appellants are allowed, and the assessments are referred back to the Minister for reconsideration and reassessment, taking into consideration the fact that the Appellants held investments in a small business corporation. However, Mr. Barrette's business investment loss must be calculated on the basis of the $39,605 investment he made, as he was unable to demonstrate that his investment exceeded this amount.
Signed at Ottawa, Canada, this 15th day of June 2004.
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"Pierre Archambault" |
Archambault J.
Certified true translation
Colette Dupuis-Beaulne
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REFERENCE: |
2004TCC437 |
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COURT FILE Nos.: |
2002-4491(IT)I 2002-4615(IT)I |
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STYLE OF CAUSE: |
Gérard Barrette and Her Majesty the Queen Dominique Bérard and Her Majesty the Queen |
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PLACE OF HEARING: |
Montréal, Quebec |
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DATE OF HEARING: |
August 19, 2003 |
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REASONS FOR JUDGMENT BY: |
The Honourable Judge Pierre Archambault
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DATE OF JUDGMENT: (Docket 2002-4491(IT)I) |
August 28, 2003 |
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DATE OF AMENDED JUDGMENT: (Docket 2002-4615(IT)I) |
September 19, 2003 |
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DECISION DELIVERED ORALLY: |
August 20, 2003 |
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EDITED REASONS FOR JUDGMENT: |
June 15, 2004 |
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APPEARANCES: |
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For the Appellants: |
The Appellants themselves |
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Counsel for the Respondent: |
Marie-Aimée Cantin |
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COUNSEL OF RECORD: |
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For the Appellants: |
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Name: |
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Firm: |
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For the Respondent: |
Morris Rosenberg Deputy Attorney General of Canada Ottawa, Canada |