Date: 20020919
Docket: 2001-4326-IT-I
BETWEEN:
MICHAEL T. KING,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
__________________________________________________________________
For the Appellant: The Appellant himself
Counsel for the Respondent: Cecil Woon
____________________________________________________________________
Reasons for Judgment
(Delivered orally from the Bench at Saint John, New Brunswick,
on Wednesday, May 8, 2002 and revised as to style and syntax at
Ottawa, Canada on September 18, 2002)
Margeson, J.T.C.C.
[1] The matter before the Court for decision at this time is that of Michael T. King and Her Majesty the Queen, 2001-4326(IT)I, under the Informal Procedure of the Income Tax Act ("Act").
[2] There are two questions before the Court at this time and those are: 1) Whether or not during the years 1997, 1998, and 1999, the taxation years in issue, the Appellant had a reasonable expectation of profit from his roofing business; and 2) If there was a reasonable expectation of profit ("REOP") from the business, was the Appellant entitled to deduct any amounts greater than $1,475.37 in 1997; $4,019.57 in 1998 and $4,630.51 in 1999, which were the amounts the Minister said were related to the operation of an enterprise or a business if it were so found to be so during those years.
[3] The Minister's position was that there was no REOP in the years in question, therefore, none of the expenses can be allowed.
[4] The Minister alternatively argued that if there was a business then the expenses could not be deducted because they were personal or living expenses.
[5] The Court congratulates Mr. King for the way that he conducted this case. He showed quite a bit of insight into the question of REOP. He did as well as one could expect him to do under the circumstances and certainly as good as many representatives might do for him if they had conducted the case in his stead. He showed a great deal of knowledge of some of the cases that have been referred to. The Court was quite impressed by the command that he seemed to have of those cases.
[6] On the other hand, counsel for the Respondent was also very fair and complete in presenting his arguments in this case. I thank the witness called by the Respondent.
[7] Unfortunately, the relationship between the Appellant, the auditor and possibly Canada Customs and Revenue Agency ("CCRA") were not all that they might have been but the Court has no great difficulty with the way that he was treated. Some of the difficulties that arose were partly of his own making.
[8] The Appellant said that when he was a teenager his father influenced him considerably in the roofing trade. He worked for building contractors, did quite a bit of work in this trade and learned roofing as a trade. This helped him work his way through college and he spent two years at the University of New Brunswick, on the Saint John campus.
[9] In 1982 he entered the police academy and during the period in question was a full-time policeman. He worked his days off as a roofer.
[10] In 1986 the schedule that he had as a policeman was four days on and four days off and with that he concluded that he would be able to run a business and so he started this roofing enterprise at that time.
[11] Later on, he registered it as "Ready Roofing". He discussed the financing and advertising with his chartered accountant. He met with a former professor of his at University of New Brunswick, Saint John campus, who advised him that he should not spend too much time and expense on assets and advertising. Word of mouth was the best type of advertisement that he would receive.
[12] He obtained a telephone business line and as a result of that, was able to advertise for one line in the yellow pages and one line in the white pages. He advertised in the newspaper and had other advertisements as well, some of which have been placed before the Court in the form of exhibits, particularly a yellow type of advertisement advertising Ready Roofing found in Exhibit A-1, a door knob type of advertisement. He delivered these to various places and stuck them on the door. It gave the name of the business and some description thereof, i.e. reroofing, new roofs, facia repairs, siding repairs and soffits and invited people to call for a free estimate. He also had letterhead under the name of Ready Roofing. He had two types of business cards, as shown in Exhibit A-1.
[13] He opened a contractor's account and then he obtained a truck. He bought ladders, staging, a compressor, a stripping machine and nailers. He received inquiries as a result of his advertisements. He started to build up a clientele, according to him.
[14] On June 1, 1998 he was helping a friend build a deck but he was hospitalized the next day. He had renal cancer. He was hospitalized for a long period of time and suffered greatly over the years from physical and mental pain. He was taxed physically and mentally, according to his evidence.
[15] He produced Exhibit A-2 which was a doctor's report. The doctor's report itself sets out some of his problems with his health. He had been a patient of Dr. Phillips since 1985 and he said that he had a number of medical problems going back to July of 1988, such as renal cell carcinoma requiring kidney removal; post-operative ulnar nerve palsy; chronic reflux eosaphagitis and duodenal ulcer, a gastroscopy in June 1988 and gastro-intestinal bleeding in 1990. He had more surgery in 1993. He was evaluated as having a dilated cardiomyopathy and possible myocarditis in 1996-1999 and gastro-intestinal bleed in 2000. He had a bicycle accident, concussion and shoulder injury in August 2000 and a motor vehicle accident resulting in a low back injury in March of 2001.
