Date: 20001011
Docket: 2000-353-IT-I, 2000-355-IT-I
BETWEEN:
ERNESTO OXCIANO and VIOLETA OXCIANO,
Appellants,
and
HER MAJESTY THE QUEEN,
Respondent.
Reasons for Judgment
Rip, J.T.C.C.
[1] Ernesto Oxciano and Violeta Oxciano have appealed income tax assessments for 1995 and 1996 which denied their claims for losses from renting property. The appeals were heard on common evidence. Mrs. Oxciano testified on her own behalf and on behalf of her husband.
[2] In 1988 Mr. and Mrs. Oxciano purchased a lot in Delta, British Columbia and completed the building of a home on that property ("Delta Property") in May 1989. They subsequently moved to their home. In late 1989 the appellants started to finish the basement of their home to include a bedroom, a bathroom and a small kitchen. The basement suite was available to rent by July 1990 but until 1996 the suite was rented at below market rent to Mr. Oxciano's mother. In 1996 the suite was rented to an unrelated tenant for about $600 to $650 per month.
[3] During 1995 and 1996 the suite in the Delta Property yielded a net rental income of $632 and $6,196 respectively. The Minister of National Revenue ("Minister") is not questioning the commercial viability of the Delta Property. The Minister, however, does question the commercial viability of a rental property the appellants acquired in Maple, Ontario, north of Toronto, in 1994 ("Maple Property"). In filing their income tax returns for each of the years in appeal, the Oxcianos prepared a statement of income and combined the gross incomes from both the Delta Property and the Maple Property, and from the aggregate gross incomes there were deducted the total expenses from each of the two properties. This resulted in a loss. The loss was attributable solely to the Maple Property and was allocated equally to each appellant. The Minister, among other things, has refused the appellants to reduce their income from the Delta Property by deducting the losses from the Maple Property.
[4] The cost of the Maple Property was $175,900 and was financed by way of mortgage on the property in the amount of $152,505 with interest at 8.95% for a five-year term and by mortgage on the Delta Property in the amount of $65,000 with interest at 7.25% for five years. Each mortgage was for a five-year term. The property included three bedrooms, an unfinished basement and a single car garage. Borrowed money in excess of the purchase price was applied to upgrade the property and to purchase furniture and light fixtures.
[5] The Maple Property was purchased, Mrs. Oxciano testified, to rent to students attending York University in Toronto. Each of three students would have his or her own room and share the rest of the house. In February 1996, at a time when not all three bedrooms were rented, the appellants completed the basement of the property by adding two additional bedrooms.
[6] At all relevant times, Mr. & Mrs. Oxciano's daughter, Katherina, attended York University as a full-time student. She also managed the Maple Property. She placed advertisements for rent on the York University campus and in local neighbourhood newspapers. She lived "on and off" in the Maple Property during 1996 when the property was not fully rented. She had her own room at one of the University's residences and also spent time at an uncle's residence in Toronto.
[7] In 1995 the appellants rented rooms to students for an eight-month term at a rent of $325 per month. Rooms were available for rent during the four summer months at the same rent. Katherina posted advertisements at Wonderland, an amusement park northwest of Toronto, to rent the vacant units during the summer. Mrs. Oxciano stated she determined the monthly rent in the area of the Maple Property by "checking newspapers for ongoing rates".
[8] According to the respondent's assumptions of facts the Maple Property was not situated near any public transportation, Mrs. Oxciano recalled that there was a bus line "nearby". She also said the property was a "five minute drive to York". She did not verify representations by the sales agent who sold her the property that eventually there would be public transportation within the Maple Property's subdivision.
[9] Mrs. Oxciano testified that she and her husband believed they could make money from the Maple Property; they thought it would be a good idea to rent to students. If anything went wrong with the property, relatives in the Toronto area agreed to attend to the property.
[10] The appellants claimed gross rents of $3,400 and expenses of $19,594 in 1994 from the Maple Property.
[11] In 1995 the appellants rented two rooms in the Maple Property and claimed expenses of $29,600 from that property in computing their income tax return for that year. Income from Maple Property was $6,950. The largest expense item was the mortgage interest of $17,627. Other charges that exceeded $2,000 were furniture and fixtures ($2,778), hydro, cable and gas ($2,027) and property tax ($2,974).
