Date: 19981127
Docket: 97-3415-IT-I
BETWEEN:
MARK CROWSHAW,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
Reasons for Judgment
Somers, D.J.T.C.C.
[1] This is an appeal pursuant to the informal procedure for the 1994 and 1995 taxation years. The issue is whether the expenses claimed were incurred by the Appellant or, if incurred, were for the purpose of gaining or producing income from a business or property.
[2] In reassessing the Appellant, the Minister of National Revenue (the "Minister") made the following assumptions of facts which were admitted, denied or ignored by the Appellant:
"(a) all facts hereinbefore admitted and stated;
(b) at all relevant times, the Appellant was a full-time employee of Bell Canada; (admitted)
(c) for the 1994 and 1995 taxation years, the Appellant reported sales revenue and expenses from the alleged business activity involving technical illustrations and business art and design (the "Activity"), as set out in Exhibit "A" and Exhibit "B" attached hereto; (ignored)
(d) in the 1994 and 1995 taxation years, the Appellant did not maintain proper records for the Activity and failed to substantiate most of the claimed expenses, as shown in Exhibit "A" and Exhibit "B" attached hereto; (ignored)
(e) for the 1994 and 1994 [sic] taxation years, the Appellant reported in respect of the Activity only minimal sales in the amounts of $645 and $694, respectively, made to unidentified clients; (denied)
(f) the expenses claimed by the Appellant for the 1995 taxation year, included the cost of a cellular phone, video equipment, household and home-repair items, personal meals and parking, and other personal items to a total amount of $1,552, as shown in Exhibit "B" attached hereto; (admitted)
(g) the claimed expenses were not made or incurred by the Appellant, or if made or incurred, were not made or incurred for the purpose of gaining or producing income; (denied)
(h) the Appellant did not have a reasonable expectation of profit from the Activity during the 1994 and 1995 taxation years; (denied)
(i) the expenses claimed in respect of the Activity were personal or living expenses of the Appellant." (denied)
[3] The Appellant, a full-time employee of Bell Canada during the periods in question, decided to operate a business involving technical illustrations and business art and design. He attended school in preparation for this type of business.
[4] In setting up his business, he consulted an accountant who registered his business. According to the Appellant his intentions were to go into a commercial venture and not with the purpose of enjoying a hobby. At the end of the year he gave the accountant the receipts to prove the expenses.
[5] The Appellant did not have a plan as to the profitability of the business. There was no projection as to the expenses to be incurred throughout each year. He stated that he was satisfied to earn $500 per year in order to establish a certain credibility with the public. If he succeeded, he was ready to leave his job with Bell Canada, which paid $26,000 to $27,000 per year, to totally devote himself to his business.
[6] As shown in Exhibit A attached to the Reply to the Notice of Appeal, the Appellant claimed a gross profit of $453.91 and claimed expenses totalling $2,542.06 for a net loss of $2,088.15 for the 1994 taxation year. No receipts, journal or banking records were provided to verify the sales amount; only two copies of sales receipts were provided to substantiate the sales. No receipts were provided to substantiate the expenses. The Appellant claimed the amount of $2,000 for salaries. There was no proper receipt or proof of payment and the expense cannot be matched to any sales receipt.
[7] As it appears in Exhibit B attached to the Reply to the Notice of Appeal, the Appellant claimed, for the taxation year 1995, a gross profit of $375.18 and claimed expenses in the amount of $3,167.39 for a net loss of $2,792.21. The type of expenses for the 1995 taxation year varied from the expenses claimed in 1994: the Appellant did not claim salary expenses in 1995 and his automobile expenses amounted to $1,594.53.
[8] Again no receipts, journal or banking records were provided for the 1995 taxation year to verify the sales amount. Only four copies of sales receipts at irregular intervals were provided to substantiate the sales amount. Expenditures included video purchases, home repair items, other household items, single meals for personal consumption, personal parking receipts and cellular phone.
[9] The Appellant attempted to explain certain expenses even though they were not entered into a ledger. The only proof of the expenditures is that he remembered them. For the taxation year 1994, the Appellant reported sales in the amount of $645.02 and vouched for $650.00. In 1995 he reported sales in the amount of $694.13 and vouched for $615.00. In 1994 he had two sales, producing a revenue of $650.00. He named the clients and explained the nature of the work. On another occasion he had a job for Miss Pollard, who resided in Scarborough, and the return from that job was $250.00; however he had to cover certain expenses and he stated he made a profit of $50.00 on that particular job.
[10] The Appeals Officer for Revenue Canada stated that some receipts were supplied by the Appellant; however there were no vouchers for the majority of the claims. Some of the expenses were personal, there were meal receipts not over $80.00 and these amounts led him to conclude that the expenses were not associated to the business. In the final analysis, the Appeals Officer concluded that the losses were disallowed because the Appellant did not operate a viable business; in fact the Appellant discontinued his business in 1995.
[11] In reassessing the Appellant, the Minister relied on sections 3, 9 and 67, on subsection 248(1) and paragraphs 18(1)(a) and 18(1)(h) of the Income Tax Act which read as follows:
"SECTION 18: General limitations.
(1) In computing the income of a taxpayer from a business or property no deduction shall be made in respect of
(a) General limitation – an outlay or expenses except to the extent that it was made or incurred by the taxpayer for the purpose of gaining or producing income from the business or property;
...
