Date: 20000602
Docket: 1999-4468-IT-I
BETWEEN:
PETER S. JENSEN,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
Reasons for Judgment
O'Connor, J.T.C.C.
[1] This appeal was heard at Edmonton, Alberta on May 2, 2000 pursuant to the Informal Procedure of this Court. The Appellant was the only witness. He gave his testimony and filed as Exhibit A-1 three volumes of documents. Volume I contains, inter alia, registration of Firebird Apparel Design ("Firebird") as a proprietorship with Alberta Consumer & Corporate Affairs in 1991, a ruling from Revenue Canada that the Appellant's wife Edith was not employed as contemplated in the Unemployment Insurance Act ("UI") and Canada Pension Plan ("CPP"), business licenses from the City of St. Albert to Firebird for 1995 and 1996 and from the City of Edmonton for 1997, 1998 and 1999 and numerous business proposals and details of work done in 1996 and 1997 by Firebird consisting principally of custom work and repairs and alterations. Volume II contains, inter alia, answers to a business questionnaire. Volume III contains photographs of the equipment used in the operations of Firebird.
ISSUES:
[2] The main issue is whether in the 1996 and 1997 years the Appellant had a reasonable expectation of profit from the activities of Firebird with the result that he was entitled to the net losses claimed in those years.
[3] The Respondent submits an alternative issue namely that if it is determined that there was a reasonable expectation of profit from Firebird's activities the business should be considered as being operated as a partnership with the result that the Appellant and his spouse are each entitled to one-half of the losses claimed by the Appellant in 1996 and 1997.
FACTS:
[4] The basic facts are as follow:
1. The Appellant registered his business, Firebird, as a sole proprietorship. The activities carried out consisted principally in sewing, mending and altering various types of clothing and equipment. The activities were carried out from the Appellant's home. The Appellant's wife, under a subcontract did the actual work. The Appellant himself was involved with administrative matters, billing, marketing and planning. For a complete understanding of the activities and their scope it is useful to cite certain extracts from the answers to the business questionnaire contained in Volume 2 of A-1 as follows:
These are my answers to the Business Questionnaire your office has provided to me on May-19-1998. The answers are in the same numerical order as the questions appear.
1. a(i) I commenced operating FIREBIRD APPAREL DESIGN (1991) in February, 1991, February-01-1991 to be exact. ...
a(ii) Operations are still ongoing; they have not ceased.
b) As per my business plan that was written in March 1996, on page three, goods and services are:
1. Selling directly to retail outlets that have specialized needs e.g. pro shops in privately owned fitness clubs promotional companies requiring clothing for their clients.
2. Selling directly to individuals who may have special fitting requirements.
3. Selling to teams of individuals who require uniforms in small quantities.
4. Producing a special garment for a special occasion
5. People who have purchased ready-made garments but need alterations.
6. People who require repairs made to their garments.
I also own a TRADE MARK REGISTRATION for Canada that includes wares such as:
(1) Suits, ties, shirts, men's and lady's trousers including jeans, dresses, lingerie, sweat suits, boxing shorts, running shorts, windproof jackets, jogging suits, swimsuits, T-shirts and aerobic outfits namely unitards, leotards, crop tops, leggings, cycling shorts, tights, shorts, pants, tank tops and crop tops.
(2) Services: Clothing alteration and tailoring, shirt making and pattern drafting and grading.
The Certificate of Registration #436176 was issued to me on November 25, 1994, to be used by me, for my business operations in Canada, since February-27-1991.
c) The business is both wholesale and retail
d) As per my business plan, on page 11, the method of sales is direct sales and referrals. I also provide proposals for various companies in the promotional wearable field.
e) Sports and team wear for individuals and teams for the various events that occur in the community.
f) As per the business plan, on page 11, I advertise my business via business cards, embroidered garment labels, yellow page ads, specific magazines for sporting events, referrals, and repeat product customers.
g) During 1996 and 1997, our major customers were Nelaine Advertising, Panther Gym and Karate Club, as well as one smaller advertising and promotional distributor, being Paranoid Ink. During the time frame of 1996 and 1997, there were a lot of customers seeking alterations.
...
