Date: 19990205
Docket: 97-3579-IT-I
BETWEEN:
LLOYD J. CRANSTON,
(L. CRANSTON TREE SERVICE)
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
Reasons for judgment
(Delivered orally from the Bench at Ottawa, Ontario, on January 8, 1999)
McArthur, J.T.C.C.
[1] The issue in these appeals is the deductibility of losses sustained by Lloyd J. Cranston from the operation of the business known as L. Cranston Tree Service. The parties have agreed to the amounts of his losses and therefore, the only question before me is the whether the Appellant had a reasonable expectation of profit for the 1993, 1994 and 1995 taxation years.
[2] In 1988, the Appellant was retired from Gloucester High School where he had taught trades, including auto mechanics. In anticipation of forced retirement, he commenced a landscaping and tree business in 1987 when he was 54 years old. Using a line of credit, he purchased a used truck with a tree spade for $20,000. Over the past 10 years, he has purchased various tractors, trucks, mowers, a backhoe, etc., all of which equipment he values at $125,000. The Appellant was a municipal councillor and then mayor of Oxford Township during the relevant years. He used his income, the proceeds of the sale of his house, and a Bank of Nova Scotia credit line to purchase the equipment. The Appellant commenced the activity with the intention of earning income to supplement his pension and support his family.
[3] I find as a fact that there was no personnel element involved in the commencement and operation of the business. The Appellant worked part-time for the business, primarily purchasing and repairing equipment and negotiating contracts. The business was commenced after some research, albeit unsophisticated. The Appellant saw a need for a tree removal service in his community. At the outset, he purchased used equipment and had the training and talent to make repairs himself. The business used heavy industrial equipment, including a terrain scope mower designed to travel on steep slopes. Much of the more expensive equipment was purchased in order to supply service to the Regional Municipality of Ottawa-Carleton in cutting medium slopes on regional roadways.
[4] In 1993, the provincial government stopped paying grants to the municipality to assist in covering the costs for this work on regional roads. As a result, the Appellant's contracts for this type of work declined drastically. The large and sophisticated 22-foot mower has been scarcely used since that time. In addition to the lost work from the Region, the Appellant suffered a further setback when Fine's Nursery became insolvent and ceased operations in 1993. Prior to this time, the Appellant had performed a significant amount of work for the nursery using a backhoe and tree spade. This equipment, again, has not been substantially used since the date of that bankruptcy.
[5] The Appellant's business was further adversely affected in 1994 when his stepson, Fred, who was a key employee, lost an eye in the course of his employment in the business. After the injury to Fred, the business experienced difficulty in finding workers who are able and willing to operate the heavy commercial equipment. The noise, vibration, heat, dust and potential danger constitute hazards which workers are often unwilling to accept. I can easily conclude that this business was no hobby.
[6] A large portion of the Appellant's contracts was with the Regional Municipality of Ottawa-Carleton. Other sources of work included commercial and residential property developers. Because of the specialized requirements of these customers, the Appellant expended significant amounts of money to purchase the necessary equipment to perform his work. After provincial cutbacks, and given the slowdown in the economy in the 1990s, the amount of work which the Appellant's business performed was greatly reduced. The Appellant had other setbacks. In 1993, he purchased a new Massey-Ferguson tractor for $30,000 which had factory defects and it could not be used or repaired. He experienced many difficulties in having the manufacturer honour its warranty. Finally in 1994, the 1993 tractor was replaced with a new one that continues to function well.
[7] The aspect of this case that is most difficult or troubling for the Appellant is the business losses reported over the years. From 1987 to 1992 the losses were the approximate amounts of $5,000, $11,600, $26,900, $8,200, $34,400, and $17,700, respectively. For the years in question, the losses were the approximate amounts of $25,200 $33,300 and $20,100. Also, in 1996 and 1997, the Appellant lost approximately $21,000 and $14,000.
