Grocott v. The Queen, 96 DTC 1025, [1996] 1 CTC 2311 (TCC) (Informal Procedure)

Bowman J.T.C.C.:— These appeals are from assessments for the 1990, 1991, 1992 and 1993 taxation years.

There are two issues: the deductibility of losses incurred by the appellant in respect of property owned by him at 867 Dorchester Drive, Sarnia, Ontario, and the correctness of the Minister’s inclusion in the appellant’s income of employment income earned by him in Saudi Arabia, at a time at which he was resident in that country and not in Canada.

Concerning the first issue, the appellant bought the property in 1987 as his principal residence. His position with Shell Canada Resources Limited as an engineer came to an end in or prior to 1989 and he and his wife moved to Toronto where they bought a condominium as their principal residence. He took up employment with an engineering firm in Toronto, Stone and Webster Canada Limited. He decided to rent the Sarnia property unfurnished and arranged with his daughter to remove the furniture if a suitable tenant was found. He consulted with a real estate firm but was told that because of economic conditions in Sarnia at the time, resulting in part from the recession and in part from the downsizing that was occurring in the resources sector of the economy, there was little hope of his being able to rent the property. Nonetheless he made vigorous efforts to do so himself. He advertised in local newspapers and posted notices in prominent places. He talked to the managers of all personnel departments in Sarnia. Unfortunately in 1990, 1991, 1992 and 1993 his efforts yielded no results and the property remained vacant from the middle of 1989, when he moved to Toronto, until August 1993, when he moved back to Sarnia. The property yielded no income.

He claimed in each of those years, as expenses, the cost of utilities, insurance, realty taxes, advertising and a small amount for maintenance and upkeep. The amounts claimed in each year, and the resulting losses, were as follows:

1990: $7,977.66

1991: $5,029.47

1992: $4,800.62

1993: $3,292.22

He did not claim mortgage interest. He was denied these losses on the basis that he had “no reasonable expectation of profit”. Mr Grocott, with some justification, feels affronted at the use of this hackneyed phrase, and at the suggestion that he did not try hard enough to find a tenant. The chanting of the phrase “no reasonable expectation of profit” as a ritual incantation by the officials of the Department of National Revenue as a substitute for rational analysis lies at the root of the problem in this case. It was perfectly reasonable for him to expect a profit had he not been in a difficult economic climate and had he been able to obtain the rental that he was seeking. Moreover he made all reasonable efforts to find tenants. Had he been given a rational explanation for the disallowance rather than the ritual repetition of a mantra, he might never have appealed.

It is not however my function to judge the behaviour of the Department of National Revenue. My concern is the correctness of the assessment. The short answer is that for there to be a deduction of rental expenses there must be a rental operation. Mr. Grocotf s proposed rental operation never got off the ground. The house was originally his principal residence and although the condominium in Toronto became his principal residence when he moved there, the Sarnia property was not converted to a rental operation until he started using it as such. A mere intention to rent it out does not, in itself, convert an asset originally acquired for personal reasons to a rental property, even if attempts to rent it are made.

A more difficult aspect of this appeal is the application of section 114. In 1991 the appellant took up employment in Saudi Arabia with a company in the Shell group. On February 19, 1991 he submitted a form NR73 - Determination of Residency Status — setting out that he would be out of Canada from April 1991 to April 1993. On the basis of the information submitted, the Department of National Revenue confirmed that he would be considered an emigrant commencing April 1, 1991. Moreover, on September 23, 1994 the Deputy Minister of National Revenue (Customs, Excise and Taxation), Mr. Pierre Gravelle, Q.C. wrote to him and stated:

I have been advised that information provided by you in 1991, and more recently in correspondence with Mr. Gallaway, indicates that you did not maintain significant residential ties with Canada during your stay abroad, which you have indicated commenced April 1, 1991 and ended August 1, 1993. I wish therefore to confirm that, for Canadian income tax purposes, you were a non-resident of Canada during this period.

It is therefore accepted by the respondent that for that part of 1991 after April 1 he was not a resident of Canada.

His problem stems from his membership in an Ontario limited partnership, Fidelity Partnership 1990. It was a small participation (100 units at $100 each). The evidence is not as clear as it might have been concerning the nature of the partnership’s activities - evidently it involved the fees paid on the acquisition or redemption of interests in mutual funds. Only the unit certificate was put in evidence — not the partnership agreement or the prospectus. On the evidence it is clear, in my view, that Fidelity Partnership 1990 carried on business in Canada. [1]

The question therefore is, if a limited partnership carries on business in Canada, does a limited partner, such as Mr. Grocott, who does not participate in any way in the activities of the partnership beyond sharing in its profits (or, as was the case here, its losses), himself carry on business in Canada. He took no part in the day-to-day operations of the partnership. Indeed he had only a rudimentary knowledge of just what it did. I accept that his participation was passive.