[16] There were a considerable number of medical problems throughout the period that this enterprise operated, between 1987 and 1999. The years in question before the Court are 1997, 1998, and 1999.
[17] In 1991, he decided to be more aggressive in the way that he conducted his enterprise. He wanted to make his business larger, seek out more business clients, commence larger advertisements and ads in the yellow pages and try to obtain more business. He did obtain more business and his losses decreased in 1990 and 1991. They went from $53,083.90 to $31,033.91 but then went back up again starting in 1992 and 1993. They were down in 1994, back up again in 1995, up in 1996, reduced a bit in 1997, up in 1998 and up in 1999. There was basically a continuous period of some 12 years of losses and a period of time during which the gross income did not change very much with the exception of the years 1991, particularly 1992, 1993, 1994 and 1995. Apart from those years the gross income changed very little and there was not a great deal of change in the net income situation no matter what happened to the gross amount of income or the number of clients he had.
[18] In 1992 and 1993, as a result of advertising in the yellow pages, his business increased. In 1992 there was $53,600 of income as a result of building a house but he still had a loss of $6,003.
[19] In 1993 his income was $15,077 although he had $18,747 of income in 1991. In 1992 he decided that a new approach was necessary and that is when he contracted to build the house. This was not profitable because it took too much time away from his roofing business and he did not stay at it.
[20] He registered for Harmonized Sales Tax in 1993 although he did not have to. There was some misunderstanding on his part that once you registered you could not de-register although the exhibit that was placed before the Court from CCRA seemed to indicate that it was possible to de-register once you registered and if you were currently registered you could cancel your registration. If you were a new business or a small business you did not have to report. He felt that he had to continue being registered once he had registered. That was his position.
[21] According to him because he had to deal with the Harmonized Sales Tax, he was less competitive in the marketplace. He had to deal with the underground economy. He would make out estimates for people and give a price including the Harmonized Sales Tax and they received a lower price from someone else in the underground economy and he lost the contract. Before that he believed that he could compete.
[22] He was competing with non-registered workers for cash deals. The economic conditions deteriorated. Many people went into the construction industry because of the fact that there were no other jobs and that affected his bottom line.
[23] Customers did not like the Goods and Services Tax ("GST") and the underground economy was affecting him. There were some discussions with people from CCRA as to the effect of the underground economy and whether it was significant or not. He introduced a document which would seem to indicate that CCRA thought it was a considerable problem. That would have to be one of the considerations that any person contemplating going into business would have to take into account at that time. After a couple of years he was aware of that and that was something that he or anybody else would have to take into account.
[24] In 1999, the last year under appeal, he decided to change. This was 10 years to 12 years after he had started in the business during which losses had been allowed. He decided he had to change. He wanted to obtain jobs from building contractors who were registered for GST so that he would not have to deal with that or contend with it. His conclusion was that he would not have to be involved with the GST and he believed that he would be more competitive.
[25] He was dealing with a major contractor. He foresaw a growth. In 1999 he obtained 14 contracts from McQueen Construction and he had four others. That was the year in which he grossed $14,293 and showed a net loss of $6,063. In 1998 he only had two jobs and he had $5,550 in gross income with a loss of $5,541 overall.
[26] His position was that he could see long-term benefits and that he would obtain many more contracts. The expenses were relatively stable and that meant that if he obtained more work he would make more money and consequently more profit. Expenses were relatively the same. Yet, in 1999 he suffered more health problems and he decided to give up the business.
[27] In cross-examination he said that he was a police officer between 1997 and 1999. He had been a policeman since 1982. The roofing business did fit in with his schedule and allowed him to start the business but that was not the reason he got into it.
[28] He had two years university at the University of New Brunswick, Saint John campus. He took business administration in 1979/80 and 1980/81. He had taken courses in management processing, mathematics, accounting, statistics and some other subject matters. He felt it would be of assistance to him in operating an enterprise.
[29] He had earlier worked at Rupert's Carpentry doing roofing. This company also did roofing, foundations and built homes. He started out when he was 15 years of age. He did roofing mainly as an employee on those occasions. He received instructions at university about running a business and had experience seeing a small business run. His experience in university was from books and lectures. There was no evidence that he had actually run a business or saw any other business run except Rupert's Carpentry with which he was quite familiar.
[30] After this problem arose with respect to the years in question he had an interview with the auditor. He did not remember telling her that he only had a year and a half at university. He started the activity in 1987. His office was in his home. The population of Saint John was about 75,000. He had no idea how many roofing companies there were there but there were a lot of them. There was no evidence about how many roofing jobs needed to be done or what the possibilities were for roofing jobs in that area.
[31] He was asked how he determined that there was a market for his service and he responded that: "There were a lot of roofs and I hoped I would get some of those jobs." He did no studies of the market to determine what the possibilities were or how successful he might be in that regard.
