Date: 20000814
Docket: 1999-1186-IT-I
BETWEEN:
OLDRICH SCHMUTTERMEIER,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
____________________________________________________________________
Agent for the Appellant: Oldrich Schmuttermeier Sr.
Counsel for the Respondent: Bobby Sood
____________________________________________________________________
Reasons for Judgment
(Delivered orally from the Bench at Toronto, Ontario, on May 25, 2000)
Bowie J.T.C.C.
[1] The Appellant in this case, Oldrich Schmuttermeier, Jr. during the relevant period of time, was employed as a machinist and aircraft assembler at de Havilland Corporation in Toronto. In his spare time, evenings and weekends, he worked on motorcycle engines in what it is claimed in these appeals was his business.
[2] The question that I have to decide is whether it was a business, or whether it was something else, because in filing his income tax returns for the taxation years 1993, 1994, and 1995, the Appellant sought to deduct from the income paid to him by de Havilland the following amounts, which he claimed were business losses sustained by him. The amounts in question are: for the 1993 taxation year, $33,736; for the 1994 taxation year, $3,186.28; and for the 1995 taxation year, $11,934.90.
[3] The Crown's contentions are that there was no business; and if there was a business it had no reasonable expectation of profit; and, finally, it was argued, although not pleaded, that the expenses which went to produce these losses were unreasonable, and should be disallowed pursuant to section 67 of the Income Tax Act. I should say that the evidence was most vague about the nature of the business. The Appellant's Notice of Appeal described it as involving re-machining and re-conditioning motorcycle engines and also fine-tuning, all within the moto-cross racing industry. It is added that in winter the work is done on snowmobiles.
[4] The Appellant's father, Oldrich Schmuttermeier, Sr. appeared as his agent. I heard evidence from Mr. Paul Snider, who described himself as a tax preparer, who prepared the statements of loss that were attached to the three income tax returns for the three years in question. Mr. Snider said quite candidly in his evidence that he prepared these documents in part from sales invoices and receipts that were furnished to him, and in part from information given to him by either the Appellant or his father.
[5] I note that in the statement of net loss for the first year under appeal, 1993, it seems to be obvious -- and Mr. Snider accepted this in his evidence -- that an amount of $3,038 has been deducted twice: once as purchases in computing the cost of sales, and once as an expense. I take this to be an error, and an innocent one on Mr. Snider's part, which he quite willingly accepted when it was pointed out to him. To my mind, nothing turns on that particular error other than the obvious fact that if the Appellant were otherwise entirely successful the loss for 1993 would have to be reduced correspondingly.
[6] In response to a question from me, Mr. Snider said that while he was furnished with various sales invoices and receipts for the years in question from which he worked, there were no books of account kept for this business. Inasmuch as all his information came directly from either the Appellant or his father, Mr. Snider's evidence is not particularly helpful.
[7] I heard evidence next from Oldrich Schmuttermeier, Sr. He has been retired for quite some years, living on a pension in a house which he owns and which has adjacent to it something in the nature of a machine shop which, although it is unheated, I gather is adequate for doing mechanical work, including the machining of parts and the like in connection with automotive and motorcycle engines. He also seems to be skilled to some degree in this type of work. He indicated in his evidence that it was his intention to help his son in building up a business, and I understood him to be saying that the ultimate goal was that his son would someday be able to leave his employment with de Havilland and make his living from this business. He indicated to me as well that he had purchased a lot of machinery and equipment to a value of something like $130,000. By his description, the activity included some work on cars, although I heard no very specific evidence about work on cars. He told me also that in 1991 he, with two other people who I gather were mechanics, was driving to the motorcycle races at Daytona, Florida, and had with him four motorcycles, two of them in a van and two, as I understand it, on the roof of the van, as well as a considerable quantity of tools and equipment and parts. The van was involved in a motor vehicle accident and one of the motorcycles, which he said was worth $40,000 U.S., was severely damaged, and the tools and equipment and parts, or many of them, were lost as a result of the accident. He placed the loss resulting from this accident at $130,000 in total.
