Date: 19991028
Docket: 96-2863-GST-I
BETWEEN:
BRUCE HEGERAT,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
Reasons for Judgment
(Delivered orally from the bench on February 12, 1997, at Edmonton, Alberta)
Mogan J.T.C.C.
[1] This appeal arises under the provisions of the Excise Tax Act (for goods and services tax) in which the Appellant has elected the Informal Procedure. The time period is the calendar years 1991 through to 1994. In those years, the Appellant claimed certain input tax credits under the provisions of section 170 of the Act and, upon reassessment, the Minister of National Revenue (the Minister) disallowed a portion of the input tax credits claimed. Also, the Minister assessed the Appellant for goods and services tax on an amount which will be referred to later as property management. The two issues in this appeal are whether the input tax credits should have been reduced by the Minister and whether it was correct to assess goods and services tax with respect to the property management item.
[2] The Appellant is a chartered accountant who received his C.A. designation in 1985 and has from time to time provided accounting services although it is my understanding that, at the present time, he has resigned from the Institute of Chartered Accountants in Alberta. In evidence, the Appellant described a number of the activities which he is either engaged in or has been employed in over the years. The Appellant is an eclectic individual, a person of many talents, who sees himself now, I believe, as an entrepreneur.
[3] In 1985, when he achieved his designation as a chartered accountant, he knew that he wanted to be in business. He did not want to be simply a professional accountant providing accounting services for the rest of his life. I asked him in argument if he regarded himself as an inventor and he said yes. That question was prompted by certain evidence of some of the ideas he has conceived and developed and, in some cases, attempted to take to market.
[4] Much of his time is spent in product design and product promotion. Some examples given in evidence were that he designed what he called a super-insulated glove. He also designed a cover for an automobile engine which could, because of the type of insulation, be put over the engine to contain the engine heat for several hours. He developed a peg board game. He observed that people were interested in the occult, and so he decided to look into tarot cards and produced evidence of different designs he had made and how some of them had been attempted to be exploited. He also worked on a special kind of deodorant powder for people who may have a problem with foot odor and how that could be developed either as a soap or a powder, and he produced in Court a box that he and another person had designed for the marketing of that product.
[5] It seems that the Appellant hardly looks at anything as he goes through life without seeing some need that could be fulfilled by some product that he might design. Apart from that special interest, however, he has other activities which, as people might say, put bread on the table except that the Appellant does not have a table, which I shall later comment on. Specifically, he has a small income tax practice during the tax season of February to April. He has a significant number of clients for whom he does income tax returns. He also has a number of small corporations for which he prepares financial statements but he describes this business as an income tax service and not a public accountancy or audit service.
[6] The Appellant took on the management of a building in Edmonton for an absentee owner who lived in Vancouver, and charged a fee for building management. At times, he has invested money in some of his projects and inventions referred to above, and has suffered significant financial losses, perhaps in the range of $20,000, more or less. At other times, when his losses have been in that range, he has taken on specific employment using his accounting knowledge to earn a good income and pay off his debts. In a particular situation, he described that he had gone to work for the Auditor General of the Province of Alberta, taking on special projects in order to pay off a debt of approximately $26,000 which had arisen from some attempt to promote one of the above products. He draws on his talents as needed to keep himself afloat while he considers, reflects upon, invents, designs and tries to arrange marketing of those products and services which he conceives in his mind.
[7] In the relevant time period, he was a registrant for goods and services tax because he was providing goods or services and was required to collect and remit tax on the revenue produced from his endeavours. By the same token, he was entitled to input tax credits from certain goods and services that he would consume.
[8] On the principal issue in this appeal, the reduction of input tax credits, I had difficulty grasping the basis on which the Minister made the disallowance because I thought it was based on the amount of time that the Appellant expends on what I will call his invention and design activities, as opposed to the other commercial time. However, in both evidence and argument, there was reference to what I would call the personal use of his dwelling, but it has not been made clear to me how the Minister relied on the personal use of dwelling or otherwise. I propose to decide this appeal on my understanding of the Minister's assessments and the basis for those assessments as affected by the circumstances in which the Appellant lives and operates.