[32] He was asked if he had a business plan and he said that he registered the business. He advertised. He spoke to a professor about advertising and financing. The bank wanted a business plan which he did not have and which he did not want to go through the expense of producing so he did not. He opened up the enterprise without the benefit of a business plan. There was no evidence that he ever had a business plan even when he indicated that he was going to make some changes. Basically he said, "I went out on my experience and hoped I would get my share". That was his evidence.
[33] On April 7, 2002 he met the auditor with respect to the matter before the Court. He was asked if he told her that he had no business plan and he said that he had.
[34] When asked by counsel if he had a contingency plan, he said, "No." He agreed that roofing is a seasonal enterprise for about six months of the year. He usually worked at it when he was on his days off. Sometimes he worked nights when he was also doing roofing work.
[35] With respect to equipment, he had a truck, ladders, staging and planks. He had air nailers or pressure nailers. He bought other equipment: four ladders at $2,000; six jacks at $99 a piece for about $600; 30 roofing brackets about $30 a piece, $900; air nailers, two at $700 each, $1,400; one compressor at $700 to $800; six shelves at $10; two rakes at $10; two brooms at $7; stripping tools four to five for a total of $300; three tarps, $60 to $100 for $300 roughly; roof rack for truck which he said was $400, and planks about $300. That came out to about $7,500.
[36] He bought them himself over a period of time. He bought them as he needed them. During the first year or so he would have bought quite a few and as he went on he had bought more ladders. The truck was the major expense. Other expenses were advertising and telephone.
[37] He did not have any employees. He used subcontractors to do the work and then he paid them first at the market rate. The Court would have to conclude that that was probably a major problem for him.
[38] After losses continued he was asked, "Did you draw up a business plan?" His answer to that was that he advertised and he said, "No, I did not write out a plan."
[39] He introduced Exhibit A-4 which was a newsletter regarding the registration for GST, which the Court referred to already. He believed that once he registered he had to stay registered. It does not appear to have been the case.
[40] He never took any more business courses. When he obtained a business line he received a one-line advertisement in the yellow and white pages as a result of it being a business line.
[41] He also put an ad in the newspaper and that ad was close to the one he put in the yellow pages which he showed in one of the exhibits which he placed before the Court. Sometimes he placed the ad in the newspaper in the spring and the fall. He had no TV and no radio ads.
[42] His position was that one of the big sources of advertisement was the door knockers that he used when he went through the neighbourhoods looking at roofs to see which ones needed work done. He would take one of those door knockers and stick it on the door knob and when the resident saw it they would get his telephone number. If they were interested they would call him and ask for an estimate. The last ad that he placed was in 1995 or 1996.
[43] He had a personal vehicle during this period. He always had two cars and for a while they had three cars. During 1997, 1998 and 1999 they had a Golf Volkswagen motor vehicle. For part of the year they had a Nissan Sentra. During parts of 1997, 1998 and 1999 there was only the truck and the Golf. It was obvious from what he said that he did use the truck that was there for business purposes. There was some personal use of it as well.
[44] The auditor knew that he had a Nissan Sentra and that he had sold it. When he had only the Golf he drove the truck to work and back. He did use the truck for personal use, according to the auditor, about 30 percent of the time.
[45] He did not respond to the letter which the Minister wrote to him, this was Exhibit R-2 which was a letter asking for more information. He had not received the letter the Minister said that he sent. When they spoke to him again about it or contacted him he still did not respond to it. He did not respond to the first letter because he did not have a very good experience with the auditors. That is why he did not respond once he found out they had sent him a letter. He preferred to wait until he came to Court to express his position. He said that the auditor was very argumentative and rude and he did not trust her.
[46] The Respondent called Sandra Clark Bain. She was an auditor with CCRA. She had a Bachelor of Commerce degree in accounting and took accounting through the University of New Brunswick. She has been an auditor since July 1994. She has been with CCRA since its creation in 1987. She did about 20 to 25 reports like the one that she gave in this case. In ten of these she concluded that there was a REOP. That meant that between 30 to 50 percent of the taxpayers were successful before her. She was the auditor in the case at bar. She had two interviews with Mr. King, one on the telephone. She interviewed him on March 3, 2000 and April 2, 2000.
[47] She was referred to Schedule A contained in the Reply to the Notice of Appeal and she testified about it. She does not include in GST the net revenue figure. She explained some changes to the figures and these were accepted by consent. These basically had to do with the way in which the Appellant had filed his returns. There was nothing untoward about them and nothing turns on them but there were some changes in the figures and the way they were accounted for.
[48] When she was calculating whether or not there was a REOP, she added $600 to office expenses to get a more reasonable bottom line. She knew that the Appellant had used an office in his home as he had testified.