[8] He also told me that the work which is said to constitute a business in this case was done at the shop at his house; that he himself, having no other employment, worked at it virtually all day, every day; and did that without pay to assist his son in building up his business. His son worked at it from late afternoon into the evening most days, he said, and all day on weekends. As I understand it, neither of them has ever taken any money out of the business by way of salary or otherwise and indeed, it is difficult to see how they could, given the long succession of losses which have been reported to the Minister of National Revenue. I shall return to those shortly.
[9] The Appellant also gave evidence, and he confirmed his father's evidence, that he had been a motorcycle enthusiast since the early 1980s and that this enthusiasm, as I understand it, had evolved into the activity now characterized as a business. He said that he has raced cars and motorcycles since about 1980, and that he started into this purported business in about 1986. I note that the address of the business as it is shown at the top of the statement prepared by Mr. Snider is the Appellant's apartment on Battleford Road in Mississauga, although the work was in fact actually done at his father's residence at 42 Algie Avenue in Etobicoke.
[10] In the course of his evidence the Appellant accepted as being accurate the history of losses produced by this activity since he began it. The first year, 1987, he reported a loss of $8,873; in 1988, he reported a loss of $7,804; in 1989, $13,175; in 1990, $20,725; in 1991 $18,441; and in 1992, $20,857. As I have earlier said, the amount claimed for 1993 was $33,736 and in light of that history, one might question why the loss claimed for 1994 was a modest $3,186. The answer to that, as it emerged in the evidence was that no business activity whatsoever was carried on during that year, by the admission of both the Appellant and his father.
[11] The Appellant's father apparently was out of the country for five months in 1993 and two months in 1994. The result of this was that there were no sales whatsoever, no gross income in that year, and Mr. Snider, in preparing a statement of loss, simply added up storage charges, which I take to have been paid to a storage company of some sort; 50% of the Appellant's telephone bill; and an amount of $620 for interest, to produce the loss of $3,186. I note in passing that an amount of $765.60 was claimed as an interest expense in 1993. I was told nothing about the loan that produced this interest, other than that Mr. Schmuttermeier, Sr. said in his evidence that he had taken a loan for equipment. It seems to me that the most logical inference is that those amounts of interest were paid by Mr. Schmuttermeier, Sr. in respect of a loan that he took to buy equipment to house in his shop.
[12] The Appellant, in his evidence, agreed that he had never formed any business plan or developed any kind of strategy to change the fortunes of the business in the face of the succession of losses between 1987 and 1992 totalling some $90,000. He did, however, agree that when he was not working on other people's motorcycles he was working on his own, and he was unable to make even an estimate of the proportion of his time that was spent working on his own machines and that spent working on the machines of others. When asked to explain why he continued to operate in the way that he did, losing money in the way that he did, his answer was to the effect that he was in love with what he was doing, and I took that to mean that the work he did evenings and weekends on his own and other people's motorcycles was essentially a labour of love for him, and while he certainly seems to have charged some people some amount of money for some of what he did, that was not, I think, by any means the sole or perhaps even the greatest motivating factor.
[13] For four reasons, I am of the view that these appeals must fail. My first reason for so concluding is that, in my opinion, there was nothing here that could be called a business or a source of income within the meaning of that expression in section 3 of the Income Tax Act. Mr. Schmuttermeier, Jr. was engaged, in my view, primarily in a hobby. He was a motorcycle enthusiast for many years before he began this activity; he clearly enjoyed the sport as both a racer and a mechanic; he had worked on his own vehicles, and he had obviously acquired some skills while doing so. He seems, as well, to have done some work for others and been paid for it from an early stage, but this should properly be regarded as a case in which the Appellant was engaged primarily in a hobby for his own enjoyment.
