Date: 19980306
Docket: 96-2825-IT-G
BETWEEN:
RENÉ FORTIN,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
Reasons for Judgment
(Rendered orally at Québec, Quebec on January 30, 1998 and subsequently revised at Ottawa, Ontario on March 6, 1998)
LAMARRE, J.T.C.C.
[1] The appellant appealed from assessments made by the Minister of National Revenue ("the Minister") pursuant to the Income Tax Act ("the Act") for the 1988, 1989, 1990 and 1991 taxation years.
[2] At the time the appellant filed his tax returns for each of those years he claimed rental losses for 1988 and 1989 on a building located at 262-264 Rue de la Couronne, in Québec. The losses which he claimed at that time amounted to $60,803 in 1988 and $26,068 in 1989. The Minister disallowed these losses.
[3] The appellant also claimed the deduction of carrying charges against his income in the order of $10,403 in 1989, $15,412 in 1990 and $25,071 in 1991. These carrying charges were disallowed by the Minister.
[4] The appellant also claimed the deduction of $31,457 as a loss on a business investment for 1991. This loss was also disallowed by the Minister. At the start of the hearing, counsel for the appellant mentioned that she was no longer disputing the Minister's position on this last amount.
[5] At the start of the hearing, counsel for the appellant also argued that the rental losses actually amounted to $141,571 in 1988 and $54,437 in 1989. She also mentioned that the carrying charges to which the appellant claimed to be entitled amounted to $21,499 in 1988, $13,824 in 1989, $12,997 in 1990 and $11,425 in 1991. She also claimed an additional interest deduction on a commercial hypothecary loan for the building of $40,921 in 1988 and $23,070 in 1989.
[6] In my opinion, on these new applications the appellant cannot amend his Notice of Appeal orally on the day of the hearing and claim considerably larger costs than those which he himself reported in his tax returns and on which he was assessed. In filing his Notice of Appeal the appellant appealed from the assessments made and asked that the assessments disallowing the costs which he had himself claimed in his tax returns be vacated. He cannot amend his pleadings at the last minute so as to substantially alter the nature of the issue. Approving such a practice would be a procedural abuse which is prohibited by law.
[7] Having said that, I will now examine the evidence.
[8] During the years at issue the appellant was an economist for the city of Québec and received an annual salary of some $55,000. In 1985 he was a partner with other individuals in the operation of a discotheque located in the building on Rue de la Couronne.
[9] On December 18, 1986 this building was purchased by the company 2418-7072 Québec Inc. ("the company"), which was created on July 29, 1986. The appellant was the sole shareholder in this company. He wished to renovate the building, which was located in a part of town which was due for redevelopment, lease it and eventually resell it at a profit.
[10] A bar was operated on the ground floor of this building and there were rooms to let on the upper floors. The basement was not finished. In view of the type of business operated in the building, the appellant did not want to buy the building personally so as to avoid any responsibility in the event of possible liability actions.
[11] The building was purchased for the sum of $140,000, $105,000 of which was financed by a hypothecary loan by the Caisse populaire with a selling price balance of $10,000. The appellant said he financed the balance of $25,000 personally.
[12] When he purchased the building the appellant converted the basement into a tavern. This gave rise to quite large expenditures. As the building was located not far from the Quebec Ministère du Revenu and a federal government building it seemed profitable to begin with. The business then began to go downhill when the premises were leased to tenants who did not comply with municipal regulations. The number of customers began to fall off.
[13] The appellant therefore wanted to renovate the upper floors by converting them into premises for business establishments. At the same time, the provincial regulations changed and this resulted in additional costs to the appellant of some $25,000.
[14] According to the appellant, in order to make the building profitable he would have had to find rental income of $3,500 a month and such income did not exist.
[15] As the company had no credit, no equity and no worth (its only asset, the building, was mortgaged to the hilt) the appellant therefore had to personally endorse loans made by the bank, and suppliers of services such as Hydro-Québec asked him to make out his cheques personally. He said these events occurred around 1987.