2. a) Major changes in my operations happened during the 1996 and 1997 time period with several events. Some of the contributing factors were and still are: the falling Canadian dollar; the G.S.T.; the North American Free Trade Agreement (NAFTA). When all of these variables became combined within the economy of Canada, I found it difficult to compete in high end men's wear in the recession years that followed. My business, like others in the textile industry, had to rethink its position and focus. I have decided not to pursue high end men's wear any longer, due to the lack of profitability. My business has now focused on sports wear during this time period. I have enjoyed a greater degree of success, until the summer of 1997. There has been a minor slow down in primarily the boxing circuit contracts. ...
It is noteworthy to express that during these events, and the events leading up to the years 1996 and 1997, a lot of clothing manufacturing plants and retail outlets went into bankruptcy. It is during these recessionary bankruptcies that I was able to pick up a vast majority of my sewing machines that I utilize for my business operations. These machines were purchased for pennies on the dollar. I had to purchase these machines so that I could make my business a more credible and worthy competitor in the market place. With the purchase of these machines, I am no longer focused on the individual, but rather attempt to land contracts with larger groups. This has been a significant change in the focus of my business.
...
d) My business operates out of my principal residence that is located:
3817 103b Street, Edmonton, Alberta T6J 2X8
The main floor has a den that is utilized as the main sewing room: its dimensions are approximately 12 feet by 11 feet. One of the upstairs bedrooms is utilized as an office: its dimensions are approximately 12 feet by 9 feet. The basement is unfinished: that is where a lot of the sewing machines are located, along with a cutting table and a drafting table. The dimensions are approximately 26 feet by 43 feet.
(ii) I calculate the portion for business use to be twenty per cent.
(iii) The main floor sewing room is being utilized for most of the smaller tasks involved, from pressing garments to sewing on the labels, and the finishing touches garments require. The library of reference books is also stored in this room.
The basement is where the heavier industrial sewing machines are located that do most of the heavier manufacturing. The cutting table is also located there for some drafting purposes, but mainly cutting out garments that have been ordered. The bulk of my inventory is also stored in various boxes and cabinets. The drafting table is used to draft full size patterns in the various required sizes.
The upstairs bedroom is utilized as my office. This is where all of my bookkeeping tasks are completed and filing is kept. This is also the location for the computer I use for my business operations.
The main floor is also used for entertaining prospective clients, and closing deals on various proposals that I have submitted.
4. a) The assets I have acquired for business purposes are as follows:
(There follows a detailed list of business assets)
8. a) I have purchased better equipment and found cheaper sources for raw materials to manufacture our garments. The business location has changed and the primary business focus has, as well, from high end wear to sports wear. ...
b) All of my business financing has been through my personal pay from my present job, as well as my personal line of credit. All profits realized by the business are applied directly to the business, for further financing.
...
10. ...
I have also changed the location of the business, putting the business closer to the client base, as well as the suppliers. The change in location has also afforded us the convenience of having considerably more room, therefore keeping all the machinery in a more central location. This step eliminates a lot of unnecessary wasted time and effort in doing the job at hand.
...
12. ...
Expansion is a very real and live issue, but time will tell when expansion is right for my business. If the opportunity arises, I expect I will act at that time. In the meantime, I will continue to hone my skills as an administrator and sales person, and gain greater knowledge of the field in which I am presently pursuing. I feel very strongly that I have excelled in the learning process of operating my own business. I realize that I have risked a lot of my own personal funds, and also invested a tremendous amount of sweat equity. I am using this as an opportunity for "hands on" experience to ensure success in the future, with minimal risk. I know that, as the economy turns around, my investments will pay off in huge dividends for the future.
