Date: 19990811

Docket: 96-3551-IT-I

BETWEEN:

RÉAL MICHAUD,

Appellant,

and

HER MAJESTY THE QUEEN,

Respondent.

Reasons for Judgment

Lamarre Proulx, J.T.C.C.

[1] This appeal under the informal procedure concerns the 1991, 1992 and 1993 taxation years. The point at issue is whether the appellant carried on a rental business involving a condominium purchased at the start of 1998.

[2] The facts on which the Minister of National Revenue (the "Minister") relied in making his assessments are set out in paragraph 4 of the Reply to the Notice of Appeal (the "Reply") as follows:

[TRANSLATION]

a. since 1988, the appellant has always reported rental losses from his condominium based on the following income and expenses:

TAXATION YEAR	GROSS INCOME	EXPENSES	NET LOSS
1988	$5,600	$14,516	$ 8,916
1989	$7,075	$13,638	$ 6,563
1990	$5,105	$16,673	$11,568
1991	$8,104	$18,326	$10,222
1992	$6,182	$15,097	$ 8,915
1993	$ 700	$ 2,578	$ 1,878
1993	FINAL LOSS		$30,000

b. gross income has been declining since the 1991 taxation year;

c. the fixed costs were higher than the gross rental income;

d. the appellant's primary intention on purchasing the condominium was eventually to live in it during his retirement;

e. the appellant did not take the necessary steps to correct the situation so as to make his condominium profitable;

f. the appellant has invested very little of his own money since the mortgage loan totalled $110,000, that is, 95 percent of the cost of the asset;

g. the appellant had no reasonable expectation of profit from the immovable property rental operation in any of the 1991, 1992 or 1993 taxation years;

h. the expenses claimed by the appellant were not incurred for the purpose of gaining income from a business or property, but rather constituted personal or living expenses for the appellant;

i. the appellant has not shown that he incurred expenses for the purpose of gaining or producing income from a business or property in the 1991, 1992 and 1993 taxation years;

j. the appellant has not shown that he incurred a final loss from the sale of an immovable used for the purpose of gaining or producing income from a business or property in the 1993 taxation year.

[3] The appellant's Notice of Appeal reads as follows:

[TRANSLATION]

THE FACTS

I had been the executive director of a rehabilitation centre since 1978 and a certified general accountant (C.G.A.) since 1972. In 1988, I decided to invest in a 176-unit condominium project known as "Au Pied du Mont" located very close to Mont Ste-Anne. After speaking with Pierre Lambert, the developer and general manager of the "Au Pied du Mont" organization and checking the previous years' results, I decided to buy a villa, as I had done well with the sale of another condo in the same project.

I therefore believed that I was making a good deal and that this property would become profitable starting in the second year, considering that we expected rentals for 183 days at $100 per day and that the break-even point was between $14,000 and $15,000, which would thus produce a net profit of $3,000 to $4,000 a year.

After talking with my manager at the Caisse Populaire, I signed on December 10, 1987 an agreement to purchase for $115,000. I took possession on February 11, 1988 as the $110,000 loan had been approved.

In the spring of 1989, Pierre Lambert gave up the management of the "Au Pied du Mont" complex. At that time, I was a member of the board of directors and we decided to hire the firm Gescona to advise the co-owners on the development of a strategic development plan to provide the vacation complex with the elements likely to promote significant development over the short or medium term.

The board of directors on which I sat decided to form two companies.

Management company: Its role was to maintain the common parts of the buildings and the lands belonging to the complex. The board of directors consisted of the presidents of the five phases, plus representatives of the rental company.

Rental company: Its role was to advertise and to look after animation, rental of the company's condominium units belonging and the day-to-day management of the complex, charging a certain amount for condominiums other than those of the rental company.

An investment of $2,000 was required to become a member of the rental company. We held a meeting to ask persons who were interested to pay the required amount.

Whereas the project could be operated year-round;

Whereas the co-owners would receive only 50 percent of the rental revenues;

Whereas the Gescona firm of hotel industry and recreational services consultants described the complex as follows:

The Au Pied du Mont complex is situated in the heart of an exceptional tourist area. It offers beautiful views of Mont Ste-Anne and is extraordinary in both its size and the interest government has shown in it. Located at the gateway to the Charlevoix region, 40 minutes from Québec and a few kilometers from the Ste-Anne-de-Beaupré pilgrimage site, it enjoys a highly enviable geographical location. In addition, Île d'Orléans to the west and Cap Tourmente to the east are sites that attract many tourists at certain times of the year.

