Date: 20020403
Docket: 2001-3048-IT-I
BETWEEN:
MARK A. RAEGELE,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
Reasonsfor
Judgment
Miller, J.T.C.C.
[1]
Mr. Mark Raegele appeals, by way of Informal Procedure, the
Minister's reassessment of Mr. Raegele's 1998 taxation
year. The Minister disallowed the deduction of expenses incurred
by Mr. Raegele in repairing damages to his premises left by a
tenant who moved out on July 15, 1998. Mr. Raegele moved
into the property on August 12, 1998. He maintains the expenses
were incurred wholly in connection with the repairing of the
damages and as such are deductible. The Respondent, while
agreeing that the expenses were incidental to the rental of the
property, argues that they cannot be deducted due to the
application of paragraph 18(1)(a) of the Income Tax
Act ("Act"), as they were not incurred for
the purpose of producing income.
[2]
Mr. Raegele is a Lieutenant Colonel in the Canadian Armed Forces.
He was posted to the United States in July, 1994. He rented his
home at 1554 Sunview Drive in Orleans for the period of his
tour of duty in the United States from August, 1994 to July
15, 1998. In May, 1994 Mr. Raegele and his wife entered a lease
with Mr. and Mrs. Krishnarajan for an initial term of three
years, later extended for just under a year to July 15, 1998.
Some terms of the lease are as follows:
14.
The Tenant:
...
d.
covenants that he will indemnify the Landlord and any other
Tenant of the said premises against any loss, costs or damage by
reason of any neglect, carelessness or injury caused by him, any
member of his family or household, any guest or other person on
the rented premises with his consent, or by reason of
non-occupancy, and for all damages caused by his dog (mini
Schnauzer);
...
f.
covenants to leave the premises clean and in good condition, and
the carpets cleaned, on the termination of the tenancy.
and in the Rules and Regulations as follows:
5.
The Tenant shall:
...
c.
at all times keep the rented premises in a proper state of
cleanliness including cleaning and maintenance of any floors, and
proper care and cleaning of any carpets provided;
...
e.
not use spikes, hooks, screws or nails on the walls or woodwork,
except those necessary to hang normal and generally acceptable
wall decorations;
[3]
Upon their return to Canada in April, 1998, the Raegeles were
dismayed to discover the state of their home, which Mrs. Raegele
described as unliveable. The worst damage was to the flooring in
the home which arose due to the tenant's dog's
unfortunate, but evidently unrelenting, habit of urinating
throughout the house. The uric acid seeped through the carpet
into the sub-flooring, which required bleach to be scrubbed
on the surface itself after removing the carpet. The kitchen and
family room were layered with grease arising from four years of
food preparations by the tenant with no sign of follow-up
cleaning. The yard was overgrown and generally the place was
filthy. The Raegeles requested their property manager to start
looking into the cost of repairs.
[4]
Mr. Raegele indicated that he telephoned the tenant on several
occasions to clean the house. The tenants did show up at one
stage after they had moved out to do so, but the visit was brief
with nothing accomplished other than the tenants' agreement
to pay for some window cleaning. As well as the extensive damage,
the tenants had also left a water bill unpaid. Only after a
number of requests was this bill paid. Mr. Raegele testified
that he felt the tenant was in breach of the lease, but that the
cost and effort to pursue the tenant would outweigh the benefit
to be gained.
[5]
The expenses at issue are set forth in Schedule A to the
Respondent's Reply, which is attached. The dates indicate
that all but the first expense were paid after the tenants moved
out. It is of note however that the Appellant received an invoice
for certain flooring work from Multi-Flooring Inc. for $7,917,
which was dated in May, 1998 although the work was not completed
until after the tenants departed on July 15th. Such invoice was
ultimately paid on August 23, 1998. I find that the
timing of the work and the entering into contracts for the work
took place between mid-May and mid-August. The nature of the
expenses are primarily in connection with the flooring
(approximately $13,000) and painting (approximately $5,000). The
Appellant did not claim for part of the hardwood flooring expense
recognizing it was an upgrade constituting a personal benefit. He
reduced the claim on that particular invoice by approximately
$2,000.