[16] At that time the appellant was advised to transfer responsibility for company’s operations to himself personally by a resolution of the board of directors. By this resolution dated December 28, 1987 (see Exhibit A-1), the following is stated:
[TRANSLATION]
In view of the company's inability to meet its expenses, the sole director of the company proposes to transfer to its sole shareholder and director all management and operations of the company, including the management of the building located at 262-264 de la Couronne, Québec, operation of a disco-bar operated at 264 Rue de la Couronne, Québec . . . and the tavern operated in the basement of the said property.
It is therefore resolved that all profits from the operations of the said René Fortin shall accrue to him personally, the company specifically undertaking to assign to him on request all rights and interests which it has in the said business capital in consideration of the assumption of certain debts of the company by the said René Fortin.
Accordingly, the said René Fortin is authorized to operate the business capital from January 1, 1988, as if he were personally owner of the said business capital . . .
[17] The appellant said he had thus operated the business personally because he had no choice. He was sued by the suppliers in any case because the company was not solvent.
[18] In September 1989 the building was retaken by giving in payment.
[19] The company had never filed any tax returns since the start of its operations. The appellant said that the company had never made any income since it was not operating the business. It never filed any financial statements either.
[20] The appellant also suggested that he had operated a snack bar elsewhere in Québec. He never reported the income from that business.
[21] Counsel for the appellant also called Messrs. Raymond Paradis, an accountant, who prepared the tax returns for the appellant's years at issue, Conrad Breton, a financial analyst who analysed the appellant's expenses, and Aldor Baron, a retired accountant who analysed the appellant's expenses one last time, though after the assessments had been made.
[22] Mr. Paradis mentioned that he had determined the expenses based on invoices given to him by the appellant. He said they were generally in his own name except for such things as real estate taxes, which were in the company's name. He arrived at the income using information supplied by the appellant without further investigation. He was the one who determined the amount of losses claimed in the tax returns. In 1988 he claimed no carrying charges.
[23] Mr. Paradis determined that in 1991 the advance made to the company by the appellant was $60,000. These advances came from a refinancing of his home, bills which he paid personally and his initial investment of $25,000. He also said that although he had looked after the payroll for the tavern, he had not done the financial statements since it was operated by another numbered company.
[24] Mr. Breton also analysed the expenses and arrived at approximately the same results as Mr. Paradis, except that he added on additional carrying charges.
[25] Mr. Baron revised these expenses upward in 1997 and estimated the hypothecary loan allocated to the appellant's home. He then estimated the hypothecary loan on the Rue de la Couronne building operation at $100,000. He arrived at this figure on the basis that the total hypothec was $140,000 and it was initially $40,000 for the purchase of the house itself. He maintained that the loan was increased in 1987 by $100,000 but had no specific documentary support for his contention. He also reduced the rental income, saying it had not entirely been received during these years.
[26] Counsel for the respondent called Messrs. Réjean Vaillancourt, an auditor with Revenue Canada who prepared the assessment, and Yves Côté, an appeals officer with Revenue Canada who confirmed the assessments. Both stated that they had disallowed the rental losses because it was not the appellant who was operating the rental building, but the company. They disallowed the deduction of the carrying charges because the appellant had submitted no tangible evidence to show that they had been incurred to produce income from a business or property. Further, as the building was retaken under a giving in payment in September 1989 the source of income, if any, had disappeared at that time, thus making the deduction of carrying charges impossible.
Analysis
[27] As to the deduction of the rental losses, the appellant had to show that he had a source of income from a business or property on which the rental loss could be calculated.
[28] On the one hand, the building which generated all the expenses claimed by the appellant was owned by the company, not by him personally. The property was purchased by the company. According to the appellant's testimony the hypothecary loan was made out to the company and according to Mr. Paradis' testimony the real estate taxes were in the company's name. If the building had produced income it is obvious that it was the owner of the property who would have received the profits, in this case the company and not the appellant. The appellant could not argue that by paying the expenses on this building he was incurring these expenses to produce income from the property.