Gescona concludes from the financial projections that the complex would be profitable if operated as a year-round family resort while continuing the existing operation based on skiing in winter and at the same time developing the off-seasons (spring and fall) for a corporate clientele and pilgrims.

Whereas I know many persons in Quebec City, in the province of Quebec and in Canada due to the fact that I have been provincial president of my professional corporation, a member of the board of directors of CGA Canada and the president and a member of various organizations;

Whereas I could advertise effectively to persons whom we knew;

Whereas we live 30 minutes from the complex;

Whereas my wife would look after maintenance of the condo in order to cut costs;

Whereas we were convinced we could make this business profitable in the first two years;

Whereas, by putting some effort into the business, we would achieve better results than the other co-owners who are part of the rental company;

Consequently,

My wife and I decided not to be part of the rental company;

I would remain a member of the management company's board of directors as I was president of Phase V of the complex;

We expected to earn higher income than the rental firm if we handled the rental ourselves, which turned out to be true;

Gescona's projections proved to be overstated;

In the fall of 1992, I had a career change: my employer put me on early retirement as a result of the reform of the Ministère des Services de la Santé et des Services Sociaux (Department of Health and Social Services).

Based on the advice of a tax expert from the firm of Samson Bélair, I decided to sell the condo; the sale took place in the month of February 1993 and the selling price of $85,000 was equal to the market value according to the real estate brokers at that time.

In conclusion, when I purchased the condo in 1988, it was in order to make it profitable and thus to increase my retirement assets because I anticipated retiring at the age of 62, in which case my pension would give me only 44 percent of my salary.

We used the condo a few weeks in 1990 because the roof of my property in town had been damaged by wind; the amounts I received from my insurance were paid as income from the "Au Pied du Mont" condo.

The other times we slept at the condo, we did so to do cleaning or prepare it for the arrival of clients.

I really believed I had made a good deal and the thought of having government pay for a portion of it by using losses to reduce my income tax never crossed my mind. On the contrary, if my action plan had worked, I would have paid more. I can state that all the expenses were incurred for the purpose of gaining income from this condominium.

[4] The witnesses in this case were the appellant, Roxanne Nadeau and Yves Côté. The latter two testified at the request of counsel for the respondent.

[5] I have reproduced the Notice of Appeal in full because the appellant restated that version of the facts in his testimony.

[6] However, the Notice of Appeal fails to say that, on December 19, 1986, the appellant had purchased a studio condominium in the same complex for $56,000. At the time of that purchase, the developer had also told him in glowing terms that the rental income would be high and would pay the purchase price (Exhibit A-1). As this turned out not to be the case, since the gross income was $2,634 and the rental losses $6,016 for 10 months of 1987 (Exhibit I-3), the appellant complained to the developer, who advised him at that time to put the property up for sale, which was done. The appellant sold the property through the real estate developer in the fall of 1987 for $20,000 more than the purchase price. In 1987, as may be seen from Exhibit I-3, the appellant claimed rental losses of $6,016 and reported a capital gain of $10,306. The appellant had signed a rental agreement with the Au Pied du Mont rental company respecting this property (Exhibit A-1).

[7] Shortly thereafter, the appellant purchased another, larger property—in the villa class—in the same complex for $115,000. The mortgage was $110,000. The purchase agreement was signed on December 10, 1987 and the purchase was closed on February 25, 1988. (The Notice of Appeal gives a possession date of February 11, 1988, but all the other documents refer to a February 25, 1988 purchase date.)

[8] According to the chronology given in the Notice of Appeal, Gescona was instructed in the spring of 1989 to work out a development plan for the Au Pied du Mont residential and rental project. The report was filed as Exhibit A-3 and is dated January 1989. It was in any case subsequent to the purchase of the property in question.

[9] The report described the deficiencies and strong points of the Au Pied du Mont project and proposed an improvement and management plan. While the appellant was one of the participants in the Gescona report as a director of Phase 5 of the project, he chose not to put his property in the group of properties for rent by the rental company, whose role is explained in the Notice of Appeal. He believed he could rent out his property himself for 183 days a year at an average price of $100 a day. He therefore estimated his annual income at $18,000 and his expenses at $14,000. He explained that his projections did not pan out because business at Mont Ste-Anne declined, particularly as a result of development at Mont-Tremblant.