[49] Motor vehicle expenses were the highest expense. She wanted to know whether they were reasonable or not. In 1998 the Appellant had two vehicles. She allowed 68 to 70 percent for business purposes. She reduced the 1997 claim by two months so that she allowed about 70 percent and disallowed about 30 percent. In 1999 she reduced six months to four months. In other words, she thought that it was only reasonable to use the vehicle for business purposes for six months.
[50] She saw no evidence of a third vehicle in 1999. She did not know if the Golf was available in 1997 for the whole year. She reduced it by two months during 1997. The claim was for seven months and she allowed five months.
[51] She reached the conclusion that there was no REOP. She was questioned about advertising and she said that she was told that he did not advertise in the yellow pages now but he used to. He had no marketing plan.
[52] She admitted that she had made contact with his wife on March 2, 2000 and left a message for him to call her back which he apparently did.
Argument of the Respondent
[53] In argument, counsel for the Respondent said that the question is whether it was a business with a REOP and if it was, were the losses those which the Minister had allowed as set out in subparagraph (c) of paragraph 7.
[54] Counsel referred to the well-known case of Moldowan v. The Queen, 77 DTC 5213, which is a decision of the Supreme Court of Canada and which is the ruling case and as far as this Court is concerned is still the ruling case on matters of REOP. That case says that you must look at the circumstances objectively to determine whether there is a REOP.
[55] Paragraphs 11 and 12 say that in order to have a source of income you must have a profit or REOP. Source of income thus is an equivalent term to business.
[56] He also referred to paragraph 12 which stated:
...whether a taxpayer has a reasonable expectation of profit is an objective determination to be made from all of the facts. The following criteria should be considered: the profit and loss experience in past years, taxpayer's training, taxpayer's intended course of action, the capability of the venture as capitalized to show a profit after charging capital cost allowance.
It was pointed out that this is not an exhaustive list nor is it intended to be. Factors will be different in each case. Some of them may be present in some cases but they might not all be present.
[57] It is fair to point out that this was a chief source of income case. This is not what we have here but the principles that have been enunciated in Moldowan apply to all REOP cases.
[58] Counsel argued that it is not enough "to have pipe dreams", it is not enough to base your REOP on a dream or a hope when there is no consistent evidence which would objectively allow you to draw such a conclusion. Counsel referred to the case of Tonn v. The Queen, 96 DTC 6001 in support of his position.
[59] Tonn allows that where there is a personal element one must apply the factors more strictly; where there is not then one does not have to apply them as strictly. In any event, one should not be second-guessing a good business decision.
[60] One has to consider the education of the individual concerned and his training for that particular enterprise that he was hoping to operate. He went to university but in studying accounting and principles of business he was not really trained in operating a specific business, certainly not one like this one. He never operated a roofing business before. He never received any specific training in operating a roofing business which is what he was trying to do here.
[61] If one looks at the financial picture disclosed by the Reply to the Notice of Appeal, which is really not contested, throughout the whole period of time between 1987 and 1999 there was a small gross income. The gross income was really not increasing steadily but it was up and down. Between 1997 and 1999 there was no consistent change in it. The only consistent thing about it was that there was always a considerable net loss in relation to the amount of income that was generated.
[62] There was very little capital invested, a little more than $7,500. There was no market study completed. The advertising and promotion were very minimal. A few ads were placed in the yellow pages, some door knockers were used, word of mouth was used, business cards and business letterhead and advertisement in the newspaper. There was no business plan, there was no contingency plan, there was no indication about how many contracts were needed to be able to show a profit, no plan or projection as to how many contracts he could reasonably hope to get in a city the size of Saint John. There was no plan setting out how many other businesses there were, what the competition was like and that the Appellant could reasonably expect to get his fair share of business.
[63] He himself admitted later on that you have to be in business for a considerable period of time to build up a good reputation. Any actions that he did take were not adjustments that would change things around. There was a failure to adjust to real circumstances as there were continuous losses.
[64] Between 1997 and 1999 he switched to subcontracting but admitted that he had to pay the standard rate. This would not enable him to overcome the underground economy. One could not reasonably conclude that he could make a profit.
[65] The reasons that the Appellant gave for explaining the losses were insufficient. He referred to GST as one that created problems for him. Yet he did not have to be registered; he was a small business and due to the income during all the years, at least between 1987 and up to 1992, he did not have $30,000 in gross income. In 1992 he did. There was never another period when there was anything near $30,000. He had $22,811 in 1994. If he believed that he had to be registered and that was causing a problem that was wrong and there was no reasonable explanation given as to why he had the losses during those periods of time.
[66] He did not draw up a business plan after the GST came in. There was no change in his activity that would indicate to him that he could reasonably expect to make a profit.