2. The Appellant's principal work was that of a constable with the Government of Alberta.
3. The activity started in 1991. The Appellant reported employment income from the Government of Alberta as follows:
|
Year |
Employment Income |
|
1991 |
$35,014.00 |
|
1992 |
37,603.00 |
|
1993 |
37,368.30 |
|
1994 |
36,533.62 |
|
1995 |
35,150.60 |
|
1996 |
35,296.25 |
|
1997 |
35,434.49 |
4. From 1991 to 1997 the Appellant reported the following losses from the activity:
|
Taxation Year |
Gross Profit |
Operating Expenses |
CCA |
Net Loss |
|
1991 |
$4,839.00 |
$ 7,192.00 |
( 2,353.00) |
|
|
1992 |
11,966.00 |
14,899.00 |
( 2,933.00) |
|
|
1993 |
2,923.62 |
14,189.94 |
$ 611.58 |
(11,877.90) |
|
1994 |
6,500.21 |
20,389.25 |
1,356.84 |
(15,245.88) |
|
1995 |
7,395.90 |
18,332.72 |
4,285.00 |
(15,221.82) |
|
1996 |
470.41 |
26,147.56 |
6,831.66 |
(32,508.81) |
|
1997 |
5,574.06 |
25,367.52 |
3,710.28 |
(23,503.74) |
5. The Appellant's time devoted to the activity consisted of approximately 2 to 7 hours in the evening of each regular work day and approximately 10 hours on week-ends. The hours devoted by the Appellant's wife were approximately 60 to 70 hours per week.
SUBMISSIONS OF THE APPELLANT:
[5] The Appellant submits that there was an extensive amount of activity being carried on with a reasonable expectation of profit. He points to Volume I of Exhibit A-1 giving detail in the extreme of the background of the business and its activities. He also points to Volume III of Exhibit A-1 containing photographs of the extensive and sophisticated equipment used in the activities. He denies that there was ever a partnership with his wife, that she had her own proprietorship for another function and that she acted as a contractor of the Appellant.
The Appellant states in regard to a statement in the 1997 return that his wife was a partner that that was obviously a mistake and points out further that in said statement no percentage of partnership profit/loss was allocated to his wife.
SUBMISSIONS OF THE RESPONDENT:
[6] Counsel for the Respondent points to the extensive losses, notwithstanding the operations carried on and concludes that there was no reasonable expectation of profit in the years in question. Further, the Appellant has had a reasonable start-up period which ended in 1995 with the result that the losses claimed in 1996 and 1997 should not be allowed. Counsel also points to the statement of business activities filed with the income tax returns in the various years and in particular refers to the 1997 year in which there is an indication that the Appellant's wife was a partner.
ANALYSIS AND DECISION:
[7] In my opinion, the Appellant had a reasonable expectation of profit in the years in question. The following are my principal reasons:
1. The set up of the proprietorship and its activities, extensively reviewed in Exhibit A-1, Volumes I and II are indicative of a business-like operation.
2. The hours devoted to the activity by the Appellant were many.
3. The Appellant's credibility is accepted.
4. It is not sufficient to simply look at the losses and conclude therefrom that there was no reasonable expectation of profit.
5. The Appellant had a business plan.
6. The Appellant attempted to increase his profit opportunities in two respects:
(a) He changed the focus of operations in 1996 and 1997; and
(b) He moved in November of 1996 from St. Albert to Edmonton to increase his client base and hopefully produce a profit.
7. The authorities submitted by the Appellant support the Appellant's position.
8. In many situations a considerable start-up period is required before an activity will turn profitable.
9. The Appellant, assisted by his wife as the Appellant's contractor, devotedly tried to make the operation profitable.
10. Schedule B of the Reply to the Notice of Appeal deletes moving expenses and legal fees. Since the move was business related and the business premises were the home I believe those expenses and fees should be allowed.
[8] For all of these reasons, the appeals are allowed and the matter is referred back to the Minister of National Revenue for reconsideration and reassessment on the basis that the Appellant is entitled to the losses claimed from the activity in the 1996 and 1997 years.
[9] As to the issue of there being a partnership, in my opinion the evidence discloses that there was clearly a proprietorship. The reference to a partnership in the 1997 statement of business income appears to have been an error and, as pointed out by the Appellant, no partnership percentage was allocated to the wife. I would add that it is curious that the Minister was prepared to accept that there was a reasonable expectation of profit if the activity was carried on as a partnership thus allowing the losses claimed but divided equally between the Appellant and his wife but was not prepared to admit or acknowledge that there was a reasonable expectation of profit if the same activity had been carried on as a proprietorship.
Signed at Ottawa, Canada this 2nd day of June, 2000.
"T.P. O'Connor"
J.T.C.C.