McNeill v. The Queen, 89 DTC 5516, [1989] 2 CTC 310 (FCTD)

JEROME, A.C.J.: —In this action, brought pursuant to subsection 172(2) of the Income Tax Act, S.C. 1970-71-72, c. 63. as amended the plaintiff appeals the reassessments for the 1981, 1982 and 1983 taxation years issued by the Minister of National Revenue, disallowing rental losses claimed by the plaintiff in the amount of $12,914 in 1981, $25,858.97 in 1982 and $42,663.21 in 1983. This matter came on for hearing in Vancouver, British Columbia, on January 12, 1989. At the conclusion of argument, I indicated that the appeal would be allowed and that these written reasons would follow.

The reassessments arise from the plaintiff's claim for losses incurred in connection with a condominium he acquired in 1980. This condominium was purchased by the plaintiff on the assumption that he might in future use it as a second residence, and in the meantime would rent the property and thereby take advantage of its Class 31 qualification as a multiple unit residential building (MURB), by deducting capital cost allowance for tax purposes. The condominium was leased until December, 1981 but, still intending to use it as a personal residence within the short term, the plaintiff declared the property as a personal residence in his 1980 income tax return, and did not claim the capital cost allowance which he might otherwise have claimed.

In November 1981, the plaintiff took steps, including terminating the tenancy of the existing tenant and buying furniture, to begin using the condominium as a second residence on weekends and during business trips. This proved impossible, however, when he was informed that his child was not welcome in the "adult oriented” building. The plaintiff had several personal confrontations with the manager and other occupants of the building, and ultimately, in December 1981, decided to once again rent the furnished suite. He attempted to do so, but partly due to the severe economic recession of the time, and partly due to an unsightly excavation taking place within direct view of the suite, he was unable to rent the property. In February 1982, the plaintiff re-financed the condominium, still intending to rent it, and executed an assignment of rents in favour of his mortgage company. By June of 1982, when the plaintiff was faced with a new by-law precluding his rental of the suite, the condominium was not rented. Accordingly, the plaintiff put the condominium up for sale, and was finally able to sell it, at somewhat less than the initial asking price, in April, 1983.

In filing his 1981 income tax return, the plaintiff recognized a change of use in 1981 from personal to business use. The plaintiff's 1981,1982 and 1983 income tax returns claimed rental losses in the amounts of $12,914 for 1981, $25,858.97 for 1982 and $42,663.21 for 1983.

The 1981, 1982 and 1983 income tax returns were originally reassessed by the Minister on September 10, 1984. The 1981 reassessment was based on the deemed disposition of the property pursuant to section 45 of the Act and a capital gain of $49,900 was calculated and tax imposed accordingly. The plaintiff filed notices of objection and dealt with the appeals division of the Department of National Revenue. On July 25, 1986 new reassessments were issued as a result of the determinations made by the appeals division, whereby the plaintiff's 1981, 1982 and 1983 taxation years were reassessed. The basis of the original reassessments was ignored and the new reassessments were based on the proposition that the plaintiff did not have a reasonable expectation of profit from the rental of the apartment building in the years 1981, 1982 and 1983. Notices of objection were again filed, but a notice of confirmation by the Minister dated January 7, 1987 indicated:

The expenditures claimed as a deduction from income in respect of the 630 Seaforth, Victoria property . . . have not been shown to have been made or incurred for the purpose of gaining or producing income from the business or property within the meaning of paragraph 18(1)(a) of the Act.

The plaintiff now argues that he did have a reasonable expectation of profit, and that this was borne out by projections which he submitted to the appeals division. Moreover, the plaintiff argues that Parliament contemplated short term losses with respect to MURBS "given that such buildings are excepted from the restrictions of allowing taxpayers to claim capital cost allowance in excess of the net rental income provided from the property, thereby creating a tax loss”. The plaintiff requests that the reassessments be vacated.

The statement of defence confirms that in reassessing the appellant, the Minister of National Revenue proceeded on the assumption that:

(a) the expenditures claimed in respect of the condominium to the extent of $20,014.00 in 1981, $25,858.97 in 1982 and $42,663.21 in 1983 were not made or incurred for the purpose of gaining or producing income from business or property;

(b) the expenditures were not made or incurred in connection with a rental property held for profit or with a reasonable expectation of profit;

(c) the plaintiff's use of the condominium did not at any material time change from some other purpose to the purpose of gaining or producing income therefrom.

