Tax Court of Canada Judgments

Date: 19990712

Docket: 98-682-IT-I

BETWEEN:

JOHN E. HIRST,

Appellant,

and

HER MAJESTY THE QUEEN,

Respondent.

Reasons for judgment

Sarchuk J.T.C.C.

[1] In computing income for the 1994, 1995 and 1996 taxation years, the Appellant deducted the amounts of $8,937, $7,354 and $3,802, respectively, as business losses. In assessing, the Minister of National Revenue (Minister) disallowed the deductions on the basis that the Appellant's business activity did not have a reasonable expectation of profit and accordingly, there was no source of income for the purpose of calculating a loss pursuant to subsection 9(2) of the Income Tax Act (the Act).

[2] The Appellant was a full-time employee of North York Hydro until the end of 1995. In or about 1986, in anticipation of his retirement he commenced investigating the possibility of embarking on a boat charter business. He conducted several years of research prior to purchasing a 20-foot Starcraft in November 1989. He then spent 1990 and 1991 outfitting the boat and learning the charter fishing trade on Lake Ontario. The nature of the business contemplated was the rental of the cabin cruiser to sport fishermen on Lake Ontario during the fishing season from April through September of each year. In 1992, confident he could succeed, he commenced a business activity known as Dad's Dream Fishing Team. His initial decision to become involved was based in part on the existence of a number of salmon and other fishing derbies which drew substantial customers.

[3] It is not disputed that the Appellant has not made a profit from this activity since its inception. His reported sales and losses for the 1992 to 1996 taxation years were:

Year	Sales	Loss
1992	$3,095	($12,154)
1993	$2,765	($16,048)
1994	$3,730	($8,937)
1995	$1,825	($7,354)
1996	$748	($3,802)

[4] In the 1994, 1995 and 1996 taxation years, the Appellant reported gross sales of $3,730, $1,825 and $748, respectively, and gross profit of $2,530, $1,825 and $748, respectively. In these same taxation years, the Appellant claimed expenses and capital cost allowance of $11,467, $9,174 and $4,550, respectively, resulting in the losses shown in the table previously referred to.

[5] The Appellant testified that in the course of his research into the viability of this project, he spoke to a number of charter boat operators carrying on business on Lake Ontario. He concluded that four charters per week (being four paying customers at $75 each for a total charter fee of $300) would produce over the course of a fishing season, a profit in his fourth or fifth year of operation. His analysis of the information obtained from other operators was that "busy boats were doing two charters a day, three to four days a week" from which he concluded that there was no reason why he would not be able to achieve the same volume. Based on these "projections" it was his objective to reach the break-even point by 1994 and to show a profit by 1995. When that point was reached he proposed to take early retirement and devote his full time to the fishing business.

[6] In practice, he discovered that although there was an increase in the number of customers in 1992 and 1993, that did not translate into an effective increase in gross sales. He concluded that this resulted, at least in part, from the fact that he had chosen to operate charters at the far western end of Lake Ontario which, although fully booked, barely met expenses.

[7] In 1994, one of the largest attractions for fishermen, the Toronto Salmon Hunt, ceased to operate and was replaced by the City of Scarborough Derby. The latter folded in 1995 resulting in a further dramatic decline in charters. This was so notwithstanding the Appellant's success in producing derby winners and his reasonable prices. He testified that no major derbies were scheduled for 1996 and that as a result, he spoke to his accountant and, since he was not earning any profit, discussed the possibility of abandoning the business. The accountant suggested that he continue, advising the Appellant that he need not have any concern with respect to Revenue Canada since they would give him "five years to make a profit". To his dismay, the Appellant followed this advice. In 1997, Revenue Canada performed an audit of his 1996 taxation year which ultimately led to the reassessments in issue. At that point of time he says he abandoned the business completely.

Conclusion

[8] At issue in these appeals is the right of this Appellant to deduct for tax purposes his business losses from other income pursuant to the provisions of the Income Tax Act. Paragraphs 18(1)(a) and (h) of the Act provides:

18(1) In computing the income of a taxpayer from a business or property no deduction shall be made in respect of

(a) an outlay or expense 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 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;

In Moldowan v. The Queen,[1] the Supreme Court of Canada decided that in order to have a source of income a taxpayer must have a reasonable expectation of profit and that "whether a taxpayer has a reasonable expectation of profit is an objective determination to be made from all of the facts". If as a matter of fact a taxpayer is found not to have a reasonable expectation of profit, then there is no source of income and, therefore, no basis upon which the taxpayer is able to calculate a loss. In the same case, Dickson J. also observed that

There is a vast case literature of what reasonable expectation of profit means and it is by no means entirely consistent. In my view, 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, the taxpayer's training, the taxpayer's intended course of action, the capability of the venture as capitalized to show a profit after charging capital cost allowance. The list is not intended to be exhaustive.

