Campbellton Enterprises Ltd. v. MNR, 90 DTC 1869, [1990] 2 CTC 2413 (TCC)

Bonner, T.CJ.:—The appellant appeals from assessments of income tax for the 1984, 1985 and 1986 taxation years. Two aspects of the assessments are in dispute. Firstly, rental losses claimed by the appellant in respect of a condominium residence in Florida were disallowed as follows:

The respondent took the position that the expenses of the Florida condominium were not laid out for the purpose of gaining or producing income from a business or property and that the prohibition in paragraph 18(1)(a) of the Income Tax Act ("Act") therefore applies. That provision reads:

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

(a) 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.

With respect to capital cost allowance, the respondent took the position that paragraph 1102(1)(c) of the Income Tax Regulations applies. It reads:

1102. (1) The classes of property described in this Part and in Schedule II shall be deemed not to include property

(c) that was not acquired by the taxpayer for the purpose of gaining or producing income.

Finally, the respondent based his disallowance of the losses on a finding that the appellant had no reasonable expectation of profit from the rental of the condominium.

Secondly, the respondent disallowed a claim for a deduction of a bonus equal to three months' interest paid by the appellant to a mortgagee in respect of the premature retirement of a mortgage on the appellant's apartment building in Fredericton.

I will deal with the interest expense question first. There was no dispute as to the facts which are relevant to this issue. The appellant carried on the business of renting apartments. In December 1982, the appellant bought a rental housing project in Fredericton consisting of two buildings. To raise money for the purchase the appellant borrowed $628,256 from Imperial Life Assurance Inc. Co. of Canada. The loan was secured by a mortgage of the apartment property. The property was sold in 1986. In order to make title it was necessary for the appellant to discharge the mortgage. However, the mortgage did not mature until 1988. The mortgage contained the following provision:

Provided that on the third anniversary of the interest adjustment date and on any monthly instalment date thereafter, the Mortgagor, when not in default hereunder, shall have the privilege of paying the whole amount owing hereunder or any part thereof, upon payment, by way of bonus, of an additional three months' interest on the principal amount of any such additional payment.

Pursuant to that provision the appellant paid to the mortgagee a bonus of $23,593.44, in addition to principal and accrued interest to the date of payment. That bonus is the amount that the appellant sought to deduct in the computation of its income for 1986.

Evidence was tendered with a view to establishing that the mortgagee included the amount of the prepayment bonus received by it in the computation of its income. The position taken by counsel for the appellant in relation to the relevance of that evidence was:

The whole spirit and intent of the Income Tax Act is to either catch you now or catch you later. And if the payment is properly deducted by my client, wherein he is asking that he not pay tax on it, and the payment made, as we will submit, was an interest payment and included in the income of the mortgagee, wherein the corporate tax rate was again paid, then the spirit of the Act was not to catch that amount and have tax paid on it twice.

By this I understand counsel for the appellant to be arguing that if the amount received forms part of the income of the payee it may be deducted in comput ing the income of the payor. There exists no principle of law which supports this argument. It is utter nonsense.

Counsel for the appellant made another argument in support of the deductibility of the bonus payment. She said it was deductible under paragraph 20(1)(c) of the Act. That provision reads:

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:

(c) an amount paid in the year or payable in respect of the year (depending upon the method regularly followed by the taxpayer in computing his income), pursuant to a legal obligation to pay interest on

(i) borrowed money used for the purpose of earning income from a business or property (other than borrowed money used to acquire property the income from which would be exempt or to acquire a life insurance policy). . . .

A prepayment bonus such as the $23,000 in issue is not paid ” . . . pursuant to a legal obligation to pay interest . . . ” within the meaning of paragraph 20(1)(c). The bonus was not compensation for the use or retention of money for a period of time. (See Puder v. M.N.R., [1963] C.T.C. 445; 63 D.T.C. 1282 and Riviera Hotel Ltd. v. M.N.R., [1972] C.T.C. 157; 72 D.T.C. 6142.) It was, to paraphrase the remarks of Thurlow, J. in Puder at page 449 (D.T.C. 1285), a sum paid in respect of the relinquishment by the mortgagee of his right to insist on payment of the mortgage according to its tenor. This branch of the appeal from the assessment for 1986 therefore fails.

I will add one further comment on the deductibility of the prepayment bonus. The bonus was an outlay or expense made or incurred by the appellant for purposes of making the disposition of the apartment property. It would seem that it was deductible by virtue of subparagraph 40(1)(a)(i) of the Act in computing the appellant's gain from the disposition of the property. I assume that the appellant was not a dealer in real property and that the apartment property was a capital asset in its hands. I am not in a position to make any decision on the computation of the gain because the issue was not raised either by the pleadings or in argument but I expect that the respondent will do what is right by way of reassessment. (See Canadian Marconi Co. v. Canada, [1989] 2 C.T.C. 128; 89 D.T.C. 5370.)

I turn next to the condominium loss issue. Evidence was given by Nolan Boudreau, president of the appellant. His wife held 50 per cent of the shares of the appellant. The remaining shares were held by one Bill Walsh, a man whom Mr. Boudreau described as his partner. Mr. Boudreau said that he and Mr. Walsh ran the day-to-day affairs of the appellant.