[12] Expenses from Maple Property increased to $31,279 in 1996. Income was $3,125. Again mortgage interest, $19,742, was the greatest expense. The appellants rented two rooms in 1996 from August and September to the end of December 1996. It appears that some tenants were unable to pay rent.
[13] During the next two years the Maple Property continued to lose money. The appellants claimed losses in computing their total real estate income of $12,711 and $6,683 in 1997 and 1998 respectively; again, losses were attributable to the Maple Property. Losses continued in 1999 when the appellants claimed as a current expense, the installation of a new furnace in the Maple Property.
[14] At the time of trial the appellants stopped renting to students and now rent to "working adults". Also, the appellants have since negotiated a lower rate of interest for the mortgage on the Maple Property.
[15] The expenses claimed by the appellants may have been overstated since they included in expenses the cost of capital property. For example, a new furnace was installed on the Maple Property. Furniture and capital assets such as appliances and a microwave were also purchased. There is no breakdown as to what portion of the expenses were of a capital nature. In computing income, the appellants did not claim capital cost allowance. (The appellants did not allocate the purchase price of the Maple Property as to land and building.)
[16] The respondent assumed, in assessing, that $255.50 was deducted by each appellant for 1996 although the amount was a capital expense. The respondent also assumed that personal expenditures of $2,804.15 were claimed by each appellant in 1996. These expenditures related to the Maple Property. There was no evidence led by the appellants to refute these assumptions.
[17] Of course the respondent's main reason for denying the losses to Mr. and Mrs. Oxciano is her view that they did not have a reasonable expectation of profit from the Maple Property in 1995 and 1996. The respondent also states that the appellants did not vouch the following expenses in 1995 and 1996:
1995 1996
Interest $9,416.20 $1,716.59
Furniture & Fixtures $2,777.59
The appellants did not raise this issue in evidence or argument.
[18] In the reasons for judgment of the Supreme Court of Canada in Moldowan v. The Queen,[1] Dickson J. (as he then was) opined at page 5215, that:
... in order to have a "source of income" the taxpayer must have a profit or a reasonable expectation of profit.
Mr. Justice Dickson added that:
... 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: ...
[19] The Federal Court of Appeal held in Tonn et al. v. The Queen,[2]the "reasonable expectation of profit" test in Moldowan is stricter than the business purpose tests set out in subsection 9(1) and paragraph 18(1)(a) of the Income Tax Act ("Act") because, in addition to requiring the presence of a subjective profit motive, it also requires that such profit motive be objectively reasonable. Linden J.A., writing for the Court, stated 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.[3]
[20] Tonn sought to bring a sense of commercial reality into the minefield of "reasonable expectation of profit" appeals.
[21] Subsequently the Federal Court of Appeal heard the appeals of A.G. of Canada v. Mastri et al.[4] In Mastri, Robertson J.A. explained at 5423 that in Tonn the Court did not intend
...to establish a rule of law to the effect that, even though there was no reasonable expectation of profit, losses are deductible from other income sources unless, for example, the income earning activity involved a personal element. The reference to the Moldowan test being applied "sparingly" is not intended as a rule of law, but as a common-sense guideline for the judges of the Tax Court. In other words, the term "sparingly" was meant to convey the understanding that in cases, for example, where there is no personal element the judge should apply the reasonable expectation of profit test less assiduously than he or she might do if such a factor were present.
Robertson J.A. explained that:
Tonn simply affirms the common-sense understanding that it is not the place of the courts to second-guess the business acumen of a taxpayer whose commercial venture turns out to be less profitable than anticipated.
[22] Later, in Kuhlmann et al. v. The Queen,[5] the Federal Court of Appeal placed the burden on the Crown to establish that on a balance of probability, the expectation of profit was "irrational, absurd or ridiculous" and therefore was not reasonable. Since the Crown did not succeed in satisfying this burden, the taxpayers' appeals were allowed.