[29] However, the appellant entered in evidence a company resolution by which the latter assigned the entire management of the building and the profits which it might produce to the appellant as of January 1, 1988. He therefore argued that as he was entitled to the income from the building he could claim the losses which it caused him.
[30] This reasoning might be valid if the appellant was able to show on a balance of probabilities that at the time the company thus transferred the income from the building to him he had a reasonable expectation of deriving a profit from the building. That is what the Supreme Court of Canada held in Moldowan v. The Queen, [1978] 1 S.C.R. 480.
[31] The appellant told the Court that at the time it was suggested that he pass this resolution the company was not in any way solvent. The debts incurred on this building were already quite high (the building was mortgaged to the hilt) and the appellant said that he had to incur further debt if he was to have any expectation of getting a greater return on the building. The suppliers required that the appellant pay personally and even brought court actions against him. In other words, he was in a tight spot financially and had no choice but to pay personally. This financial impasse ended when possession was retaken of the building in September 1989.
[32] Further, if we look at the reported rental income in 1988 and 1989 as contained in the appellant's tax returns we see that just the interest expense in 1988 was $47,764, that is double the rental income of $20,800, and $11,006 in 1989, once again almost double the rental income of $6,500.
[33] It may be that the rental income was not as high as expected. However, the interest item was so high that the appellant had to show that he had a realistic plan to reduce the principal of the loan, as Robertson J.A. of the Federal Court of Appeal suggested in Mohammad v. The Queen, 97 DTC 5503, 1997 F.C.A. No. 1020 (Q.L.). That was not shown. On the contrary, the evidence showed that the appellant increased his loans during these years.
[34] Though the company may have had a reasonable expectation of making a profit on the building at the time of the purchase in 1986 (which I do not have to determine), I cannot conclude on the evidence before me that at the time the appellant began managing the building personally such a reasonable expectation of deriving a profit from rental of the building existed. It should also be borne in mind that as the building was still the property of the company the appellant had no control over the possible retaking of possession of the building by a creditor who might appear at any time. This fact by itself, and the others I mentioned above, indicates that the appellant could not reasonably expect to derive a profit from any income the building might produce. Accordingly, the appellant had no right under the Act to deduct rental losses during the years at issue.
[35] The same reasoning applies to carrying charges. If the appellant had no reasonable expectation of a profit in 1988 and 1989 the source of income had disappeared and the interest charges were no longer deductible under s. 20(1)(c) of the Act (see Emerson v. The Queen, [1986] 1 CTC 422 (F.C.A.)). This is all the more true in 1990 and 1991, when the building was no longer part of the company's assets.
[36] As Linden J.A. of the Federal Court of Appeal said in Corbett v. The Queen, [1997] 1 F.C. 386, at 402, when no profit can be made in the taxation year or subsequently, as here, the deduction cannot be allowed.
[37] Additionally, in Bronfman Trust v. The Queen, [1987] 1 S.C.R. 32, at 47, Dickson C.J. of the Supreme Court of Canada said the following:
A taxpayer cannot continue to deduct interest payments merely because the original use of borrowed money was to purchase income-bearing assets, after he or she has sold those assets and put the proceeds of sale to an ineligible use.
[38] Accordingly, a continuing obligation to pay interest to a creditor does not conclusively prove that the taxpayer is still using the borrowed money and that he is using it to generate income (Bronfman Trust, supra, at 48 and 52).
[39] In the instant case it appeared that the carrying charges were incurred by the appellant by hypothecating his home to advance money to the company and pay the debts on the building. The evidence did not show that these loans were used to generate income either from the company itself or from the building as such.
[40] In conclusion, I consider that the appellant did not show on a balance of probabilities that he was entitled to deduct the rental losses in computing his income or that he was entitled to deduct carrying charges for each of the years at issue.
[41] The appeals are therefore dismissed.
Signed at Ottawa, Canada, March 6, 1998.
Lucie Lamarre
J.T.C.C.
[OFFICIAL ENGLISH TRANSLATION]
Translation certified true on this 29th day of June 1998.
Mario Lagacé, Revisor