Minister of National Revenue v. Alfred Gordon, [1966] CTC 722, 66 DTC 5445

THURLOW, J.:—This is an appeal by the Minister from a judgment of the Tax Appeal Board ( (1966), 40 Tax A.B.C. 105) allowing the respondent’s appeal from re-assessments of income tax for the years 1961 and 1962. In computing the respondent’s income for the years in question the Minister disallowed deductions of $4,727.42 for the year 1961 and $6,543.99 for the year 1962 which the respondent had claimed in respect of what will be referred to as the ‘‘Sutherland’’ property and the sole issue in the appeal is whether the respondent was entitled to these deductions. The respondent’s appeal to the Tax Appeal Board also raised the question of his right, in computing his income for 1962, to deduct the expenses of certain litigation in which he had engaged and the Board held him entitled to deduct them but this matter is not in issue in the present appeal.

The respondent is a physician who during the years in question as well as both before and since then resided and practised his profession at Dartmouth, Nova Scotia. He earned a substantial income from his practice and prior to 1961 had acquired five rental producing properties in Dartmouth. These were multiple family dwellings and represented an investment of about $146,000. As reported in the respondent’s income tax return for 1961 they showed a loss of about $5,000 after deducting expenses and capital cost allowances from gross revenues of $20,325. All of these properties were managed by the respondent personally rather than by an agent.

The “Sutherland” property was acquired by the respondent on or about November 1, 1961 for $38,000 of which $34,000 was the price of real property and $4,000 the price of furniture and furnishings. To pay for the property the respondent provided $3,000 from his own resources and borrowed the remaining $35,000 from his bank at 6% interest. In each of the years in question interest paid on this loan is one of the items making up the amount in dispute.

The property is situated at Cookville some three to four miles north of Bridgewater, Nova Scotia, on the highway leading from Bridgewater to New Germany. It comprises about 80 acres of land, part of which lies west of the highway and has a frontage of about 1,000 feet on the La Have River. The other, and much larger portion lies east of the highway. On it stands a modern and rather lavish three bedroom single family dwelling house which was said to have been built by Fred Sutherland about fifteen years ago.

On acquiring this property the respondent had the telephone service continued and thereafter he visited the property from time to time during the winter, staying over-night on one occasion. The heat was left on, but unfortunately in January some of the plumbing froze and flooding ensued in the dining and living room areas. In the spring the leaks were repaired and the respondent’s wife and three children later moved to the property and spent the months of July and August there. During this period, probably in August, the respondent himself spent a week or two there. At the end of August the family moved back to Dartmouth. A dishwater purchased for the property in June was then taken to Dartmouth where it remained until the following summer when it was returned to the property. The cost of transporting it to Dartmouth is among the items in dispute. The cost of the dishwasher itself is also included in an amount claimed in respect of repairs, but this was said to be an error made by the respondent’s accountant and it was not contended that this amount was deductible as an expense. From the end of August to the end of the year 1962, that is to say, to the end of the second of the taxation years involved in the appeal, the property remained unoccupied.

Shortly before or shortly after the end of the year Earl Johnson of Halifax, who was expecting to move to Bridgewater to live and was looking for a residence in or near the town, visited the property one day. He saw indications that the property had been broken into and after reporting this to the R.C.M.P. contacted the respondent in Dartmouth, both for the purpose of reporting the discovery and of inquiring if the property was for sale. He was told that it was not for sale but that it was for rent and this led to Johnson taking a lease of the property for three and one-half months commencing on March 1, 1963 at $200 a month. It was a term of the lease that the respondent should have the right to inspect the property and according to Johnson the respondent exercised the right often and on average twice a month during his occupancy. At the end of the term, in midJune, the Johnsons moved out and during July and August the respondent’s wife and family again occupied the premises, the respondent himself again spending a week or two with them during the period. In fact, the property has been occupied by the respondent’s family each summer since the respondent acquired it. It has not been let to any tenant since Johnson vacated and in the period of about five years has produced no revenue beyond the $700 which Johnson paid as rent.

In December 1962 the telephone service, which formerly had been on a regular basis costing $12.15 monthly, was changed to an absentee basis costing .50 monthly and thereafter (save during Mr. Johnson’s occupancy) this was the basis on which the service was continued except during the months of July and August in each year when the service was restored to the regular basis.