[23] In The Queen v. Milewski,[6]the Minister disallowed certain losses incurred by a partnership that were deducted by the appellant, one of the partners. In the Minister's view the appellant had no reasonable expectation of profit because of significant borrowing to finance the investment and related interest expenses. The principal of the borrowing was to be paid according to an amortization schedule of 25 years. No evidence suggested the payments were not or would not be made according to the amortization schedule. The Federal Court of Appeal agreed that the finding of Bowman T.C.C.J. (as he then was), that the investment was bona fide with the expectation that all of the debt ultimately would be paid off, and the appellant and his partners would have a lasting investment, satisfied the reasonable expectation of profit test on the facts of that appeal.
[24] The Federal Court of Appeal held that a 25-year amortization period is not unusual for long-term investments in real estate. All things being equal, profitability will "in the fullness of time" be achieved.
[25] On the facts at bar, the Minister has conceded that one of the properties owned by the appellants had a reasonable expectation of profit but another did not.
The concession was due to the fact a net profit was realized by the appellants from the Delta Property; the Minister really had no choice. It is the Maple Property that is in dispute.
[26] One should be leery to always conclude that losing investments never have a reasonable expectation of profit. I would assume that the same thought process that went on in the minds of the appellants when they decided to improve the Delta Property repeated itself when it came to acquire the Maple Property. It is true they lived in British Columbia and the Maple Property was in Ontario. But the appellants had family in the Toronto area who they could trust and who were prepared to help them if there were problems. The appellants felt comfortable in acquiring the Maple Property. There is absolutely no evidence that the appellants' expectation of profit from the Maple Property was any different from that of the Delta Property or that it was "irrational, absurd or ridiculous".
[27] In fact, the appellants negotiated a reduction in the interest rate of the mortgage on the Maple Property. The initial mortgages were for five-year terms. Mrs. Oxciano impressed me as a hard-working individual whose goal is to reduce the expenses from the Maple Property and make it profitable. There is no evidence the appellants purchased the property to sell for a gain. Theirs is a long-term, bona fide investment. I do not see why this couple of modest means cannot "in the fullness of time" accomplish their goal.
[28] However, there is some problem with respect to the expenses actually incurred by the appellants. The Minister has assumed that interest in the amounts of $9,416.20 and $1,716.59 in 1995 and 1996, respectively, were not vouched. There are also no vouchers for furniture and fixtures in the amount of $2,777.59 for 1995. The Minister also assumed that the appellants deducted personal expenses of $2,804.15 in 1996 and claimed capital expenditures of $255.50 for 1996.
[29] Based on the annual rates of interest on the money borrowed to acquire the Maple Property, which was secured by two mortgages, it appears the amount of interest the appellants would have had to pay in 1995 was approximately $18,300. They claimed they paid $17,627. If they did not pay the $9,416 which the Minister says is not vouched, I would assume their mortgagees would have had something to say about the delinquent payments. The $9,416 is a significant amount. But, there is no evidence, one way or the other.
[30] As far as the other expenses questioned by the Minister are concerned, the appellants did not challenge that capital or personal expenditures were actually deducted. Also, the appellants did not challenge the disallowance of expenses for furniture and fixtures in 1995. Therefore these amounts ought not be included among the operating expenses of the Maple Property. The reason I am reluctant to do the same with the interest expense is that the appellants were liable for these amounts to mortgagees. I cannot imagine the mortgagees tolerating such a default in payments. The non-payment in 1996 of an amount of interest of $1,716.59, on the other hand, may have been overlooked.
[31] Therefore, the appeals for 1995 and 1996 will be allowed and the assessments are referred back to the Minister of National Revenue for reconsideration and reassessment on the basis that:
The Maple Property was acquired by the appellants with a reasonable expectation of profit;
for 1995, the amount of $2,777.59 (furniture and fixtures) not be included in computing expenses for the Maple Property;
for 1996, the amounts of $255.50 (capital expense), $2,804.15 (personal expenditures) and $1,716.59 (interest) not be included in computing expenses for the Maple Property;
with respect to the amount of interest of $9,416 deducted in computing income from the Maple Property in 1995, that the appellants provide the Minister with acceptable proof within 60 days that the amount of $9,416 was paid to the creditors of the appellants for money borrowed to acquire the Maple Property; and
the appellants shall be entitled to costs, if any.