[67] One has to look at the loss experience in past years as indicated by Moldowan. There were continuous losses whether gross income was up or down.
[68] The nature of the activity did not require a long time for it to be brought to profitability. There were not a great deal of capital assets. One should have been able to make a profit very quickly. One did not need a heavy capital commitment, large capital outlays and the expenses that would be incurred were minimal. These were basically the truck and the supplies but those should have been covered once he got paid for the jobs that he did.
[69] All of the losses were allowed from 1987 up to 1996, and the Minister finally said, "Stop, no more." This was long enough according to counsel to prove that this business was non-viable. The Appellant should have known by that time that he was not going to make a profit at it and he should have got out.
[70] Counsel took the position that there was also a personal element. There was a leased vehicle used for both business and pleasure. He drove it back and forth to work. He claimed some of the expenses which were later re-adjusted by the Minister. There was a personal element as referred to in Tonn. Therefore, the factors set out in Moldowan should be applied strictly.
[71] Counsel also referred to the case of Landry v. Canada, 94 DTC 6499 and said that on that basis alone this case should be dismissed. In that particular case the Court held that the taxpayer acknowledged that he had not changed his method of practice since 1936, occurred loss upon loss and the losses grew each year. He had no plan for operating or for adapting and he had no alternative plan. He made no effort to alter the way of practising which to all appearances had been overtaken by time and his practice was not leading and could not lead anywhere.
[72] It was held that he was unable to show realistically that he could expect to draw income from his professional activities during the period in issue. Counsel referred specifically to paragraph 6 of that case where the Court said:
There comes a time in the life of any business operating at a deficit when the Minister must be able to determine objectively, after giving someone a head start for a number of years, as the case may be, that a reasonable expectation of profit has turned into an impossible dream.
In that particular case the Court was not satisfied that he had done so and so the case was dismissed.
Argument of the Appellant
[73] The Appellant said that he had some problems with the audit process. He referred to the case of Spearing v. The Queen, Court File No. 2000-2106(IT)I at paragraph 29 in that regard and concluded that the Minister in making the audit that she did in the present case went about it the wrong way. She relied on the REOP test to rectify any inappropriate claims. In accepting expense claims, she shifted the focus of examination as to whether an activity is commercial. This was a lazy, unacceptable practice.
[74] Regarding the REOP test, the Appellant said that he was sick, and that had a great deal of effect on him. He encountered many problems. These health problems stopped him from correcting things that were wrong. They stopped him from doing enough work to be able to make it profitable. They interfered with the way that he was going to conduct a business. This was a new event or an extraneous circumstance which prevented him from making a profit even though he might have reasonably expected to do so. He was required to register for GST and that created a problem for him.
[75] The underground economy was a problem for him as well. The auditor said that this was not as bad as everyone thinks, but the document that he put in from the Minister's office shows that it was a problem and it would appear that the underground economy was somewhat of a problem. He said that he had shown where the market was unfair because the underground people could get jobs and charge cheaper prices than he could. They did not have to pay GST and this is one of the reasons why he was not able to make a profit. He was a registrant and non-registrants were in an advantageous position. The auditor ignored this circumstance.
[76] There were other factors that affected growth. He referred to Tonn, and particularly paragraphs 13 and 14. He took the position that what the Minister was doing in the present case as in Tonn was second-guessing and making judgment calls.
[77] The Appellant said that he did not present a plan; he admits that but says that he charges a certain rate, a fee, for his work and that all he had to do was obtain more work. If he received more work his expenses would stay roughly the same and he would have to make a profit. That was his position.
[78] He took the position that that was how he was going to make money in the future by obtaining more work. But when asked where the figures were to support that position, he did not have any. But he said, "If I increased the amount of work, there had to be more profit." That is the position he took. He had no doubt that if he had more jobs he would have a profit.
[79] He referred to the case of André Labrèche v. The Queen, 99 DTC 5083 at paragraph 17 in particular. That paragraph referred to some of the benchmarks that were used for objectively assessing whether to allow or disallow an expense for tax purposes. It referred to a number of consecutive years during which the losses occurred, the time related to make the activity profitable, the time devoted by the taxpayer to the business, the profit and loss situation for the years subsequent to the years in issue; the reasons behind the increase in expenses, the decreases in income during the course of the relevant periods; the persistence of factors causing losses and the presence or absence of adjustment. That is what the case said that one should take into account.
[80] The Appellant said that he had genuine intentions of starting a business to make money but there were unforeseen circumstances and factors that he could not reasonably foresee that prevented him from doing so. He also took the position that he went into it as a business and not as a hobby.
[81] He argued that the Minister did not make a realistic analysis of the income and expense statements for the years in question. The Minister got the cart before the horse. He determined that there was no REOP and then he went back to look at the financial statements to see whether or not there were personal living expenses in it and this is not the way you should do it.