In support of the position taken by his counsel that the property was acquired for the purpose of earning income therefrom, the respondent stated in evidence that he had seen a newspaper advertisement that the property was for sale, that he and his wife thought it to be in a very nice location and that after seeing it he felt that it was worth much more than the $38,000 which he later paid for it. He said that Dr. Robertson, from whom he bought it, felt it was worth $80,000 - $90,000. He also said that when he decided to buy it, he intended ultimately to build about ten cottages on the river frontage to let to salmon fishermen and to build and operate a convalescent unit near the existing house using it as an office structure in which nursing staff might be accommodated. He pointed out a number of features of the property which he suggested made him feel that these projects would be feasible as profit making enterprises, said they would involve investment of a large amount of money, that he had in mind ten or fifteen years in which to carry out these projects and was, in the meantime, building up his financial resources for that purpose and that he had not abandoned either of them. He also said that in deciding to buy the property he felt it was opportune to do so because the price was less than the property was worth and that he planned to rent it to obtain enough to maintain it until he was able to build. Relying on his understanding of real estate in Dartmouth, he felt there would be people willing to rent it and that he would be able to get $200 a month which would be sufficient revenue to carry it. He also said that he had no intention of selling it at any time or of using it as a summer cottage, that after buying it he verbally let it be known, though to whom was not specified, that he wanted a tenant but that he did not have much hope because it was winter, that after the plumbing froze and the flooding ensued the house was not rentable and took a long time to dry, that his wife and children moved there in July in order to help clean the house and let it dry and that until the summer he did not attempt to find a tenant, but that during the summer months he let it be known that he was interested in renting the property. One person he said he told was a bank manager in Bridgewater. No others were specified. He said he did not advertise in the newspapers because he felt that if he did so he would spend too much time going back and forth to show the property. In the summer of 1963 when the Johnson lease was already completed and he was spending some time with his family at the property, he contacted two real estate agents in Bridgewater and made arrangements for them to look for a tenant at $200 per month for a full year and failing that at $500 per month for July and August. This brought no results and it does not appear that these agents so much as advertised the property in a newspaper. He says they thought renting would be difficult because rentals in Bridge water were much lower than those which he had set. Several of the agents were interested in listing the property for sale and several persons have from time to time inquired whether it was for sale either through them or directly. In February or March of 1964 the respondent listed the property for rent with another real estate agent who advertised the property in his office window at Lunenburg, in Halifax and Lunenburg County newspapers and through a province-wide multiple listing service. This agent received at least one enquiry from another agency and he showed the property to a person who was interested in buying rather than in renting, but he has been unable to secure a tenant for it. It appears from the evidence of this agent that he still has the property listed for letting but that its location does not enjoy popularity with persons in a financial position to afford so high a rent. The property was characterized by another of the witnesses as a ‘‘white elephant”.

The deductions claimed by the respondent which with the exception of the cost of the dishwasher included in the item for repairs and maintenance, make up the amounts in dispute in the present appeal are as follows :

With respect to all of these, the Minister’s position is that the property was not acquired for the purpose of gaining or producing income, but as a summer residence for the respondent and his family and that the amounts are therefore not deductible in computing the respondent’s income. In the alternative the Minister takes the position that even if the property was acquired for the purpose of gaining or producing income there was a change in such purpose by July 1962 when the respondent’s family occupied the property and that from that time on the property was not held or used to produce income.

The right of a taxpayer to deduct capital cost allowance in computing income arises under Section 11(1) (a)* [1] of the Income Tax Act and Section 1100 of the Regulationsf [2] made pursuant thereto which provide for the right and prescribe how much allowance may be claimed. The right is, however, limited by Section 1102 which provides:

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

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

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The right of a taxpayer to deduct interest in computing income arises under Section 11(1) (c) which provides:

“11. (1) Notwithstanding paragraphs (a), (b) and (h) of subsection (1) of section 12, the following amounts may be deducted in computing the income of a taxpayer for a taxation year :

(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

(ii) an amount payable for property acquired for the purpose of gaining or producing income therefrom or for the purpose of gaining or producing income from a business (other than property the income from which would be exempt),

or a reasonable amount in respect thereof, whichever is the lesser ;’’

The right of a taxpayer to deduct other expenses incurred in connection with property depends first on whether, on accepted principles for computing income from property, they would properly be taken into account in computing the profit from the property, but even if admissible, having regard to such principles, they are deductible only in so far as they fall within the exception of Section 12(1) (a) which provides that:

“12. (1) In computing income, 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 property or a business of the taxpayer,”

(Italics added in each of the foregoing. )

Though the test is stated negatively in Section 1102, the critical question in the present appeal with respect to all three types of deductions is whether the property was acquired, or the expenditure was incurred ‘for the purpose of gaining or producing income ’ ’ from the property or from a business and the onus of satisfying the Court that the answer should be in the affirmative rested on the respondent. It would, of course, fortify the opposite conclusion if it manifestly appeared that the property was purchased simply as a summer home for the respondent and his family, as counsel for the Minister contended, but it does not appear to me that such a finding is essential 'to the Minister’s case. Property may, I think, be acquired and expenses may be incurred in respect thereof in the pursuit of a purpose which is neither the gaining of income nor personal enjoyment (for example simply as a hedge against inflation) but what appears to me to be essential to success on the part of the respondent in the present appeal is a positive finding that the property was acquired and the expenses incurred ‘‘for the purpose of gaining or producing income’’.