[9] Donald Sager, a senior auditor with Revenue Canada,testified on behalf of the Respondent. He had been a senior appeals officer at the time the Appellant filed his Notices of Objection. Therefore, Mr. Sager was the one who had to consider the objections raised by the Appellant and respond to them. Mr. Sager’s evidence was pretty clear to me and he produced a schedule (Exhibit R-1) to illustrate the computations he made. Also, he submitted Exhibit R-2 which was an amendment to some of the calculations he made in Exhibit R-1 because he acknowledged that some of those calculations had been erroneous.
[10] I will first deal with the computations made by Mr. Sager and then with the Appellant's evidence. The Appellant informed Mr. Sager that he works approximately 2,835 hours in a year, 900 hours of which are on product design, invention, development, etc. On that basis, Mr. Sager determined that the portion of working hours in the year which the Appellant expended on product development and design was 31.75%. My understanding is that the Minister looked at the Appellant’s commercial activities and found his income tax service, his management of the Edmonton property and other things that the Appellant did which produced revenue, and contrasted those activities with his product development and design activity which produced no revenue at all, because none of the products has been successfully taken to market. Some have been interesting enough to develop prototypes, but not one of them has produced a patent or a product that has been sold in commercial quantities. The Minister therefore concluded, as I understand his position, that this product development and design activity was not a “commercial activity because it did not have a reasonable expectation of profit”. Therefore, it was an activity like a hobby to which GST would not apply, and anything connected with that activity would not produce input tax credits.
[11] The Minister then proceeded, as shown in Exhibits R-1 and R-2, to apply the 31.75% to what Mr. Sager described as overhead items. That is non-capital items, but things like auto expense, promotion and entertainment, utilities and travel, etc. The Minister took these items which appeared from the Appellant’s own records as producing input tax credits and, applying 31.75%, disallowed that portion of the input tax credits claimed.
[12] I will take 1992 as a typical year because the same formula applied to 1991, 1993 and 1994. By applying 31.75% to the various overhead items of $594.95 on which the Appellant had claimed input tax credits, the Minister produced a result of $188.90. The Minister made a further calculation using the input tax credits claimed on all of the operations for the year ($1,128) and created a new fraction by taking the portion that the ineligible income tax credits ($188.90) were of all input tax credits ($1,128.81). The new fraction was 16.73%. The Minister adopted the new fraction of 16.73% as a method of determining the volume of ineligible input tax credits.
[13] For 1992, the Minister took this most recent fraction of 16.73% and applied it to all of the reporting periods. For example; for the first three months of 1992, the Appellant had claimed input tax credits of $67.30. The Minister disallowed 16.73% of that amount, or $11.26. By applying that formula to each of the four quarterly reporting periods in 1992, it confirmed the original amount of $188.90 because on the original amounts it produced $188.85 which is almost the same amount. Therefore, the Minister took the position that because there was no reasonable expectation of profit on the product development and design activity, then this was an appropriate portion of the input tax credits to disallow.
[14] Before turning to the Appellant’s evidence, I will touch briefly on what I consider to be a red herring in this appeal and that is the so-called personal items which I believe both the Appellant and the Respondent were hung up on. The Appellant has gone to extraordinary lengths to make his lifestyle almost exclusively commercial, hardly acknowledging that he needs any personal comforts, like a dwelling or a personal automobile. He described his very spartan apartment where he works almost all the time. He was at great pains to explain how he has divested himself of all his furniture, distributing it to sisters and other relatives. He has divested himself of cutlery he might have inherited from his mother. He has a mattress on the floor, a harmonica, a guitar, a refrigerator that has only cold water in it with a little fruit on the top. Those are the comforts of his apartment because the rest of it is dedicated to commercial activity.