[82] Taking the position that he saw in Labrèche, the Minister gave too much weight to the personal element. In this particular case he said there was not very much of a personal element involved. There was not a sufficient analysis of the statements to come to the conclusion that the Minister did.
[83] He also referred to the case of Tramble v. The Queen, [2001] T.C.J. No. 522 (Q.L.), particularly at paragraph 17. This was a decision by Bowman A.C.J.T.C. in which he criticizes the way that the Minister sets up the Reply to the Notice of Appeal. He says the real question that should be asked is whether or not there is truly a business. That is a more meaningful way of looking at it.
...It is the inherent commerciality of the enterprise, revealed in its organization, that makes it a business. Subjective intention to make money, while a factor, is not determinative, although its absence may militate against the assertion that an activity is a business.
Those are all the factors which the Court has to take into account and will take into account in deciding whether or not there is a REOP.
[84] This Court agrees basically with what that Court had to say.
[85] The Appellant said that the Court should consider the nature of this trade and how long it takes to make it profitable. He did not agree with the Respondent that this enterprise required little capital and that it should be able to adapt over a short period of time.
[86] There is a profit that can be reached after one obtains more jobs. If he obtained more jobs he could make more profit.
[87] He referred to the case of Shaughnessy v. The Queen, 2002 DTC 1272. The Appellant stated that Bowman, A.C.J.T.C. in Shaughnessy, sets out all of the different matters that the Court should take into account in deciding whether or not there is a REOP. He says that the Minister in the case at bar did not consider that there was no personal element except the truck. Yet, the truck was not substantial. Further, he argues that the REOP test should be applied sparingly; there should not be second-guessing; the fact that the business or the property is 100 percent financed is not in itself reason for applying the REOP principle; a reasonable period of time to get the business going must be considered. One should not just blindly refer to the REOP principle and one should not substitute it for a clear analysis of the facts in any given case. For the expectation of profit to be reasonable, it must not be irrational and ridiculous. The fact that an investment or a business is motivated in part by tax consideration is not relevant in determining whether or not there is a business, nor is tax motivation itself relevant in determining deductibility of expenses.
[88] The initial question, where losses are claimed, is whether they are personal or living expenses. If they are not, the REOP test must be applied with extreme care and the question becomes "Is there a business?" It is back to that concept, "Is there a business?"
[89] The Court has no problem with asking that question. That is another way of putting it. It is not much different than asking, is there a REOP, because Moldowan says that there cannot be a business unless there is a REOP.
[90] According to Bowman, A.C.J.T.C. when to start a business and when to abandon a business are business decisions and the Appellant suggested that one should not be too quick in refusing to accept the businessman's decision. That is what it is. It should be treated with great respect.
[91] But at the same time Bowman A.C.J.T.C. says that you have to give weight to the principle that enough is enough. There comes a time when the business or enterprise is not going to be profitable and you have to abandon it.
[92] Then Bowman A.C.J.T.C. went on to decide that in that case there was no personal element involved and second-guessing of the Appellant was what the Minister was doing. The property was not fully financed and there was not enough analysis of the financial situation. There was merely a chanting of REOP. He found that there was nothing irrational or absurd and ridiculous about expecting a profit in the circumstances that he saw there. The Appellant put a considerable amount of his own money into it. There were no personal or living expenses. It was not unreasonable that the expenses be allowed. The Appellant, over a 10-year period acquired an increasingly larger interest in the property that was in issue.
[93] This Court takes no issue with that reasoning but in applying such reasoning one must look at the facts in any particular case.
[94] In accordance with Tonn, you should not be second-guessing the taxpayer or businessman, but at the same time just because the businessman makes what he calls a business decision this Court is not bound to accept that as a good business decision because it could very well be very wrong.
[95] There has to be a reasonable time to establish the business. The Appellant argued that. One must take into account exceptional factors. The Appellant says the Minister did not do that here.
[96] He says that the principles enunciated by Bowman A.C.J.T.C. were not applied by the Minister to the situation at bar.
[97] Anything that the Appellant did here was not irrational, it was not absurd or ridiculous to expect a profit, and the business judgment that he made to proceed should be looked at with great respect. He looked at the circumstances and he concluded as a businessman that he could make a profit providing that he got more work down the road.
[98] In conclusion, he said that the Court should look at the type of business, decide on the commerciality test, was it a commercial business, was it entered into for the purposes of making a profit, and when the Court does so and considers what he had to say, the Court should conclude that there was a REOP.
Analysis and Decision
[99] The Court has already said what the issues are. The first issue is, was there a REOP in the case at bar considering the cases which have been referred to? In this particular case, when one looks at the assumptions contained in the Reply to the Notice of Appeal, very few were disputed. Paragraph 6(c) was denied but the Court is satisfied that the Appellant devoted his days off to the activity together with a bit more of his time.