The evidence does not satisfy me that that was the respondent’s purpose. While I regard it as unlikely that he would have invested $38,000 in such a property simply to use it as a summer home for two months of each year, I think that one of the things he had in mind was that he might use it for that purpose and as a year round resort as well. These, in fact, were the only purposes which the property served in the 14-month period involved in the appeal and save for the period of three and one-half months in the spring of 1963 when the property was let to Earl Johnson, they were the only purposes which the property served during the period of nearly five years from the time it was purchased to the time of the trial. In the whole of that period nothing whatever was done with the property to further either the scheme for building and operating cottages or the scheme for developing a convalescent centre, though in the latter case the respondent did say that he had acquired additional information on such establishments. To my mind the most that can be said of these is that they were ideas for possible use of the property and that by acquiring it when he did and holding it the respondent put himself in a position to undertake either or both of them if at some future time it should be expedient to do so. In such circumstances I do not think it can be said that his purpose in acquiring the property was to carry out these schemes. Nor do I think the respondent acquired the property to earn income by letting it either pending his embarkation on either scheme, or generally. He said he hoped to be able to realize $200 per month as rent, but to my mind no one vaguely familiar with what would be a reasonable income return on an investment of $38,000 in such a property, and least of all a person of the intelligence and astuteness of the respondent, would have made so large an investment for the income he could get from it at $200 a month and a fortiori when there was no tenant in sight he would be likely to pay even that amount. That he did not expect to earn income in this way during the period here in question is, I think, apparent from the feebleness or utter lack of any effort in find a tenant immediately after he bought the property and throughout the year that followed and from the fact that he had the regular telephone service continued for the better part of a year, not for the purpose of helping to get a tenant, but to ensure that he could be contacted by his office in Dartmouth whenever he was at the Cookville property.

I would infer moreover that one of the more important considerations which he had in mind in deciding to buy the property was that he might obtain a deduction for capital cost allowance which would not represent an actual outlay of money, but would, because of his large income from his practice and the rate of taxation applicable thereto, afford a saving in income tax of about half the amount of such allowance.

On the whole the conclusion which I reach is that the respondent acquired the property largerly because, at the price at which it was available, he regarded it as a very good bargain. In deciding to buy it I think he had in mind several uses to which he thought it might conceivably be put some day, including the schemes to build and let cottages and to build and operate a convalescent centre, that he also had in mind that he would let it, if he could, to reduce the expense of holding it and that when and so long as it remained unoccupied he would make such use of it for his own private purposes as occasion might suggest being confident that having bought at a low price he would ultimately turn the property to account and be ahead whether it produced income in the meantime or not. This, in my opinion, is not acquiring a property ‘‘for the purpose of gaining or producing income” within the meaning of any of the three statutory provisions to which I have referred and by which the respondent’s right to the deductions in question is governed and as the property was neither acquired for the purpose of gaining or producing income nor actually used for that purpose at any time during either of the taxation years involved in the appeal, I can see no basis for holding the respondent entitled to any of the deductions in question. It follows that they were properly disallowed.

In view of this conclusion it is unnecessary to consider the Minister’s alternative position beyond observing that apart from the fact of occupancy of the property by the respondent’s wife and family in July of 1962, which was explained on the ground that they moved there for the purpose of cleaning and drying the house, there is in my view, nothing in the evidence to indicate any change or alteration during the material time of the purpose for which the property was acquired and if I had been persuaded that the property was acquired for the purpose of gaining or producing income, I should not have thought that this occupancy alone in the circumstances indicated a change of purpose and use for the property.

I should add, in case it may be of some importance in the event of an appeal, that I observed nothing about the demeanour of the respondent while giving evidence which would have induced me to discredit his testimony, but I have the impression that he has persuaded himself (1) that mere ideas which he may have had at the time of the purchase as to possible uses for the property were, in fact, his purposes; (2) that in the period here in question steps were taken to find a tenant when in fact nothing that could fairly be so characterized was done; and (3) that the expenses claimed were incurred for the purpose of earning income from the property when, in fact, they had nothing to do with the earning of income therefrom.

The appeal accordingly succeeds and it will be allowed with costs. The re-assessment for the year 1961 will be restored and the re-assessment for the year 1962 will be referred back to the Minister for re-assessment on the basis that the respondent is not entitled to any of the deductions in question in this appeal and, subject to this alteration, on the basis of the judgment of the Tax Appeal Board.