(h) Personal and living expenses – personal or living expenses of the taxpayer, other than travel expenses incurred by the taxpayer while away from home in the course of carrying on the taxpayer's business;
SECTION 67: General limitation re expenses.
In computing income, no deduction shall be made in respect of an outlay or expense in respect of which any amount is otherwise deductible under this Act, except to the extent that the outlay or expense was reasonable in the circumstances."
[12] The first issue to address is the possibility of a reasonable expectation of profit in operating the business, pursuant to paragraph 18(1)(a) of the Income Tax Act.
[13] In the case of Tonn v. R., 96 DTC 6001, Justice Linden of the Federal Court of Appeal stated the following:
"I am now ready to decide this case. A variety of factors have been proposed over the years by which objective reasonability might be demonstrated in given circumstances. In the original Moldowan decision, these factors were enumerated as follows:
The following criteria should be considered: the profit and loss experience in past years, the taxpayer's training, the taxpayer's intended course of action, the capability of the venture as capitalized to show a profit after capital cost allowance. The list is not intended to be exhaustive.
Another listing of the factors to be assessed was set out in Sipley v. R.:
The objective test includes an examination of profit and loss experience over past years, also an examination of the operational plan and the background to the implementation of the operational plan including a planned course of action. The test further includes an examination of the time spent in the activity as well as the background of the taxpayer and the education and experience of the taxpayer.
Finally, Landry v. R. suggests the following items to consider:
Apart from the tests set out by Mr. Justice Dickson, the tests that have been applied in the case law to date in order to determine whether there was a reasonable expectation of profit include the following: the time required to make an activity of this nature profitable, the presence of the necessary ingredients for profits ultimately to be earned, the profit and loss situation for the years subsequent to the years in issue, the number of consecutive years during which losses were incurred, the increase in expenses and decrease in expenses in the course of the relevant periods, the persistence of the factors causing the losses, the absence of planning, and the failure to adjust..."
[14] In the appeal before this Court, the Appellant did not have from the outset a general plan allowing him to project a reasonable expectation of profit. He had a full-time employment, therefore the time devoted to the business was rather limited. He was not able to determine the costs on each sale he made; on one particular job he made a profit of approximately $50. Even though the Appellant had some technical training, that as such was not sufficient to enter into such a business venture without determining if he could reasonably expect to succeed. He admitted that at the beginning he did not know the amount of the expenses involved.
[15] It appears from the exhibits and the Reply to the Notice of Appeal that the expenses were different in nature. In 1994, he claimed expenses for advertising, promotion, interest bank charges and in particular the sum of $2,000 for salaries. In 1995, he claimed automobile expenses, office expenses (cellular phone), meals and entertainment and travel expenses. Forcasting expenditures is an essential element to determine if there was a reasonable expectation of profit. He did not give any indication as to the need for such a business. His intentions might have been sincere but he had to have some assurance that he could succeed. The revenues generated during the two years in question were very minimal. The Appellant realized his dreams were flawed since he discontinued his business in 1995.
[16] The Appellant is not allowed to deduct his personal and living expenses pursuant to paragraph 18(1)(h) of the Income Tax Act. The Appellant admitted that he claimed, for the 1995 taxation year, expenses for a cellular phone, video equipment, household and home-repair items, personal meals and other personal items for a total amount of $1,552. He used his car for business as well as for personal use. He claimed he travelled 6,500 kilometres in the taxation year to earn income. He was rather vague as to how he could account for travelling that much, considering the minimal revenue generated.
[17] As set out in section 67 of the Income Tax Act, a taxpayer's right to deduct expenses in the operation of his business is limited. In the case of Mohammad v. R., [1997] 3 C.T.C. 321, Robertson, J.A., of the Federal Court of Appeal stated:
"...This part of my analysis begins with the wording of section 67 of the Act:
In computing income, no deduction shall be made in respect of an outlay or expense in respect of which any amount is otherwise deductible under this Act, except to the extent that the outlay or expense was reasonable in the circumstances.
It is important to recognize that section 67 does not deal with the issue of deductibility per se but rather with the reasonableness of an expense which is otherwise deductible under the provisions of the Act. The effect of that provision is to limit the extent to which an expense is deductible, that is to an amount which is "reasonable in the circumstances":..."
[18] Robertson, J.A. added the following in his decision:
"I concede that there will be instances where the objective component will be difficult to isolate and, therefore, practical experience informed by commonsense will have to prevail. Such is true in respect of those expenses deemed to be unreasonable because they are believed to be excessive or extravagant:...".
[19] The quantum is a factor in evaluating the reasonableness. The net losses for the 1994 and 1995 taxation years were of $2,088.15 and $2,792.21 respectively and the sales for those two years were in the amounts of $645.02 and $694.13. However, these amounts must be considered in the light that the Appellant did not establish at the outset of the operation of his business that there was a reasonable expectation of profit. In his testimony he had difficulty explaining these expenses and admitted he could not establish the costs involved in each job.
[20] Considering all of the evidence and the various aspects of the operation of the business, the Appellant did not establish that he had a viable business operation.
[21] The appeal is dismissed.
Signed at Ottawa, Canada, this 27th day of November 1998.
"J.F. Somers"
D.J.T.C.C.