[6]
The Appellant's agent relies on subsection 9(1) and (2) of
the Act which read:
9(1) Subject
to this Part, a taxpayer's income for a taxation year from a
business or property is the taxpayer's profit from that
business or property for the year.
(2)
Subject to section 31, a taxpayer's loss for a taxation year
from a business or property is the amount of the taxpayer's
loss, if any, for the taxation year from that source computed by
applying the provisions of this Act respecting computation of
income from that source with such modifications as the
circumstances require.
[7]
He maintains expenses that are linked to the revenue-generating
activities in a cause and effect relationship are acknowledged in
the accounting period in which the revenue is recognized. This
principle he propounds from the CICA Handbook. He further refers
me to the Exchequer Court case of Dominion Natural Gas Co. v.
M.N.R.,[1940-41] C.T.C. 144, although later reversed, which
stated:
The generally recognized rule as regards trade expenses is
that a deduction is permissible when it is justifiable on
business and accountancy principles, but the principle is subject
to certain specific statutory provisions which prohibit the
allowance of certain expenses as deductions in computing the net
profit or gain to be assessed. To the extent that ordinary
business and accountancy principles are not invaded by the
statute, they prevail.
[8]
The Appellant's agent also referred to Justice Stone's
statement[1] in
Her Majesty the Queen v. Canderel Limited, 95 DTC
5101 at 5102:
In my view, the matching principle of accounting has, at least
in this Court, been elevated to the status of a legal principle.
The principle was best expressed by MacGuigan, J.A. in
West Kootenay Power and Light Company Limited v. The
Queen (1991), 92 DTC 6028, at pages 22 (6028):
The approved principle is that whichever method presents the
"truer picture" of a taxpayer's revenue, which more
fairly and accurately portrays income, and which
"matches" revenue and expenditure, if one method does,
is the one that must be followed.
[9]
Finally the Appellant referred me to Gordon Kenneth Daley v.
Minister of National Revenue, 50 DTC 877 and specifically the
following passage:
That being so, it follows that in some cases the first enquiry
whether a particular disbursement or expense is deductible should
not be whether it is excluded from deduction by section 6(a) or
section 6(b) but rather whether its deduction is permissible by
the ordinary principles of commercial trading or accepted
business and accounting practice. If the answer to such enquiry
is in the negative then that is the end of the matter and it is
not necessary to make any further enquiry, for it would then
automatically fall within the exclusions of section 6(a) and it
would not be necessary to consider whether it would fall within
those of section 6(b).
[10] In
addressing the application of paragraph 18(1)(a) of the
Act the Appellant's agent stressed that the expenses
cannot be viewed in isolation, but must be seen as part of the
whole year's operation. Implicit in his argument is that the
Appellant's business continued after the tenant moved out,
albeit only to the extent of dealing with damages flowing from
the rental operation.
[11] The
Appellant recognized that some of the expenses would relate to
his personal benefit and suggested an arbitrary 85% allocation of
the expenses to business and 15% allocation to personal benefit.
Finally, the Appellant's agent presented an argument which he
did not pursue forcefully. He suggested that had a financial
statement been prepared for Mr. Raegele for the month ending July
31, 1998, a reserve for doubtful accounts would have been set up
to reflect the work required to repair the damage, which the
Appellant believed was owed by the tenant. The Appellant's
agent argues that by year-end the debt purported to be owed by
the tenant had indeed become bad and should consequently be
written off in accordance with paragraph 20(1)(p) of the
Act.
[12] The
Respondent's position quite simply is that the expenses at
issue were not incurred for the purpose of earning income from
property and therefore were not deductible in accordance with
paragraph 18(1)(a). In the pleadings the Respondent also
indicated that such expenses were personal or living expenses of
the Appellant pursuant to paragraph 18(1)(h). The
Respondent went so far as to agree that the expenses in issue
were connected to the rental operation and were indeed
reasonable, however, given that the Appellant admitted that the
purpose the expenses were incurred was so he could live in the
property, this did not meet the purpose requirements set out in
paragraph 18(1)(a). When put to counsel for the Respondent
that this strict reading of the section would preclude the
deductibility of any expenses incurred by a business in a
winding-up phase, if there was no longer a purpose to earn
income, Respondent's counsel acknowledged that indeed would
be the Respondent's position.
