October 07, 2011

Her Majesty the Queen (Appellant) v. Edward Milewski (Respondent)

2000 DTC 6559
Federal Court of Appeal
September 26, 2000

(Court File No. A-596-99.)

Deductions — Interest — Taxpayer having invested in units of a limited partnership carrying on the business of renting apartments — Taxpayer having financed almost all of the purchase price of their said units by arm’s length borrowings on the strength of their own promissory notes — Whether taxpayer entitled to deduct certain partnership losses, as well as the interest incurred in respect of the aforementioned borrowed funds — Whether Minister having misapplied the “no reasonable expectation of profit” doctrine — Income Tax Act, R.S.C. 1985 (5th Supp.), c.?1, as amended, ss.?20(1)(c), 67 and 96.

The taxpayer had invested in units of a limited partnership carrying on the business of renting apartments. They had financed almost all of the purchase price of their said units by arm’s length borrowings on the strength of their own promissory notes. In assessing the taxpayers for 1993 and 1994, the Minister disallowed the deductions of certain partnership losses, as well as the interest incurred in respect of the aforementioned borrowed funds. In allowing the taxpayer’s appeals (99 DTC 968), the Tax Court of Canada concluded, inter alia: (a) that the Minister had misapplied the reasonable expectation of profit doctrine in resorting thereto for the purpose of supporting his assessments; (b) that the partnership was obviously carrying on a profitable business; (c) that the Minister had ignored the plain meaning of the interest deduction provisions of paragraph 20(1)(c) of the Act; and (d) that, as a result of the foregoing, the taxpayer were entitled to the deductions sought. The Crown appealed to the Federal Court of Appeal.

Held: The Crown’s appeal was dismissed. The Minister had argued that the taxpayer had no reasonable expectation of profit because his financing arrangements for his investment in the limited partnership in issue involved payments of interest that exceeded his income from that partnership. However, as the Tax Court judge pointed out, the limited partnership was a viable business with a reasonable expectation of profit. It had started making a profit in its second year of operation. In addition, the taxpayer’s investment in this viable and profitable business was devoid of personal interest, and the business was genuine. The Minister’s position would extend the “no reasonable expectation of profit” doctrine to individual partners for their involvement in a partnership which, in all respects, carried on a profitable business. As the Tax Court judge said, “[T]his was wrong as a matter of logic, law and common sense”. In addition, the Tax Court judge found that the investment involved was long-term and bona fide with the expectation that the debt would be paid down leaving the taxpayer with a lasting investment. That conclusion was sufficient to satisfy the reasonable expectation of profit test in the circumstances of this appeal. In light of the foregoing, the taxpayer was entitled to the deductions claimed. The Minister was ordered to reassess accordingly.