Obviously in each case the factors will differ depending on the nature and extent of the undertaking. The proof necessary to establish the existence of a reasonable expectation of profit goes beyond the declared intentions of a taxpayer, even given under oath. Such statements, of course, cannot be ignored, but all of the facts surrounding the business, its earning potential, the carrying charges, the previous earning history and so forth must be such as to satisfy an objective observer that a profit can reasonably be expected to flow from the venture.

[9] Counsel for the Respondent argued that the Appellant's projection of income and expenses was grossly inadequate and was not what would be expected of someone commencing a business enterprise. This failure was put forward as evidence that the Appellant did not have a reasonable expectation of profit and that accordingly, the deduction should be disallowed.

[10] In Tonn et al v. The Queen,[2] Linden J.A. speaking for the Court said at page 6013:

Though I do not support the use in the Nichol case of the word "patently", I otherwise agree that the Moldowan test should be applied sparingly where the taxpayer's "business judgment" is involved, where no personal element is in evidence, and where the extent of the deductions claimed are not on their face questionable.

In my view, although the Appellant might have benefited from enlisting the assistance of a professional to perform an analysis of the potential of his proposed venture, it is clear that losses from bona fide businesses should not be disallowed solely because the taxpayer made a bad judgment call. As was observed by Linden J.A.:[3]

The tax system has every interest in investigating the bona fides of a taxpayer's dealings in certain situations, but it should not discourage, or penalize, honest but erroneous business decisions. The tax system does not tax on the basis of a taxpayer's business acumen, with deductions extended to the wise and withheld from the foolish. Rather, the Act taxes on the basis of the economic situation of a taxpayer – as it is in fact, and not as it should be, subject to what is said below.

Insofar as his intention with respect to the profit-making potential of the charter business, I am not prepared to accept the Respondent's position that it was unrealistic and that expectation unreasonable. In the present case, it must be noted that by 1992 when he began the charter boat business, the Appellant had paid off the full purchase cost of the boat in the amount of $16,000. As well, the truck acquired in 1991 for $24,000 to haul the boat was not purchased with borrowed monies.[4] I am satisfied on the evidence that this Appellant's intention to produce profit may reasonably be inferred from the circumstances.

[11] Furthermore, I am unable to accept the Respondent's position that there was a strong personal element involved. While the Appellant no doubt derived a certain degree of personal satisfaction when his charter clients successfully competed in the derbies this does not by itself support the Respondent's position that the impugned activity had a strong personal element. Nor can I conclude that his desire for profit from this venture was no more than a "fanciful dream". Last, there is no evidence that by embarking on this business, the Appellant was merely seeking a tax subsidy by deducting the cost of what was in reality a personal expenditure.

[12] In this case, certain circumstances beyond the Appellant's control are relevant and must be given consideration. It is significant that at the conclusion of 1995, given the cancellation of a number of major fishing derbies and tournaments, he himself concluded that the business was no longer worth pursuing. Indeed, he spoke to his accountant with respect to continuing through the 1996 year and did so only because of what I consider to be extremely poor advice. In Kuhlman et al v. The Queen,[5] the Federal Court of Appeal pointed out that a taxpayer is able to establish a reasonable expectation of profit by showing that such expectation is "not irrational, absurd and ridiculous". While I would not necessarily subscribe to the choice of words, I do conclude that this Appellant's expectation of earning profits was rational and not unreasonable.

[13] I believe that this Appellant was entitled to a reasonable time to establish the profitability of the operation. However, on the evidence, I have concluded that the Appellant should only be permitted to deduct his losses with respect to the 1994 and 1995 taxation years. I reach this conclusion because for all intents and purposes, he had abandoned the business in 1996.

Signed at Toronto, Ontario, this 12th day of July, 1999.

"A.A. Sarchuk"

J.T.C.C.

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