[100] The Appellant disagreed with the suggestion in (l) that he did not operate the activity in a manner that would reasonably expect it to result in a profit. He disagreed that he did not have a business plan but the Court is satisfied that he did not.
[101] The Court is satisfied that the expenses were directed toward the enterprise, but that is not the same thing as saying that they were expended for the purposes of gaining or producing income from a business because to do that there must be a business.
[102] The Appellant denied the alternative argument in paragraph 7 that the Appellant used his vehicle to drive to and from his place of employment. The Court is satisfied that that has been made out in the case at bar.
[103] Other than that the other assumptions contained in the Reply to the Notice of Appeal were admitted. But again, we have to go to the evidence itself as to what constituted the enterprise.
[104] The Court is satisfied at the end of the day that applying the principles as set out in the cases that are referred to, and giving a reasonable interpretation to the evidence, treating it fairly, that it is the Appellant's job on the balance of probability to establish that there was a REOP in the years in question.
[105] The Court has come to the conclusion that it would not be reasonable for the Appellant to conclude that he could have made a profit in the years in question by any objective test or standard.
[106] The case of A.G. of Canada v. Mastri et al., 97 DTC 5420 was a case that was an appeal from the Tax Court of Canada where the Tax Court Judge had decided that there was no REOP, but in spite of there not being any REOP because there was no personal element involved that the expenses could be deducted. The Federal Court of Appeal in overturning said that:
Tonn did not intend to establish a rule of law to the effect that even though there is no reasonable expectation of profit, losses are deductible from other income sources unless, for example, the income earning activity involved a personal element. The reference in Tonn to the Moldowan test being applied sparingly was intended as a common sense guideline for the Tax Court. "Sparingly" was meant to convey the understanding that in cases where, for example, there is no personal element, the judge should apply the reasonable expectation of profit test less assiduously than if such a factor were present.
That did not mean that the losses are automatically deductible where there is no personal element. This Court certainly agrees with that.
[107] In the case at bar, the Court is satisfied that on the basis of Tonn there was a personal element here. It was not a large personal element, but the Court is satisfied there was a personal element. It was the use of the vehicle for non-business purposes and that has to be taken into account. But even if the Court were to find that there was no personal element and it was required to apply the principles set out in Moldowan less strictly and more leniently, the Court is still satisfied on the basis of the evidence that there was no REOP during the years in question.
[108] One certainly has to look to the financial picture that presented itself during the years in question and one cannot help but go back to that in considering whether or not there was a REOP. Look at the financial picture. From 1997 to 1999 there were continual losses. There was no regular relationship that appeared to exist between the gross income and the losses that were incurred. It was not as though when the number of jobs went up, that the loss was decreased and that was one of the principle basis upon which the Appellant sought to convince the Court today that there was a REOP. He expected that the more jobs that he had, the more income he would have and that there would be a profit at the end of the day sometime after year 2000.
[109] Some years the gross revenue was higher and the net loss was higher. Even in the year when the Appellant had the greatest amount of income, which is the year when he went to build a house producing $53,600 of gross revenue, he still had a $6,003 loss. This was double the loss in the year before, which was even higher than the loss two years before that, equivalent to the loss three years before that, higher than the loss four years before that and double the loss five years before that.
[110] The Appellant's position that he expected to have a larger number of contracts in the future is not founded on the evidence. It was nothing more than wishful thinking or a pious hope that he was going to have those jobs. He did no study that would indicate to him that he would have more jobs and gave no basis for such a belief. He did no study and produced no evidence which would indicate that if he had more jobs the profit would go up and therefore that the profit was directly related to the number of jobs that he had. He had nothing to show when he might expect to make a profit or the number of jobs that he would expect to have on any reasonable basis over a period of time. He did not show that he did anything to correct the problems that existed in the past. As far as the Court is concerned the problem that existed in the past was that there was not enough work.
[111] It is not that he was overspending. It was not that he was claiming a great deal of personal expenses. It was not that his expenses were exorbitant. It is just that he did not have enough income. The only way to get income would be to have more jobs, and he has not shown the Court in any way how he would have more jobs to create more income from which he could make a profit. If he did not do that there was no way that he could expect to make a profit.
[112] Again, the Court has to take cognizance of the principles set out in Moldowan and Tonn, certainly the experience of the business in the past years and what could be expected in future years.
[113] The Court is not saying that the Appellant did not have any training; he certainly had a good knowledge of doing roofing but that was not a significant reason why he did not have a REOP in the years in question. He was trained enough. He could probably do the job; there was no evidence that he could not. But he just did not have the work. Why did he not have the work? He did not have the work because there were other people out there who were able to underbid him successfully because they were on the underground economy. He did not have the work because he was sick part of the time and probably was not able to do much more work.