[10] Exhibit I-1 consists of the statements of rental income and expenses for the years 1988 to 1993. It may be seen from those statements that the main expenses were interest expenses of $9,062.42, $9,883.30, $11,666.96, $13,123.77, $10,099.39 and $1,523.77. The interest increased because the mortgage payments were made in part from the appellant's line of credit. In the last year, the interest ran from January 1 to February 12, 1993, the date on which the property was sold.

[11] Roxanne Nadeau is an auditor with the Québec office. At the of February 1995, she wrote to the appellant asking him to provide supporting documentation and to complete a questionnaire entitled [TRANSLATION] Rental Property Questionnaire. The appellant went to meet Ms. Nadeau on March 23, 1995, taking the supporting documentation and other documents with him, but he had not completed the questionnaire. Ms. Nadeau asked him questions and completed the questionnaire for him. She read the answers back to the appellant and he signed the last page of the questionnaire. The auditor's report was filed as Exhibit I-2 and the questionnaire as Exhibit A-6. Ms. Nadeau stated in her testimony that this was the first time she had heard of the Gescona report.

[12] The questionnaire was filed by the appellant in order to explain certain answers that appear on it. To question 4, [TRANSLATION] "For what purpose was the property originally purchased?" The answer was [TRANSLATION] "1. To serve as his principal residence upon retirement, planned for 96."

[13] The appellant explained in his testimony that this was an eventual and distant goal, but that the primary goal was to rent the property at a profit. Question 11 was [TRANSLATION] "If the unit was available for rental, what efforts did you make to find tenants? Describe in detail the advertising you did, providing where possible supporting documents concerning advertisements placed, rental agencies used, etc." The appellant answered [TRANSLATION] "telephone, mailings, word of mouth."

[14] The appellant testified that he had advertised in the newspapers. On this point, he filed Exhibit A-4, which consists of a business card bearing a photograph of the condominium and giving the address of the appellant and his wife, advertising letters, some newspaper advertisements and bulletin board advertisements. Exhibit A-5 consists of the appellant's customer list. He and his wife sent out advertising to those customers twice a year. The appellant did not use the services of any rental agency.

[15] In 1990, his main residence suffered damage and the appellant and his wife occupied the condominium for three weeks. The appellant realized that he would not like to live there year-round. Otherwise the appellant and his wife stayed at the condo only 10 times or so when they went there to do the cleaning. Their main residence is in Giffard, 20 minutes from Mont Ste-Anne.

[16] The appellant explained that, by way of corrective action, he had done some advertising and then finally put the property up for sale.

[17] Yves Côté, an appeals officer with Revenue Canada, communicated with the appellant on two occasions. The appellant did not give him any other reasons for buying than those stated in the questionnaire. The appellant explained to him that profitability was difficult because the property was only rented on weekends. The appeals officer confirmed the assessment because income never covered the fixed costs. He found the rental losses of $48,062 over a five-year period for a single property totally disproportionate for a rental business. There was no reasonable expectation of profit.

[18] Counsel for the appellant referred to the decisions in Moldowan v. The Queen, [1978] 1 S.C.R. 480, Tonn v. Canada, [1996] 2 F.C. 73, Mastri v. Canada, [1998] 1 F.C. 66, and Mohammad v. Canada, [1998] 1 F.C. 165, but more particularly to the decisions by Judge Archambault of this Court in Beaudry v. The Queen, [1995] E.T.C. 459, Jerome J. of the Federal Court, Trial Division in McGovern et al. v. The Queen, 94 DTC 6527 and Judge O'Connor of this Court in Egger v. The Queen, [1997] T.C.J. No. 1335, dated December 16, 1997.

[19] Counsel for the appellant referred to the following passages in Beaudry, supra:

In order for there to be a business or property from which income can be gained, the taxpayer must have a reasonable expectation of profit. Otherwise he or she is engaged in a hobby or owns an asset for purposes other than earning income. This reasonable expectation of profit must be determined at the time the expense is incurred. In this case, during 1991 and 1992, it is useful to determine whether there was such a expectation of profit at the time the rental property was purchased. Unless there is a change in intentions or in the conduct of a taxpayer following the purchase, the original intention should therefore continue to exist during the relevant years.

What was the situation in this instance? The evidence shows that Mr. Beaudry purchased his two condominium units for the purpose of earning a profit. If he had known in advance that he would incur all these losses from 1988 to 1993, he would not have bought them. Even though he was experienced in appraising agricultural land, Mr. Beaudry, like other mortals, did not have a crystal ball and did not know what would happen. Whether there was a reasonable expectation of profit cannot be determined relying solely on information known after the fact. This would be highly unfair to taxpayers.

