Date: 19981030
Docket: A-981-96, A-982-96
CORAM: DÉCARY J.A.
LÉTOURNEAU J.A.
CHEVALIER D.J.A.
IN THE MATTER OF an Appeal from the Tax Court of Canada
A-981-96
BETWEEN:
PETER ALAN KUHLMANN
Appellant
(Plaintiff)
AND
HER MAJESTY THE QUEEN
Respondent
(Defendant)
A-982-96
BETWEEN:
RUTH EDITH KUHLMANN
Appellant
(Plaintiff)
AND
HER MAJESTY THE QUEEN
Respondent
(Defendant)
Heard at Montreal, Quebec, Wednesday and Friday, 28th and 30th day of October 1998.
Judgment delivered at Montreal, Quebec, Friday 30th day of October 1998
REASONS FOR JUDGMENT BY: DÉCARY J.A.
Date: 19981030
Docket: A-981-96, A-982-96
CORAM: DÉCARY J.A.
LÉTOURNEAU J.A.
CHEVALIER D.J.A.
IN THE MATTER OF an Appeal from the Tax Court of Canada
A-981-96
BETWEEN:
PETER ALAN KUHLMANN
Appellant
(Plaintiff)
AND
HER MAJESTY THE QUEEN
Respondent
(Defendant)
A-982-96
BETWEEN:
RUTH EDITH KUHLMANN
Appellant
(Plaintiff)
AND
HER MAJESTY THE QUEEN
Respondent
REASONS FOR JUDGMENT
DÉCARY J.A.
[1] This is another of those cases which involve, to use the words of my brother Robertson in Canada v. Donnelly, [1998] 1 F.C. 513 at 517 (leave to appeal denied by the Supreme Court of Canada, S.C.C. 26371), "taxpayers who earn their income in the city and lose it in the country". The decision of the Tax Court Judge is reported at 97 D.T.C. 865.
[2] A novelty in the two appeals before us is that as a result of a last-minute change in the basis of the assessments made by the Minister, it is the Minister who has the burden of proving that the partnership formed by the appellants ("Southern Cross Stables" or "SCS") did not have a reasonable expectation of profit in the four taxation years under appeal, i.e. 1986, 1987, 1988 and 1989. The Minister had originally relied on section 31 of the Income Tax Act (loss from farming) which implies that there is a business and a reasonable expectation of profit.
[3] It is precisely on this question of burden of proof that the Tax Court Judge made in our view a first mistake. He found that the admission by the appellants of their loss history and the entry in the evidence of the financial statements of SCS from 1984 to 1994 inclusive were sufficient to "make a prima facie case for the respondent". This conclusion, as this Court recently decided in Watt v. Minister of National Revenue, [1997], 220 N.R. 47 (F.C.A.), does not find support in the jurisprudence.
[4] The facts are not really in dispute. The two appellants are husband and wife. They are both medical doctors. Neither of them rides horses but both have developed a keen interest in horses and more particularly in English riding (show jumping, dressage, three-day eventing, endurance, vaulting and combined driving). The circumstances in which they started what they allege to be a business were described as follows by the judge at 867, 868:
| [...] |
| It was through the riding lessons of Ruth and the two older children in 1983 that the Appellants got the idea of establishing their own facility for English riding. The arena where they took their lessons was an old building; it was drafty, very dusty and cold in the winter. Also, it was located at the west end of Windsor when most of the potential clientele for riding lessons lived at the east end of the City. Ruth concluded that it was difficult to do English riding in Windsor because the facilities were inadequate and at the wrong end of the City. The Appellants reviewed the situation and decided that a new English riding school would be successful at the east end of the City because it would be close to potential customers and Windsor is an affluent industrial city. |
| [...] |
| Early in 1984, the Appellants found 26 acres of land for sale just outside the eastern limits of Windsor. They caused CMS Inc. to purchase the land for $130,000. They tiled the whole property to achieve proper drainage, and then contracted for the construction of a stable/arena building. Exhibit A-21 is a series of 15 photographs of the property featuring the building. In addition to the stalls for 22 horses, there was an enclosed arena where riding lessons could be given through the winter and other times of bad weather. The Appellants put a great deal of thought into the design of this building with respect to the storage of hay, the removal of manure and two extra stalls for washing horses to ensure that the care of the horses would not be labour intensive. When the facility was completed at the end of 1984, CMS Inc. had invested $360,000 including the costs of the land, the tiling for drainage, the parking area and the stable/arena building. Over the next four to five years, the company invested another $100,00 in fences and run-in sheds. |
| (n.b.: CMS Inc. is a company incorporated by the appellants which purchased land in Windsor and constructed the office building in which they carry on their medical practice.) |
| [...] |
| The SCS operation had two quite different divisions. One could be called "lessons and boarding" and the other "horse development". In the lessons and boarding division, SCS would earn fees by providing lessons for those persons (adults and children) who wanted to learn English riding, and would earn other fees by boarding (feeding and caring for) horses which belonged to individuals who did not own a stable facility. |
| [...] |