[13] Before
reviewing the application of paragraphs 18(1)(a) and
(h) of the Act, I wish to deal with the
Appellant's argument regarding the deduction of a bad debt.
Paragraph 20(1)(p) of the Act reads as follows:
20(1) Notwithstanding
paragraphs 18(1)(a), (b) and (h), in
computing a taxpayer's income for a taxation year from a
business or property, there may be deducted such of the following
amounts as are wholly applicable to that source or such part of
the following amounts as may reasonably be regarded as applicable
thereto:
...
(p)
the total of
(i)
all debts owing to the taxpayer that are established by the
taxpayer to have become bad debts in the year and that have been
included in computing the taxpayer's income for the year or a
preceding taxation year, and
This section requires for its applicability that the debt has
been included in the taxpayer's income for the year. Even if
I were to accept that the tenants' indemnity contained in the
lease constituted a debt owed to the Appellant, such debt had not
been included in the taxpayer's income for the year. Frankly
I see this bad debt argument as something of a red herring. The
issue is not the deductibility of a debt gone bad, but of the
very real expenses incurred by the Appellant in the summer of
1998. It is these expenses which I must determine qualify for
deductibility. In making that determination I find it is
significant that Mr. Raegele believed it was the tenants'
responsibility to honour their indemnity contained in the
lease.
[14] I agree
with the Appellant that based on ordinary commercial principles
and accounting guidelines, the expenses at issue have created a
loss. But are ordinary commercial principles sufficient to
justify the deduction of the Raegles' repair expenses against
their income from the property? Justice Iacobucci stated the
following in the Canderel case:
Ordinary commercial principles dictate, according to the
decisions, that the annual profit from a business must be
ascertained by setting against the revenues from the business for
the year, the expenses incurred in earning such revenues.
31
Accepting this fundamental definition, in Symes, supra, at pp.
722-23, the majority made the following observations about the
computation of profit:
. . . the "profit" concept in s. 9(1) is inherently
a net concept which presupposes business expense deductions. It
is now generally accepted that it is s. 9(1) which authorizes the
deduction of business expenses; the provisions of s. 18(1) are
limiting provisions only. . . .
Under s. 9(1), deductibility is ordinarily considered as it
was by Thorson P. in Royal Trust, [Royal Trust Co. v. Minister of
National Revenue, 57
D.T.C. 1055 (Ex. Ct.)] (at p. 1059):
... the first approach to the question whether a particular
disbursement or expense was deductible for income tax purpose was
to ascertain whether its deduction was consistent with ordinary
principles of commercial trading or well accepted principles of
business ... practice ... (Emphasis added.)
Thus, in a deductibility analysis, one's first recourse is
to s. 9(1), a section which embodies, as the trial judge
suggested, a form of "business test" for taxable
profit.
This is a test which has been variously phrased. As the trial
judge rightly noted, the determination of profit under s. 9(1) is
a question of law: Neonex International Ltd. v. The Queen....
Perhaps for this reason, and as Neonex itself impliedly suggests,
courts have been reluctant to posit a s. 9(1) test based upon
"generally accepted accounting principles"
(G.A.A.P.).... Any reference to G.A.A.P. connotes a degree of
control by professional accountants which is inconsistent with a
legal test for "profit" under s. 9(1). Further, whereas
an accountant questioning the propriety of a deduction may be
motivated by a desire to present an appropriately conservative
picture of current profitability, the Act is motivated by a
different purpose: the raising of public revenues. For these
reasons, it is more appropriate in considering the s. 9(1)
business test to speak of "well accepted principles of
business (or accounting) practice" or "well accepted
principles of commercial trading". [Emphasis in
original.]