The situation must be analyzed as it was at the time the taxpayer purchased the condominiums and at the time the expenses were incurred in 1991 and 1992. It is reasonable to believe that Mr. Beaudry had a reasonable expectation of profit in December 1988 when he purchased the two condominium units. He first relied on his financial adviser from Samson Bélair. While his financial adviser was in a delicate situation because, at the time of the offer to purchase, he was one of the owners of the units in question, it appears that Mr. Beaudry did rely on that adviser, who was a chartered accountant.

Mr. Beaudry did not restrict himself to his accountant's advice. He examined a report prepared by hotel industry and recreational services experts, who recognized the excellence of this project and of the Mont Ste-Anne area. The report, which followed the feasibility study, recognized that the resort complex development program was viable.

The fact that Mr. Beaudry financed more than 97 per cent of the purchase price of his two condominium units is a factor that supports the Minister's argument. However, this factor is only one of those that the Court must consider. The fact that Mr. Beaudry had to pay more than $16,000 of his own funds to repay the 1988 loss at the time of the purchase somewhat offsets the negative impact of the high level of financing.

[20] In Egger, supra, counsel for the appellant referred to the following passage:

. . . His intention to only occupy the Property 15 years later is consistent with an intention to rent in the interim. Interest on the mortgage was reduced. A profit was projected for 1997 and there is no evidence to contradict this.

[21] Judge Archambault's decision in Beaudry concerns two properties in the same complex as the appellant's. The rental losses amounted to $14,275 and $12,057 for 1991 and 1992 respectively. The properties had been purchased in 1988 and had produced rental losses for each of the previous years of amounts similar to those for the years in issue. The Court allowed the appeal on the ground that the evidence had clearly showed that the properties had not been purchased for personal purposes, that they had been bought in December 1988 on the strength of the Gescona report and that they had been offered for rent through the rental company. According to the judge in that case, the appellant had every valid reason to believe at the time he purchased the properties that the rental income would be positive.

[22] The facts of the instant case are not identical. The appellant had previously purchased a property in the same project in December 1986, had been dissatisfied with the rental income and had immediately put that property back up for sale. When he signed the purchase agreement in December 1987, the Gescona report had not yet been produced or even commissioned.

[23] I refer to Dickson J.'s remarks in the Supreme Court of Canada's judgment in Moldowan, supra, at pages 485 and 486:

There is a vast case literature on what reasonable expectation of profit means and it is by no means entirely 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 in 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 . . . .

(My emphasis.)

[24] I also refer to Linden J.A.'s comments in the Federal Court of Appeal's decision in Tonn, supra, at pages 102, 103 and 104:

The primary use of Moldowan as an objective test, therefore, is the prevention of inappropriate reductions in tax; it is not intended as a vehicle for the wholesale judicial second-guessing of business judgments. A note of caution must be sounded for instances where the test is applied to commercial operations. Errors in business judgment, unless the Act stipulates otherwise, do not prohibit one from claiming deductions for losses arising from those errors.

. . .

. . . I otherwise agree that the Moldowan test should be applied sparingly where a taxpayer's "business judgment" is involved, where no personal element is in evidence, and where the extent of the deductions claimed are not on their face questionable. However, where circumstances suggest that a personal or other-than-business motivation existed, or where the expectation of profit was so unreasonable as to raise a suspicion, the taxpayer will be called upon to justify objectively that the operation was in fact a business. Suspicious circumstances, therefore, will more often lead to closer scrutiny than those that are in no way suspect.

[25] In the instant case, the evidence showed that the appellant purchased the property in question as a future retirement home. This was a personal element which is not fatal, but which calls for some circumspection in analyzing the alleged profitability of a business. At the time he purchased the property in question, the appellant knew that it was not easy to achieve a return from the rental. He had been very disappointed with an initial acquisition. As regards capitalization, the appellant had borrowed 95 percent of the cost of purchasing the property. In addition, the mortgage payments had to be financed over the years by borrowing against the line of credit. The financial structure of the purchase allowed no leeway in the event that the rental income was insufficient. It was clear from the outset that the capital paid to purchase the property (on which the return from rental was problematical) was clearly insufficient. In the circumstances, the property did not have the capability, as capitalized, to show a profit.

[26] The appeal is accordingly dismissed.

Signed at Ottawa, Canada, this 11th day of August 1999.

"Louise Lamarre Proulx"

J.T.C.C.

[OFFICIAL ENGLISH TRANSLATION]