Mr. Boudreau's testimony was that in the 1980s when the recession hit Canada it was thought that it would be a good investment to buy property, possibly a motel or condominium project in the United States market. It was decided to "test the market" by buying a condominium. Mr. Walsh apparently met with a broker and was advised to “buy on the water". The condominium was bought in either November or December of 1983. It was located in a building still under construction. At some time in 1984 Mr. Boudreau approached the real estate agent and asked her if she could find a tenant. However, he discovered that in Florida in the summertime, two-thirds of the condominiums are empty. Messrs. Boudreau and Walsh also discovered, and it is not quite clear when, that, under the constitution of the condominium, they could not rent the unit for periods less than six months and that every rental had to be approved by the Board. In 1986, Mr. Walsh decided to retire. Discussions ensued between him and Mr. Boudreau and a decision was made that the unit would be rented to Messrs. Boudreau and Walsh.

Mr. Boudreau said as well that when the condominium was bought, he and Mr. Walsh intended to rent it themselves for a couple of months of the year during the winter season and to rent it to others during the rest of the year. He said that the condominium was in Boca Raton, that a lot of young scientists worked there and formed the market for the property. Mr. Boudreau stated that he has not kept the results of his research into the rental market. He asserted that buying a condominium is an excellent way to become familiar with real estate laws, taxes and insurance and with the manner in which condominium associations work.

The appellant has not bought any other apartments in Florida but Mr. Boudreau stated that it will if the appeal succeeds. He said . . . it makes it a good investment if we can use the capital cost allowance and if we can get the appreciation on the property in the company". Mr. Boudreau was asked why no income was reported in 1984 and 1985. He answered that in 1984 the project was still under construction and that in 1985 he and Mr. Walsh each spent a couple of months at the apartment and decided to rent it year-round and not try to rent it to anyone else. He said the decision was made partially because the apartment was not rentable during the summer and also because the two decided the apartment was going to be their private place where they would leave their clothes and golf clubs. They decided too, he said, to pay the going rate, $500 a month. It is a little difficult to understand why, in light of that decision, no rent was paid to the appellant in 1985 and only $3,000 was paid in 1986. Mr.Boudreau's explanation was ”. . . nobody pays rent before you move in and even if you own the project yourselves. So we started to rent when we moved down to Florida in the fall of the year and that's when the rent started”.

Evidence was also given by Barry Coleman, the accountant who prepared and filed the appellant's tax returns. In 1990 he prepared a projection showing that the condominium may show a profit in 1992. This projection is not one that could have been made during the years in question. For one thing it makes no provision for interest on the condominium mortgage. That mortgage was not paid off until 1986 or 1987 when funds became available from the 1986 sale of the Fredericton property. It is unlikely that the decision to retire the mortgage could have been foreseen at any time in 1984 and 1985 and during much of 1986. Secondly, it was not reasonably foreseeable, at least until sometime in 1986, that the apartment would generate revenues in the amounts used in Mr. Coleman's projections. The appellant had not dedicated itself to wringing out of the apartment the maximum revenues the market would bear. Mr. Boudreau's evidence was ”...in ‘86 we decided consciously to charge ourselves rent. Because we weren't renting the thing to other people and we had used it. So we said, 'We better charge ourselves rent because the Tax Department will come in and do an audit and they'll charge us anyway.' So . . . ”.

In argument counsel for the appellant addressed the question whether a reasonable expectation of profit existed. She referred to a number of authorities including the decision of this Court in Baker v. M.N.R., [1987] 2 C.T.C. 2271; 87 D.T.C. 566 and in particular to the following passage at 2274 (D.T.C. 568):

. . . a reasonable expectation of profit exists where given all the facts pertinent to a venture it could, within a realistic time (the period will vary depending on the nature of the operation), yield a profit barring abnormal circumstances. In other words, is the venture as structured and normally operated capable of generating a profit?

Counsel argued that it is significant that the appellant is in the business of renting apartments. In consequence, she submitted:

. . . the Income Tax Act looks at it much differently than a personal taxpayer who, in some courts' eyes, have been judged to have been trying to evade taxes as opposed to avoid them. He is allowed to create paper losses by the use of capital cost allowances. And there is specific regulations that permit a business client renting apartments to do that.

Counsel also said:

. . . a businessman in the rental business . . . knows he will have to write off expenses against income for quite some time before profit will materialize. My point was to suggest that it was not unreasonable and it is quite allowable by the Act. Regulation 1100 specifically addresses that.

Inferences drawn from events are often more reliable than statements of subjective intention. The central events in this case are the following. The appellant bought a condominium unit which was subject to restrictions which would have made short-term rentals somewhat difficult. The unit was used exclusively by two persons only, one being the principal shareholder of the appellant and the other, the husband of the other principal shareholder. There was no evidence showing that a genuine effort was made to rent the condominium to other persons or that there was ever any reasonable prospect of doing so particularly during the summer months when Messrs. Boudreau and Walsh were not using it. It was not shown that any of the costs of the condominium exceeded expectations. Such costs including capital cost allowance amounted to more than two times the market rentals. The only inference I can draw from the evidence is that profit from the rental of the condominium was neither expected nor sought. It seems clear that the condominium was acquired and held not for the purpose of earning income but rather for the purpose of providing accommodation for the shareholders and their spouses. It is difficult to imagine how the purchase of the condominium could have assisted in "testing the market". If that had really been the appellant's purpose the condominium would have been sold in 1985 when the market had been tested and found incapable of generating any revenue even from the shareholders who occupied the apartment. Thus the paragraph 18(1)(a) prohibition applies to the listed expenses. Paragraph 1102(1)(c) of the Regulations has the effect of preventing the deduction of capital cost allowance. The appeals will therefore be dismissed.

Appeals dismissed.