[15] It seems to me that he has gone to these lengths to establish the fact that everything about his apartment is deductible for either income tax purposes or can be used for input tax credits for goods and services tax because it is just as much a place of business as if he owned a factory and it were the factory. In connection with these personal items, although he operates three different activities, he has only one bank account. He explained how he is like the mirror image or the inverse image of consolidated financial statements. We all know what consolidated financial statements are. He says his bank account is itself a consolidated financial statement from which he, because he is careful, is able to extricate and prepare financial statements for his various activities because he keeps such careful records. I believe that he keeps careful records. He seems like the kind of person who would save chits and receipts, and he is able to show that he gave somebody a carton of cigarettes or whatever. Because he is so meticulous on small items and trying to divest himself of personal effects, it seems that the Minister somehow got caught up in this. At the end of the day, I think it is only a red herring and that the real issue in this appeal relates to the time he dedicates to invention, design and product development.
[16] The Appellant called a number of witnesses, all of whom were believable, as he was himself. Most of the witnesses simply corroborated the Appellant's description of his lifestyle, with the possible exception of Mr. James Granger who described himself as a visual consultant. When all was said and done, however, it seems to me that Mr. Granger was only an employee of AMS Plastics. He described his employer as capable of manufacturing and filling containers with some of the product that the Appellant might eventually produce if he can ever get this foot balm into a commercial quantity. I do not put a lot of weight on Mr. Granger’s evidence. I found him believable, but I found it of peripheral relevance, whereas the other witnesses seemed to genuinely corroborate the Appellant’s story. Not that it needed corroboration.
[17] On the main issue, the disallowance of the input tax credits in the amount of $713.97 as shown in Exhibit R-2, I find that the Appellant’s case is hopeless. He cannot possibly succeed against the Minister’s disallowance of those tax credits for the following reasons. In the goods and services tax legislation, the definition of commercial activity in section 123 contains the following words:
123(1) Commercial activity of a person means
(a) a business carried on by the person (other than a business carried on by an individual ... without a reasonable expectation of profit) except to the extent that ...
As I read that definition, a commercial activity of a person means a business carried on by the person other than a business carried on by an individual without a reasonable expectation of profit. If there is no reasonable expectation of profit from an activity which purports to be a business, then it is not a business for purposes of commercial activity and, therefore, not a business in respect of which input tax credits can be claimed.
[18] That raises the question whether this activity of invention, design and product development is an activity with a reasonable expectation of profit. I find that it is not. It is an activity in respect of which there is no revenue. There is no question that the Appellant has an intense interest in it, and he is imaginative, to say the least, and dedicated to the idea of bringing better mouse traps to the market but, without any revenue at all, without any sales, I find it hard to visualize this activity as a business. If I could compare it to a mine, the Appellant is like a person who has discovered an ore body and is working at it before producing an ounce of ore. The Appellant is working at the development of ideas without an idea which he can yet take to market.
[19] In Knight v. M.N.R., 93 DTC 1255, Mr. Knight was an extremely talented machinist. He became a teacher in an Ontario high school teaching machine shop in the vocational side of a high school. He became fascinated with wind-drive power like a windmill, He did a lot of work on that and finally got the idea that, if he could match a computer program to some of his machinery, he could easily and inexpensively manufacture the fins and blades for what I would call the fan or the propeller-type part of the windmill. He got so taken up with this idea that he took a leave of absence from his teaching to dedicate a year to it. Over a three-year period, he showed nil revenue in 1986 but expenses of $12,500; in 1987, nil revenue and expenses of $67,000; and in 1988, nil revenue and expenses of $41,000. After the year's leave of absence from teaching, he went back to teaching, so in one of these years he had a significant loss and in the other years, he had losses which he attempted to apply against his salary as a teacher. The Minister disallowed the losses and the appeal came before me. I am going to read certain passages from my own judgment because I think they have a bearing on this activity that the Appellant operates as a product invention, design and development activity. At page 1258-1259, after setting out the financial statements of Mr. Knight’s activity for those years, I make the following statements:
It is significant in the above financial information that there were no sales and no revenues of any kind in the years 1986, 1987 or 1988. If there were no sales, there were no customers, and if there were no customers one has to question whether there was any business to carry on. ...