In argument, counsel echoes the Minister's "assumption", submitting as well that if the plaintiff rented the property with a reasonable expectation of profit, which the defendant denies, then such an expectation only existed until June, 1982 and that no rental expenses may be claimed as the property was not rental property after this point, but capital property of the plaintiff.

The statutory provisions relevant to this appeal are paragraphs 18(1)(a) and (h) and 248(1)(a) of the Income Tax Act:

Sec. 18. General limitations.

(1) In computing the income of a taxpayer from a business or property no deduction shall be made in respect of

(a) General limitation. - an outlay or expense except to the extent that it was made or incurred by the taxpayer for the purpose of gaining or producing income from the business or property;

(h) Personal or living expenses. - personal or living expenses of the taxpayer except travelling expenses (including the entire amount expended for meals and lodging) incurred by the taxpayer while away from home in the course of carrying on his business.

Sec. 248. Definitions.

(1) In this Act,

Personal or living expenses. — “personal or living expenses" includes

(a) the expenses of properties maintained by any person for the use or benefit of the taxpayer or any person connected with the taxpayer by blood relationship, marriage or adoption, and not maintained in connection with a business carried on for profit or with a reasonable expectation of profit.

As indicated by counsel for both parties, the questions to be determined here are, therefore, whether the losses claimed by the plaintiff were ^incurred for the purpose of gaining or producing income from the . . . property", and whether the condominium itself was a source of income for the plaintiff with a “reasonable expectation of profit".

Counsel referred me to the decision of the Supreme Court of Canada in William Moldowan v. The Queen, [1977] C.T.C. 310; 77 D.T.C. 5213, a case which involved a farming operation and the applicability of subsection 13(1) of the former Act. In Moldowan, Mr. Justice Dickson stated, at pages 313-14 (D.T.C. 5215):

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 . . .

. . . There is a vast case literature on what reasonable expectation of profit means and it is by no means consistent. In my view, whether a taxpayer has a reasonable expectation of profit is an objective determination to be made from all of the facts. The following criteria should be considered: the profit and loss experience of past years, the taxpayer's training, the taxpayer's intended course of action, the capability of the venture as capitalized to show a profit after charging capital cost allowance. The list is not intended to be exhaustive. The factors will differ with the nature and extent of the undertaking.

Having regard to the criteria listed in Moldowan, as well as to the other factors which came into play in this particular plaintiff's situation, I am satisfied that the plaintiff's condominium was a property acquired and held by him as a source of income with a "reasonable expectation of profit".

The property in question had been approved by the Minister as a Class 31 MURB. The issuance of a certificate to this effect implies an acceptance on the part of the Minister that the property is to be used for investment purposes. The Minister’s assumptions, as articulated by counsel for the defendant and reproduced herein, are inconsistent with his earlier issuance of the MURB certificate. The Minister's fundamental assumption, that "the plaintiff's use of the condominium did not at any material time change from some other purpose to the purpose of gaining or producing income therefrom" fails to recognize that the plaintiff was, during the period in question, faced with a change in circumstances surrounding the property.

I find the testimony of the plaintiff and his wife to the effect that their intentions with respect to the property changed on a number of occasions to be credible and reasonable in the circumstances. The combined effect of the extraordinary interest rates and inflation of the time, an unsightly excavation on the adjoining property, the unpleasant attitude of the other inhabitants of the building and, finally, the enactment of a by-law completely precluding further rental of the property acted to reverse the circumstances in play at the time the condominium was purchased. I am unable to accept the Minister's conclusion that the plaintiff failed to change his mind with respect to his intentions for the property or, in light of the above circumstances, that he was unreasonable in doing so.

I conclude, therefore, that during the three taxation years in question the property was held by the plaintiff for the purpose of gaining income. Moreover, applying the criteria recommended by Mr. Justice Dickson in Moldowan, I find that the plaintiff had a reasonable expectation of profit from that property. Despite the extraordinarily high interest rates of the 1981-1983 period, the plaintiff, had he not been prevented by other factors from renting the property, was in a situation where rentals from the property would have been sufficient to cover the mortgage. In the absence of these largely unexpected negative factors, the property would have been viable in terms of its long-term rental income potential.

The losses suffered by the plaintiff during the years 1981, 1982 and 1983 were, therefore, losses incurred in the course of the plaintiff's maintenance of a property held by him for the purpose of producing income. Paragraphs 18(1)(a) and/or (h) do not, therefore, act to ban the proper deduction of these losses. I have therefore allowed this appeal.

Appeal allowed.