Signed at Montreal, Canada this 11th day of October 2000.
"Gerald J. Rip"
J.T.C.C.
COURT FILE NO.: 2000-353(IT)I
2000-355(IT)I
STYLE OF CAUSE: Ernesto Oxciano and Violeta Oxciano and
Her Majesty the Queen
PLACE OF HEARING: Vancouver, British Columbia
DATE OF HEARING: June 26, 2000
REASONS FOR JUDGMENT BY: The Honourable Judge Gerald J. Rip
DATE OF JUDGMENT: October 11, 2000
APPEARANCES:
Agent for the appellant: Violeta Oxciano
Counsel for the respondent: Kristy Foreman Gear
COUNSEL OF RECORD:
For the respondent: Morris Rosenberg
Deputy Attorney General of Canada
Ottawa, Canada
2000-353(IT)I
BETWEEN:
ERNESTO OXCIANO,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
Appeals heard on common evidence with the appeals of Violeta Oxciano (2000-355(IT)I) on June 26, 2000, at Vancouver, British Columbia, by
the Honourable Judge Gerald J. Rip
Appearances
Agent for the Appellant: Violeta Oxciano
Counsel for the Respondent: Kristy Foreman Gear
JUDGMENT
The appeals from the assessments made under the Income Tax Act for the 1995 and 1996 taxation years are allowed and the matter is referred back to the Minister of National Revenue for reconsideration and reassessment on the following bases:
a) The Maple Property was acquired by the appellants with a reasonable expectation of profit;
.../2
b) for 1995, the amount of $2,777.59 (furniture and fixtures) not be included in computing expenses for the Maple Property;
c) for 1996, the amounts of $255.50 (capital expense), $2,804.15 (personal expenditures) and $1,716.59 (interest) not be included in computing expenses for the Maple Property;
d) with respect to the amount of interest of $9,416 deducted in computing income from the Maple Property in 1995, that the appellants provide the Minister with acceptable proof within 60 days that the amount of $9,416 was paid to the creditors of the appellants for money borrowed to acquire the Maple Property; and
e) the appellants shall be entitled to costs, if any.
Signed at Montreal, Canada this 11th day of October 2000.
|
"Gerald J. Rip" |
J.T.C.C.
2000-355(IT)I
BETWEEN:
VIOLETA OXCIANO,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
Appeals heard on common evidence with the appeals of Ernesto Oxciano (2000-353(IT)I) on June 26, 2000, at Vancouver, British Columbia, by
the Honourable Judge Gerald J. Rip
Appearances
For the Appellant: The Appellant herself
Counsel for the Respondent: Kristy Foreman Gear
JUDGMENT
The appeals from the assessments made under the Income Tax Act for the 1995 and 1996 taxation years are allowed and the matter is referred back to the Minister of National Revenue for reconsideration and reassessment on the following bases:
b) The Maple Property was acquired by the appellants with a reasonable expectation of profit;
.../2
f) for 1995, the amount of $2,777.59 (furniture and fixtures) not be included in computing expenses for the Maple Property;
g) for 1996, the amounts of $255.50 (capital expense), $2,804.15 (personal expenditures) and $1,716.59 (interest) not be included in computing expenses for the Maple Property;
h) with respect to the amount of interest of $9,416 deducted in computing income from the Maple Property in 1995, that the appellants provide the Minister with acceptable proof within 60 days that the amount of $9,416 was paid to the creditors of the appellants for money borrowed to acquire the Maple Property; and
i) the appellants shall be entitled to costs, if any.
Signed at Montreal, Canada this 11th day of October 2000.
|
"Gerald J. Rip" |
J.T.C.C.
[1] 77 DTC 5213
[2] 96 DTC 6001
[3] Supra, 6013
[4] 97 DTC 5420. See also Mohammad v. The Queen, 97 DTC 5503
[5] 98 DTC 6652
[6] F.C.A. Court No. A-596-99, dated September 26, 2000, as yet unreported, an appeal from this
Court under the name of Allen et al. v. The Queen, 99 DTC 968 per Bowman, T.C.C.J.