"REOP" Concept Cannot be Maintained as Independent Source Test

On May 23, 2002, the Supreme Court of Canada presented a unanimous decision regarding Stewart v. Canada, a case first heard on December 12, 2001, allowing Brian J. Stewart’s appeal with costs throughout.

The S.C.C. held that Stewart’s rental activities constituted a source of income from which he was entitled to deduct his rental losses. In reaching its conclusion, the court held that the “reasonable expectation of profit” or “REOP” concept cannot be maintained as an independent source test, that such a concept is imprecise and causes an unfortunate degree of uncertainty for taxpayers.

Stewart wholly financed the purchase of four condominium units from which he earned rental income. For the tax years in question, Stewart incurred losses, mainly as a result of significant interest expenses. These losses were disallowed by the Canada Customs and Revenue Agency (CCRA), on the basis that Stewart had no reasonable expectation of profit, and therefore no source of income.

Richard Thomas of McMillan Binch LLP successfully argued that REOP is a concept that is limited to ascertaining whether a taxpayer was attempting to deduct a personal expense under the guise of a commercial expense. The REOP concept has no role in a commercial context where there is no personal element.

The minister unsuccessfully argued that Stewart had no REOP from the properties he purchased and that he purchased the properties as a tax shelter, attracted by the promises of income tax deductions and capital gains projections. Since Stewart had no REOP, the minister unsuccessfully contended he had no source of income against which to claim interest and other expenses incurred on the properties.

Stewart was represented by McMillan Binch, with a team headed by Richard Thomas and including Lisa Wong and McShane Jones. Donald Gibson and Richard Gobeil of the Department of Justice in Ottawa represented the Minister of National Revenue.