Does his participation as limited partner, however passive, bring him within section 114 of the Income Tax Act? That section, in 1991, read as follows:

114. Notwithstanding subsection 2(2), where an individual was resident in Canada during part of a taxation year, and during some other part of the year was not resident in Canada, was not employed in Canada and was not carrying on business in Canada, for the purpose of this Part, his taxable income for the taxation year is the aggregate of

(a) his income for the period or periods in the year throughout which he was resident in Canada, was employed in Canada or was carrying on business in Canada, computed as though such period or periods were the whole taxation year and as though any disposition of property deemed by subsection 48(1) to have been made by reason of the taxpayer having ceased to be resident in Canada were made in such period or periods, and

(b) the amount that would be his taxable income earned in Canada for the year if at no time in the year he had been resident in Canada, computed as though the portion of the year that is not in the period or periods referred to in paragraph (a) were the whole taxation year,

minus the aggregate of such of the deductions permitted for the purpose of computing taxable income as may reasonably be considered wholly applicable to the period or periods referred to in paragraph (a) and of such part of any other of those deductions as may reasonably be considered applicable to such period or periods.

Section 2 of the Income Tax Act reads as follows:

2.(1) An income tax shall be paid as hereinafter required upon the taxable income for each taxation year of every person resident in Canada at any time in the year.

(2) The taxable income of a taxpayer for a taxation year is his income for the year plus the additions and minus the deductions permitted by Division C.

(3) Where a person who is not taxable under subsection (1) for a taxation year

(a) was employed in Canada,

(b) carried on business in Canada, or

(c) disposed of a taxable Canadian property, at any time in the year or a previous year, an income tax shall be paid as hereinafter required upon his taxable income earned in Canada for the year determined in accordance with Division D.

Section 115, which forms part of Division D starts with the words:

115. For the purposes of this Act, the taxable income earned in Canada for a taxation year of a person who at no time in the year is resident in Canada is the amount of his income for the year that would be determined under section 3 if

(a) he had no income other than

(i) incomes from the duties of offices and employments performed by him in Canada,

(ii) incomes from businesses carried on by him in Canada,

(iii) taxable capital gains from dispositions described in paragraph (b),

From these provisions it will be apparent that subsection 2(1) alone would subject to tax the world income for the year of any person who was resident in Canada at any time in the year. Section 115 is aimed at persons who are resident in Canada at no time in the year and taxes them on employment and business income earned in Canada and dispositions of taxable Canadian property as well as a number of other types of income arising in Canada. Part XIII deals with interest, rent, dividends and certain other types of passive income earned by non-residents. All of these provisions relating to non-residents are subject to any applicable treaties. Canada has none with Saudi Arabia. Section 114 endeavours to fill in the gap left between section 2 and section 115 and relates to persons, such as Mr. Grocott, who are resident in Canada part of the year and non-resident part of the year. Section 114 effects a modification of subsection 2(2). It applies only to a person who during part of the year was a resident and during part of the year was not only a non-resident but also was not employed in Canada and was not carrying on business in Canada. If during part of the year he was a non-resident who was employed in Canada or carried on business in Canada his taxable income for the year is treated as his world income for the period in which, although a non-resident, he was employed in Canada or carried on business in Canada. Therefore, if he carried on business in Canada during the period in which he was resident in Saudi Arabia, his Saudi Arabian income would be included in his world income for 1991 and taxable in Canada.

Did his participation in the Fidelity Partnership 1990 constitute carrying on business in Canada? Unfortunately I think that it did. The partnership carried on business in Canada. The partnership’s income or loss is from the source of carrying on business and under paragraphs 96(1 )(/) and (g) the partner’s income or loss is an income or loss from that source. This applies in my view whether the partnership is general or limited.

Limited partnerships are created by statute. In Ontario, unlike certain other provinces, the Limited Partnerships Act is a separate statute from the Partnerships Act. One of the most salient features is that the liability of the limited partner is, under section 9, limited to his capital contribution. Also, under section 13 a limited partner is not liable as a general partner unless, in addition to exercising rights and powers as a limited partner, the limited partner takes part in the control of the business. Mr. Grocott took no part in the control of the business. A limited partner of course has the right to be informed as to the business of the partnership and to receive his or her share of the income. A limited partner is nonetheless a partner in a partner ship. It is simply that his liability is limited by statute provided that he does not participate in running the business.

I do not think it can be said that this limitation of liability and prohibition against any active part in the control of the business means that he is not carrying on business through the partnership. [2] A non-resident partner who did not actively participate in the business of a general partnership but who was nonetheless a participant in the profits was held in Randall v. R. (sub nom. Randall v. The Queen, [1985] 1 C.T.C. 268, 85 D.T.C. 5208 (F.C.T.D.) to be carrying on business in Canada. I do not think that the fact that the partnership is a limited partnership alters the nature of the nonresident limited partner’s participation. I trust that I am being neither (C.T.C. 114), (D.T.C. 6506), (N.R. 333) “results oriented” (Tennant v. R. (sub nom. Tennant v. Canada), [1994] 2 C.T.C. 113, 94 D.T.C 6505, 175 N.R. 332 (F.C.A.)) nor (C.T.C. 384), (D.T.C. 6635), (N.R. 226) “purely mechanical” (Swantje v. R. (sub nom. Swantje v. Canada), [1994] 2 C.T.C. 382, 94 D.T.C. 6633, 174 N.R. 224 (F.C.A.)) in my interpretation of these provisions when I observe that it would be a rather surprising result if a non-resident who is a limited partner in a Canadian limited partnership that carried on business in Canada could escape taxation under section 115 on his Canadian source profits from the partnership on the basis that he was not carrying on business in Canada.

The result in this case is unfortunate and possibly unforeseen. Indeed section 114 was amended with application to 1992 so as to avoid the problem, but the plain wording of section 114 in 1991 has the effect that I have indicated.

The appeals are dismissed.

Appeals dismissed.