32
The great difficulty which seems to have plagued the courts in
the assessment of profit for income tax purposes bespeaks the
need for as much clarity as possible in formulating a legal test
therefor. The starting proposition, of course, must be that the
determination of profit under s. 9(1) is a question of law, not
of fact. Its legal determinants are two in number: first,
any express provision of the Income Tax Act which dictates some
specific treatment to be given to particular types of
expenditures or receipts, including the general limitation
expressed in s. 18(1)(a), and second, established rules of law
resulting from judicial interpretation over the years of these
various provisions.
(emphasis added)
Subsection 9(2) of the Act specifically requires
that the loss is to be computed by applying the provisions of the
Act. The question is whether the deductibility of these
expenses is to be denied as not being incurred for the purpose of
gaining or producing income as required by the specific wording
of paragraph 18(1)(a)? This places such a restrictive
interpretation on that section to deny any taxpayer who is
winding-up his business the right to ever claim what any
reasonable commercially-minded business person would regard as
legitimate business costs. As Associate Chief Judge Bowman
indicated in Randhawa v. Canada, [2001] T.C.J. No.
308 where expenses similar to the expenses at issue here were
incurred due to a tenant's neglect:
11.
These expenses arose out of the rental operation that the
appellant carried on. They were a direct and necessary incident
of that operation and were expenses that have to be satisfied out
of the circulating capital of the business.
In that case the Appellant did rent the premises, albeit
briefly, after the expenses were incurred, but then personally
moved into the property shortly thereafter.
[15] The
Respondent's position is that as soon as the last tenant
shuts a door behind him and consequently turns off the income
stream, no expenses thereafter can be deductible. I do not accept
however that the rental business has immediately ceased at that
point. The evidence was that the Appellant continued to hound the
tenant to make good on his commitment under the lease, to the
point that the tenant actually did show up to assist in the
cleaning. The rental business as such was not fully wound-up
until the last of the damage issues with the former tenants had
been resolved. This should occur within a reasonable time period
given the nature of the business and clearly should involve only
such costs as are reasonable in the circumstances.
Mr. Raegele did deal with the repairs on a timely basis and
did incur only reasonable expenses. The Raegeles did not take
this as an opportunity to complete extensive upgrades, and where
they believed there was some improvement they themselves deducted
an appropriate amount for their claim. Even though Mrs. Raegele
had no income against which to deduct expenses, Mr. Raegele did
not try to claim all of the expenses himself. Indeed the Raegeles
were the epitome of reasonable. I find the rental business
continued until all the repairs were completed and bills paid. As
such the expenses were incurred as part of the business and as
Vern Krishna stated in The Fundamentals of Canadian Income
Tax, 6th edition at page 278:
The essential limitation in paragraph 18(1)(a) is that the
taxpayer must incur the outlay or expense "for the
purpose" of gaining or producing income "from the
business". Thus, the purpose must be that of gaining or
producing income from the business in which the taxpayer engages.
A fortiori, the business must exist at the time that the taxpayer
incurs the expenditure.
[16] I refer
to a recent case by Judge Hershfield, Mikhail v. Her Majesty
the Queen, in which he indicated at paragraph [29]:
As to the application of paragraph 18(1)(a), I am
inclined to say that it should not be so readily applied simply
because the income producing asset is up for sale during an
extended period of income deprivation particularly in cases such
of this where the extended period of income deprivation is caused
by extraordinary conditions beyond the control and expectation of
the taxpayer. The asset was acquired and held as a rental
property. It continued to be a rental property even when the
income stream ended. One should not so readily dismiss an income
earning purpose in respect of an expenditure when the
characterization of the property has not changed. That is,
provided the property has not been put to another use to which
such expenditure might more appropriately attach, it remains a
rental property and current expenses incurred, including expenses
incurred while the property is not earning income, should not be
so readily denied as not having been incurred for the purpose of
earning income. While contrary to current thinking, I might go so
far as to suggest that even if the income stream of an enterprise
was at an absolute end, a reasonable sell-off period should be
recognized during which holding expenses should be allowed. They
are costs attaching to the income earning process which includes
start-up costs as well as wind-up costs. That expenses during the
last days of the life of an enterprise might relate to income
earned in a prior year should not necessarily be fatal to their
deductibility where they are costs that are a necessary part of
the income producing activity albeit not incurred during the
income producing years. Recognizing such expenses gives a truer
picture of the profit or loss from a particular activity.