The Appellant was like any amateur inventor who has a good idea but has not yet ironed out all the wrinkles to make his idea commercially viable. Until he has something to take to the market, he is still only an amateur inventor developing his idea or product. During 1986 and 1987, he had no product to sell. He had no customers. He had no sales or revenue of any kind. He could not and did not advertise. There was no trading. In summary, there was no commerce or business.
This is not like an existing business making sales to the public but operating at a loss because it needs a start-up period to develop enough customers to become profitable. In the Appellant’s situation during 1986 and 1987, he could not open his door to the public and could not make any sales because he had no product to sell. Even four years later in 1991, when he signed a contract with a school board to provide a milling machine for $19,500, he was unable to fulfil the contract because his process did not have CSA approval. Although the Appellant had a real intention to be in business and a clear concept of what his business would be, and although he made a significant commitment of time and capital to that intention and concept, I have concluded that his proposed business was still in the development stage in 1986 and 1987.
I read those passages because, in my view, they apply directly to the Appellant in this case. He has an abundance of imagination and ideas but he is not in business. In fact, a couple of times in his evidence, he referred to what he was doing as research and development with these products. In the Knight decision, I say the following at page 1259 about research and development:
... Research and experiment are essential in the development of any new product but, standing alone, they do not comprise the carrying on of a business. Because the Appellant was not engaged in any other commercial endeavour in which he was attempting to sell and ready to deliver any product or service to the public, he had no possibility of earning any revenue. If there was no possibility of revenue, there was no possibility of profit. And of course if there was no possibility of profit, then there was no reasonable expectation of profit.
[20] It is not the best practice for a judge to quote his own prior decision. It is better to find a decision of some other judge who has said exactly what is relevant but I do not know of any other decision which bears as directly on the Appellant’s case. Therefore, I would simply adopt those words to the invention and design activity of the Appellant in this case. To the extent that he spent 31.75% of his time in this activity, he is not carrying on any business because there is no business to carry on. Therefore, there is no profit, there is no reasonable expectation of profit and, in the words of the goods and services tax legislation, it is not a commercial activity. It is not an activity in respect of which he can expect to claim input tax credits. I therefore dismiss the appeal with respect to the first issue because I am satisfied that the computations made by the Minister in Exhibit R-1 and, particularly as amended in Exhibit R-2, are reasonable in the circumstances, and a reasonable application of the statute to the Appellant’s case.
[21] The second issue is a very simple one, and that is the $299 which was levied in respect of the management fee for services in property management. The Appellant was a GST registrant at the time. It was a commercial activity in which he took on the management of a significant building for an absentee owner from Vancouver. He was paid some kind of fee and, as a GST registrant, any “commercial activity” in respect of which he earned fees was an activity on which he was obliged to charge his client goods and service tax and remit that tax to Revenue Canada. It was clearly a taxable transaction.
[22] The Appellant’s defence of this particular item is that he had intended to incorporate a property management company and at that time he had a claim against the Government of Canada under other legislation that does not pertain to the goods and services tax or the Income Tax Act. It was another dispute that the Appellant had before a bona fide Court or tribunal and in which he was ultimately successful. But at that time, he had incurred significant debt in connection with his development/design activities and he was hard pressed financially. He said: "I had a valid claim against the federal government; they owed me money; they ultimately acknowledged it; but by the time they acknowledged the debt, it was too late and this whole property management activity was over. But if I had had the money in time, I would have incorporated, it would have been in a limited company which was not a GST registrant and I would not have been obliged to pay".
[23] That is an impossible argument for me to accept because I would have to get into a concept of set-off which is not permitted in the taxing legislation of either the federal government or the provinces. The debt owing to the Appellant may have produced a hardship, or it may have produced from the Appellant’s point of view a sense of unfairness but, in this Court, I cannot take into account what a taxpayer perceives as unfair even if an objective person might agree. I have to apply the legislation as it is passed by Parliament. On the facts of this case, the Appellant being a registrant under the goods and services tax legislation, he was liable for the amount of $299.83 in connection with the management fee. Therefore I dismiss the appeal with regard to the second issue.
Signed at Ottawa, Canada, this 28th day of October, 1999.
"M.A. Mogan"
J.T.C.C.