[114] He did not have the work and therefore more money because of the fact that he did not do any more advertising. He did a minimal amount of advertising. He was not able to compete with the people who were not charging GST. He could have remedied that in part by de-registering, presumably, but he did not do that. He thought that he could not do that but if he had, that certainly would have been of some significance.
[115] He had no business plan to show how he was going to increase his income. He had no contingency plan as to what was going to happen when he was sick. He certainly was sick a significant amount of time during this period. There is no doubt that that had a significant effect on his work. But at the same time he knew from many years before 1997, 1998 and 1999 that he had health problems.
[116] He knew that the GST problem existed. He knew that the problem existed with the underground economy. These were all things that a reasonable businessman would take into account when assessing whether or not there was a REOP. These were not exceptional circumstances, exceptional conditions, new conditions or the but-for conditions. These were not the but-for conditions which would allow the Appellant to make a profit if they had not existed.
[117] These were normal, ordinary problems that all businessmen have to face up to and have to take into account when determining whether or not there is a REOP. Surely long before 1997, 1998 and 1999 the Appellant should have come to the irrebuttable conclusion that unless he changed drastically the way that he was going in operating his business he was not going to make a profit.
[118] Now he says he did change. He changed by going about it in a different way, by going with contractors so that he got away from the problem with GST, and that the second change was going to be that he was going to get more work. But on the first one, the Court is not satisfied that getting in with other contractors was going to give him the work that he needed. He needed to increase the number of jobs to make a profit but there was nothing before the Court to show how many jobs he could reasonably expect to get even though he went with contractors.
[119] With respect to the GST problem, the Court is not satisfied that by going with the contractors he was going to make it any better for him, except that he was not going to be bothered with it. At the end of the day there was no evidence that this would improve the bottom line.
[120] The Court is not satisfied that the Appellant has shown that there were new intervening acts which prevented him from making a profit even though it would have been reasonable for him to expect to make a profit when he started out.
[121] The Court is satisfied that long before the years in question, the Appellant should have reasonably known, as a sound businessman, that he was not going to make a profit unless he did change something drastically. With respect to the changes that he intended to make, the Court is satisfied that they were not sufficient.
[122] He did not draw up a business plan; he did not present any statistics or factors or figures as to how he was intending to make a profit and how much profit he would make in later years.
[123] There was no change in his activity of such a nature that one could reasonably conclude that it was enough of a change so that down the road, however long it would take, that there would be a profit. The Court is unable to see that at the end of the tunnel there was a foreseeable profit.
[124] With respect to the type of activity that the Appellant was involved in, it is true there was not much capital required; there was not a great deal of expenditure involved. He should have been able to know right away each year whether he was going to make a profit or not because he should have been able to calculate just how many jobs he would need in order to make a profit. Those are calculations which should have been readily foreseeable. But the Court is satisfied that the business continued in the same way without having any more work and without having some plan as to how it was going to turn around. The business was doomed to failure long before 1997, 1998 and 1999, and certainly during those years there was no REOP.
[125] The Court is satisfied the Minister gave a considerable leeway in the amount of time the Appellant had in order to turn things around. From 1987 to 1996, over a period of nine years there were considerable losses each year. During all of those years the Minister allowed the losses to be taken. That was certainly more than enough of a start-up period. If it was going to be turned around it certainly should have been able to be turned around before the years in question here.
[126] The Court concludes that the Appellant did not have a REOP in the years in question. The appeal must be dismissed and the Minister's assessment confirmed. That being the case the Court does not have to decide whether or not the losses that were incurred exceeded the amounts allowed the Minister in paragraph 8(b) of the Reply to the Notice of Appeal, but if the Court were required to do that, the Court is satisfied that there was no evidence before it which would satisfy it that the amounts that the Minister found were not the appropriate amounts or correct amounts.
[127] The appeal is dismissed and the Minister's assessment is confirmed.
Signed at Ottawa, Canada this 19th day of September 2002.
"T.E. Margeson"
J.T.C.C.
COURT FILE NO.: 2001-4326(IT)I
STYLE OF CAUSE: Michael T. King and
Her Majesty The Queen
PLACE OF HEARING: Saint John, New Brunswick
DATE OF HEARING: May 8, 2002
REASONS FOR JUDGMENT BY: The Honourable T.E. Margeson
DATE OF REASONS FOR JUDGMENT: September 19, 2002
APPEARANCES:
For the Appellant: The Appellant himself
Counsel for the Respondent: Cecil Woon
COUNSEL OF RECORD:
For the Appellant:
Name:
Firm:
For the Respondent: Morris Rosenberg
Deputy Attorney General of Canada
Ottawa, Canada