Considering the purpose test in paragraph 18(1)(a) then,
it should not be required that a purpose be only forward looking
although that is how paragraph 18(1)(a) has always been
applied. That paragraph does not, after all, say "for the
purpose of gaining or producing income in the future".
[17] I wish to
address Judge Hershfield's comments as to whether the
expenses relate to the next use of the property being, in this
case, the personal residence of the Raegeles. In effect, are the
expenses personal or living expenses? Personal or living expenses
are defined in section 248 as follows:
248 (1) In this Act,
"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,
[18] There are
two conditions to be met to fall in this category: first, the
property expenses were for the benefit of the taxpayer and
second, they were not in connection with the business. It is easy
to find that Mr. Raegele would personally benefit from these
expenditures, as indeed he did take up residence in the property.
However, as I have found that Mr. Raegele's business
continued until the last of the repair expenses were incurred, I
have no difficulty in finding that such expenses relate to a
property maintained in connection with a business carried on for
profit. I am not prepared to find that on July 15, 1998
Mr. Raegele's business went from a business carried on
for profit to a not for profit business. It is simply a matter of
a profitable business winding down. I find the expenses relate to
the business, more so than to the next use of the property as the
Raegeles' personal residence.
[19] I am
drawn to Judge Hershfield's reasoning. I am also satisfied
the expenses were incurred while there still existed a business,
albeit in a wind-up phase. Does adopting this approach elevate
the application of ordinary commercial principles to a status
which effectively overrides a specific provision (paragraph
18(1)(a)) of the Act? I think not. The purpose
required of paragraph 18(1)(a) in a wind-up situation,
need not be to produce future income, but it is met where the
cause of the expenses incurred is directly linked to the income
producing activity of the business. Clearly such expenses must be
reasonable and must be incurred prior to the final nail being
hammered into the business' coffin.
[20] While the
analysis thus far would suggest that there is sufficient reason
to allow the Appellant's appeal, I find in this case there is
a more direct answer to the "purpose" question posed by
paragraph 18(1)(a). The Respondent argues that Mr. Raegele
admitted his purpose in making the expenditures was so he could
move in, which does not sound like a purpose of earning or
producing income. However, neither Mr. Raegele nor his agent are
lawyers versed in the complex nuances of legal phrases. Why did
Mr. Raegele incur the expenses when indeed they were the
tenant's responsibility? Had the tenant met his obligation
under the lease to pay for such repairs and reimbursed Mr.
Raegele for the cost of the damage, that payment to
Mr. Raegele would have been in the nature of income. Would
the expenses then still have been disallowed? Certainly not. The
Appellant should not be denied the deduction because of a tenant
defaulting on his indemnity. Mr. Raegele incurred the expenses
with the knowledge and understanding that he had an income right
related to the expenditure, being a right of indemnity.
[21] Mr.
Raegele hounded the tenant to meet his contractual obligations
and indeed had some success in obtaining payment for the water
bill and some window cleaning. These amounts were not paid
directly to Mr. Raegele but to the utilities company and the
window cleaning company. Mr. Raegele determined however that
potential lengthy and costly legal proceedings did not justify
pursuing the tenants more aggressively than he had already. I am
satisfied however that the fact he could have done so, provides
to Mr. Raegele the necessary purpose required by
paragraph 18(1)(a). The expenses were incurred to
position Mr. Raegele to rely on the tenants' indemnity
in the lease (a production of income). The effect of the
expenses was to make the property habitable for Mr. Raegele
and his family. I find that the requisite purpose of
paragraph 18(1)(a) has been met.
[22] In
summary, common sense and ordinary commercial and accounting
principles support the Appellant's position that expenses
incurred, during a wind-up phase of a rental property
business, to repair damages caused by a former tenant, are
legitimate deductible business expenses. They are not personal or
living expenses. For the reasons given I do not believe this
abuses the specific wording of paragraph 18(1)(a).