| The horse development division was intended to acquire young horses of higher quality than the "school" horses and develop them to the stage where they could compete on the "A" Circuit. Mr. Millar (an expert witness) described the three stages of training as follows. Basic training gives a horse the skills of obedience; how to walk, trot, canter, do a small course of jumps and be ready for local competitions. Intermediate training brings a horse to the level where it can compete in a series of competitions thought Canada rated by the national federation and known as the "A" Circuit. The top end of the sport is Grand Prix Jumping or Grand Prix Dressage which is international competition. In terms of a horse's age, basic training may take from age three to five or six. Intermediate training may take from age five or six to age eight or nine. And depending of the horse's ability, grand prix or international competition may go from age eight or nine to age 15 or 16. The Appellants' business plan was based on the premise that training adds value. If they could buy good quality horses at a young age and develop them through basic and intermediate training to compete effectively on the "A" Circuit, they expected to sell those horses at a good profit. |
[5] In order to reach the decision that the Minister had satisfied the burden that was his, the judge essentially considered the following factors:
| a) "one of the dominant facts in these appeals is Peter (Kuhlmann)'s love of horses from his early youth" (at 869); |
| b) "the appellants' love of horses and their determination to be known on the "A" Circuit (i.e. beyond the Windsor area) blinded their judgment and caused them to move forward where dispassionate business persons not in love with their "product" (i.e. horses) would have retrenched or changed directions. I will describe three specific situations when the objective business judgment of the Appellants was subordinated to their motive, as horse enthusiasts, to become known on the "A" Circuit as the owner of a good quality riding stable. |
| "The first situation was a decision in 1986 to send certain development horses to Toronto"... (at 869); |
| "The second situation ... was their purchase of three expensive horses" (at 872), one in 1989 and two in 1990; |
| "The third situation ... was their decision to send certain horses to Ian Millar for training" (at 873) in August, 1990; |
[6] In relying on these factors the way he did, the judge erred, in our view, in his interpretation and application of the concept of "reasonable expectation of profit" as developed by the jurisprudence.
[7] He erred in giving to the "personal element" factor in this concept a breadth wider than that contemplated by the case law. Much more is required than one's love for one's work to attract the scrutiny mandated by Tonn v. Canada, [1996] 2 F.C. 73 (F.C.A.) where a "personal element is in evidence" (at 103). The test has been described as follows by Mahoney J. (as he then was) in The Queen v. Matthews, [1974] 74 D.T.C. 6193, at 6196:
| I am satisfied that the Defendant was carrying on the "tree farming" operations on both properties during 1969 as a business and not merely pursuing a hobby or avocation in a businesslike way. The mere fact that a person enjoys a business activity, as the Defendant undoubtedly enjoys his forestry, or incidentally derives pleasure from a personal activity on a business property, as the Defendant no doubt does when he walks or rides about the North Gwillimbury property, does not per se alter the "business" nature of either the property or the activity. On the basis of the evidence before me, I cannot find that the defendant's "tree farm" operation on either property was a mere sham or device. I think it most unlikely that he would be engaged in "tree farming" if it were not for his abiding interest in forestry but I am convinced that he is bona fide engaged in it as a business, in the ordinary sense of that word, with the intention that it be profitable. |
[8] In Tonn (supra, at 99), Linden J.A. spoke in terms of "element of personal benefit". He explained, at 105, that
| "By personal satisfaction, of course, I mean that the rental operation had neither a hobby nor a personal benefit element about it. The taxpayers purchased the property as a form of business investment. It was not a residence for them. It was not a future retirement home in some balmy southern climate. Neither was it a residence for children or other relations. It was a residential property purchased for commercial purposes. There was nothing suspicious about it. |
[9] In Watt, supra, this Court reminded, at 49, that "a personal element may coexist with a profit motive".
[10] The appellants, clearly, loved horses. They, clearly, chose to get involved in horsing activities because they loved horses. This "love" factor, assuming the other required factors are present, cannot be held against them. Quite to the contrary, it would appear in the instant case that the fact that Peter Kuhlmann has loved horses from his early youth and was heavily involved with his father in horse racing, selecting and training, qualifies him even more as a competent entrepreneur in the horse industry.
[11] In addition, the judge erred when he focussed almost exclusively on the amount of the expenses involved as if he was engaging in an exercise relating to the examination of the reasonability of expenses under section 67 of the Act. Instead, he should have looked more carefully at the essential elements and attributes of the activity at issue, such as the amount of capitalization, the appellant's experience and intended course of action, the professionalism of the work accomplished and the slow but constant movement towards the making of profits. It is indeed remarkable that the judge was unable to identify any defect or weakness in the appellants' original business plan or in their selection of instructors and horses.