[14] My second reason for concluding that the appeals must fail is that, if I am wrong with respect to the first reason and there was a business, then it was the business of Mr. Schmuttermeier, Sr. and not that of Mr. Schmuttermeier, Jr. As I have already said, Mr. Schmuttermeier, Sr. testified that he was trying to build this business up for his son. His evidence was that the loan to purchase equipment was made by him, and the business was operated in his premises. He himself worked at it more or less full-time throughout the period in question for no pay. Most telling, perhaps, is that when he was absent from the country in 1994 there was, by his admission and by that of the Appellant, no business activity carried on and while the Appellant attempted to salvage what he could of that by testifying that he worked a great deal of overtime in 1994, my appreciation of his evidence and that of his father is that the real reason that the sales reported in 1994 are zero and in 1995 a mere $7,300 is not the overtime worked by the Appellant, but the fact that his father was not there to carry out all of the activities that he had been carrying out theretofore.
[15] The third reason that these appeals must fail is that, on the evidence of both the Appellant and his father, the statements which were submitted with the income tax returns of the Appellant and put into evidence as Exhibits R-1, R-2 and R-3 are blatantly fraudulent. Mr. Schmuttermeier, Sr. told me, somewhat to my surprise, in the course of his evidence that it was their intention to recover the loss of $130,000, by his estimate, that took place in respect of the van containing motorcycles, tools and other equipment on the way to Daytona in 1991 by writing it off in later years, and the years they chose seem to have been 1993, 1994, and 1995. Exactly where these amounts are to be found in those statements was never made entirely clear, although I note that there were a number of items that could be described as questionable, such as, for example, the claim for capital cost allowance of $6,467 that appeared in 1995. I was never told what capital equipment that might pertain to, but the evidence of both the Appellant and his father was quite clear that they decided to spread the loss in 1991, which in my view could not possibly be characterized as a business loss. It was a personal loss sustained while they were on the way to participate in a motorcycle race before the years under appeal. No proper books and records ever seem to have been kept for this business. I was told that certain records had been given to the officials of Revenue Canada and that not all of them were returned. I do not know whether this is so, but I do have Mr. Snider's evidence that there were never ledgers or anything of the kind, and it seems quite clear to me from the evidence of the Appellant and his father, that many of the expenses that go to make up these very substantial losses were in fact more personal than related to any business of repairing motorcycles, if any such business existed. I have no confidence at all that if there was a business, its results are properly reflected by these exhibits. In saying that, I do not mean to cast any aspersion on Mr. Snider, who prepared them. He was quite clear that he prepared them from information given to him, and he does not purport to be an accountant or to have passed upon the appropriateness of the expenses. I take it his role was essentially as scribe and arithmetician.
[16] Finally, the fourth reason that these appeals must fail is that if there was a business, and if it was the business of the Appellant, and if, contrary to what I have found, its results are properly reflected in the income tax returns filed for the years under appeal and properly reflected in those for the preceding six years, then this business had no reasonable expectation of profit. Mr. Sood, for the Respondent, pointed out to me, quite correctly, that this is a case which at least involves a personal element if it is not -- as I have found it is -- entirely personal. As a case that involves a personal element, it is subject to close scrutiny under the reasonable expectation of profit test. The Federal Court of Appeal has so held in Watt Estate v. The Queen, 97 DTC 5459.
[17] Here we have a remarkable history of losses totalling about $140,000 over a period of nine years. We have what is admitted by the Appellant to be an activity which he loves, and one closely associated, at least, with a hobby he has carried on since about 1980. We have no business plan, no business experience, no attempt to respond to the recurring losses by restructuring the way in which the business was carried out. The Appellant's evidence as to that, simply was that the only way he could do anything about the losses would have been to raise his prices, and that if he did, the customers would have gone elsewhere. This submission, of course, ignores the obvious fact that if enough of the business had gone elsewhere a sufficiently long time ago, the Appellant would not have lost the enormous amount of money that he has.
[18] For all of the foregoing reasons, the appeals are dismissed.
Signed at Ottawa, Canada, this 11th day of August, 2000.
"E.A. Bowie"
J.T.C.C.