However, in further addressing the application of paragraph
18(1)(a) specifically to these circumstances, I find the
Appellant's purpose in making the expenditure was to produce
income from the tenant through the tenant's obligation under
the lease to indemnify the Appellant. Paragraph (18)(1)(a) does
not restrict the deductibility of Mr. Raegele's expenses.
[23] For these
reasons I allow the appeal and refer the matter back to the
Minister of National Revenue for reassessment on the basis that
the Appellant is entitled to deduct 50 percent of the repair
expenses claimed by him in the amount of $16,373.68.
Signed at Ottawa, Canada, this 3rd day of April, 2002.
"Campbell J. Miller"
J.T.C.C.
COURT FILE
NO.:
2001-3048(IT)I
STYLE OF
CAUSE:
Mark A. Raegele v. The Queen
PLACE OF
HEARING:
Ottawa, Canada
DATE OF
HEARING:
February 27, 2002
REASONS FOR JUDGMENT BY: The
Honourable Judge Campbell J. Miller
DATE OF
JUDGMENT:
April 3, 2002
APPEARANCES:
Agent for the
Appellant:
B. Belchamber
Counsel for the
Respondent:
J. Michelle Farrell
COUNSEL OF RECORD:
For the
Appellant:
Name:
Firm:
For the
Respondent:
Morris Rosenberg
Deputy Attorney General of Canada
Ottawa, Canada
SCHEDULE A
Mark Raegele
Taxation Year - 1998
STATEMENT OF MAINTENANCE & REPAIR
EXPENSES
|
Date
|
Description
|
Amount
|
|
08-Jun
|
Parent Heating & Cooling Inc.
|
$398.63
|
|
26-Jul
|
House cleaning
|
25.12
|
|
29-Jul
|
Home Depot
|
60.24
|
|
31-Jul
|
Home Depot
|
49.80
|
|
2-Aug
|
Home Depot
|
17.68
|
|
8-Aug
|
Pierre Cantin Flooring
|
5,003.32
|
|
10-Aug
|
Discount Pro Cleaners
|
128.40
|
|
12-Aug
|
Assured Renovations Limited
|
4,815.00
|
|
21-Aug
|
Home Depot
|
139.54
|
|
23-Aug
|
Multi Flooring
|
7,917.00
|
|
9-Sep
|
Professional Driveway Sealing
|
200.00
|
|
11-Sep
|
Home Depot
|
58.05
|
|
18-Sep
|
Builder's Warehouse
|
16.62
|
|
19-Sep
|
Builder's Warehouse
|
25.49
|
|
24-Sep
|
Builder's Warehouse
|
4.34
|
|
24-Sep
|
Builder's Warehouse
|
25.57
|
|
24-Sep
|
Builder's Warehouse
|
16.62
|
|
28-Sep
|
Builder's Warehouse
|
6.64
|
|
|
Total of receipts submitted
|
18,908.06
|
|
Amount of maintenance & repairs claimed by
App'l
|
$16,373.68
|
|
Amount allowed incurred prior to July 15, 1998
|
(398.63)
|
|
Difference
|
15,975.05
|
|
Appellant's share (50%)
|
$7,988.00
|
|
Rental loss as claimed by Appellant
|
$(6,087.00)
|
|
Add: disallowed expenses per above
|
7,988.00
|
|
Revised net rental income
|
$1,901.00
|
|
|
|
2001-3048(IT)I
BETWEEN:
MARK A. RAEGELE,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
Appeal heard on February 27, 2002 at Ottawa,
Canada, by
the Honourable Judge Campbell J. Miller
Appearances
Agent for the
Appellant:
B. Belchamber
Counsel for the
Respondent:
J. Michelle Farrell
JUDGMENT
The
appeal from the reassessment made under the Income Tax Act
for the 1998 taxation year is allowed, and the matter is
referred to the Minister of National Revenue for reconsideration
and reassessment in accordance with the attached Reasons for
Judgment.
Signed
at Ottawa, Canada, this 3rd day of April, 2002.
J.T.C.C.
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