[12] The judge also erred in second-guessing the business decisions made by the appellants. This Court, in Tonn (supra) and in A.G. Canada v. Mastri [1997] 97 D.T.C. 5420 (F.C.A.), cautioned judges against using the benefit of hindsight to question business decisions that could have made sense at the time they were made. In the instant case, the judge was much too quick, whenever business decisions made by the appellants did not turn out to be successful, to conclude that such decisions had been dictated by a "personal element" which he identified as love for horses. Of the three situations he described that led him to conclude that the appellants were guided more by their passion for horses than by a realistic desire to make profits, only the first one could be related in full to the years at issue. This is not a case where there were so many questionable business calls from the inception and throughout the years as to put in doubt the legitimacy of the expectation of profit. The judge erred, on the facts of this case, in relying on decisions made in late 1989 and in 1990 -- even if one were to assume that these were questionable decisions -- to deny any reasonable expectation of profit during the years 1986 - 1989.
[13] Furthermore the judge, in second-guessing as he did some judgment calls of the appellants, failed to take into consideration the unavoidable risks which are associated with the horse industry, such as the sudden resignation of the number one trainer, the injuries suffered by horses, the unexpected non-performance of a most promising horse and the exceptional death of a horse from cancer. In a perfect world the appellants might have made some profit earlier, although this is not the test that has to be met. In the imperfect and challenging world in which they operated, they nevertheless succeeded in gradually generating some profit, albeit small.
[14] More generally, the judge erred in failing to recognize the particular nature of the activities in which the appellants were involved. The uncontradicted evidence is to the effect that a minimum of five or six years is needed in the best of circumstances for such an activity as that carried by the appellants to earn profit. The four taxation years at issue are part of that period which Linden J.A. in Tonn described as "a grace period for emerging operations" (at 107). It is true that the appellants eventually abandoned their "horse development" division when they realized that it could no longer reasonably be expected to earn profit, but this is precisely the capacity to adapt to changing circumstances that one would expect from a taxpayer in the early stages of potentially profitable operations. The evidence shows that the appellants had to attempt to exploit the two divisions of their operation if there was to be any reasonable hope of profit. The reality is that, within ten years, one division made it to the profit column, that the other one did not and that the one which did it can now have a life of its own. According to Mr. Millar, who testified in 1995, the Southern Cross Stables had acquired "the best reputation in the field of English riding" in the Windsor area. (A.B. vol. 2, at 159). There is evidence on the record that such achievement was due to a considerable degree to the non-profitable portion of the operation which gave the appellants visibility, credibility and respectability.
[15] Both counsel agreed that for an expectation of profit to be reasonable, it had to be not "irrational, absurd and ridiculous". In the case at bar, the burden was on the Minister to establish on a balance of probability that the expectation of profit was irrational, absurd or ridiculous. Clearly, in our view, the Minister did not succeed and the Tax Court Judge could not have found otherwise had he applied the proper legal principles.
[16] The appeal will be allowed with costs here and below, the judgment of the Tax Court of Canada will be set aside and the matter will be referred back to the Minister for reassessments on the basis that the appellants' losses from the Southern Cross Stables partnership should be allowed in full for the appellants' 1986, 1987, 1988 and 1989 taxation years.
Robert Décary
J.A.
FEDERAL COURT OF CANADA
APPEAL DIVISION
Date: 19981030
Docket: A-981-96, A-982-96
IN THE MATTER OF an Appeal
from the Tax Court of Canada
A-981-96
BETWEEN:
PETER ALAN KUHLMANN
Appellant
(Plaintiff)
AND
HER MAJESTY THE QUEEN
Respondent
(Defendant)
A-982-96
BETWEEN:
RUTH EDITH KUHLMANN
Appellant
(Plaintiff)
AND
HER MAJESTY THE QUEEN
Respondent
(Defendant)
REASONS FOR JUDGMENT
FEDERAL COURT OF CANADA
APPEAL DIVISION
NAMES OF COUNSEL AND SOLICITORS OF RECORD
COURT NUMBER: A-981-96, A-982-96
| BETWEEN: PETER ALAN KUHLMANN |
RUTH EDITH KUHLMANN
Appellants
(Plaintiff)
AND
HER MAJESTY THE QUEEN
Respondent
(Defendant)
| PLACE OF HEARING: Montreal (Quebec) |
DATE OF HEARING: October 28th and 30th, 1998
REASONS FOR JUDGMENT OF THE COURT (DÉCARY, J.A., LÉTOURNEAU, J.A. AND CHEVALIER D.J.A.)
RENDERED FROM THE BENCH BY: DÉCARY J.A.
DATED: October 30, 1998
APPEARANCES:
Me Claude Nadeau for the Appellants
Me Margaret Nott
Ms Susan Shaughnessy for the Respondent
SOLICITORS OF RECORD:
LAFLAMME NADEAU
Montréal, Québec for the Appellants
Morris Rosenberg
Deputy Attorney General
of Canada
Ottawa, Ontario for the Respondent
[17]