[8] Originally, he purchased used equipment that broke down. He paid $25,500 in 1991 for a backhoe with a spade for use in the Fine's Nursery contracts, but that business went into bankruptcy in 1993 owing him substantial money. In addition, a real estate developer went bankrupt owing him money and he lost his key employee when his stepson was injured in October 1994.
[9] The Appellant's evidence was credible and his accountant stated that in 1997 and 1998 the income increased and the expenses decreased. But for $3,000, the equipment at this time has been paid for. The Appellant's daughter-in-law, Fred's wife, is operating the equipment and the Appellant is no longer involved in municipal politics and is free to devote his full-time to the business. He has examined his contracts and is disposing of the unprofitable ones, and aggressively looking for new contracts nearer his place of business.
Appellant's position
[10] The Appellant states that during the entire course of his tree and landscaping business, he has never had a business loss of a personal nature and all expenses were made for proper business purposes. The expenses and losses were consistent with the ordinary principles of operating a commercial business venture throughout the relevant period. Also, continuing to the time of this appeal, the business has been purely commercial with no personal element where improper tax avoidance was in any way planned. The business losses resulted from declining contracts due to provincial cutbacks and slowing development environment, combined with the loss of major customers, Fine's Nursery and the Regional Municipality of Ottawa-Carleton.
Respondent's position
[11] The Minister of National Revenue decided that after six years of losses, it was sufficient to conclude that the Appellant had no reasonable expectation of profit.
Analysis
[12] We have the following factors:
1. At all times, the Appellant had an honest good faith intention to earn income from his landscaping business;
2. There is no personal element;
3. After suffering losses over 11 years, the Appellant's business now appears to be profitable.
4. There is a reasonable explanation for the losses and an outlook for a more stable business in the future;
5. The Appellant presented a plan to decrease costs and increase possibilities after years of experience;
6. In 1999, there is a stronger overall economy than what existed in the early years of this decade.
7. Finally, the history of 11 years of losses must be analyzed keeping the positive aspects in mind.
[13] Counsel for the Respondent relied on the decision of the Federal Court of Appeal in Landry v. The Queen, 94 DTC 6625 and the comment of Decary J. as follows:
There comes a time in the life of any business operating a deficit where the Minister must be able to determine objectively, after giving someone a head start for a number of years, as the case may be, that a reasonable expectation of profit has been turned into an impossible dream. ...
Also he referred to the criteria contained in the decision of Moldowan v. The Queen, 77 DTC 5213 (S.C.C.).
[14] Counsel for the Appellant referred the Court to three post-Moldowan decisions, namely, Tonn v. The Queen, 96 DTC 6001, Mastri v. The Queen, [1997] 3 C.T.C. 234, and Mohammad v. The Queen, [1997] 3 C.T.C. 321. In the Tonn appeal, Mr. Justice Linden stated at page 6012, 6013 and 6014:
When the cases are categorized into two groups, as above, one cannot help observing that the hobby and personal benefit cases are rarely decided in the taxpayer's favour. In contrast, where the activity is purely commercial, they are rarely challenged. If they are the Courts have been reluctant to second-guess the taxpayers, with the benefit of the doubt being given to them. I also note, that in terms of sheer numbers, the hobby/personal-benefit cases vastly outnumber those of commercial activity and variety, which are quite rare, indicating the taxpayers are challenged less often in such situations.
The primary use of Moldowan as an objective test, therefore, is the prevention of inappropriate reductions in tax; it is not intended as a vehicle for the wholesale judicial second-guessing of business judgments. A note of caution must be sounded for instances where the test is applied to commercial operations. Errors in business judgment, unless the Act stipulates otherwise, do not prohibit one from claiming deductions for losses arising from those errors. ...
... the Moldowan test should be applied sparingly where a 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. ...
...losses may occur for several years until the project becomes profitable.
[15] In the present appeals, the Appellant has satisfied me that much of the losses occurred for reasons beyond his control which include the economy, bankruptcies of customers, the Municipality's cutbacks, faulty equipment and the injury to his stepson.
[16] The Appellant commenced the business in good faith to earn income, without the aid of a sophisticated market analysis. When things appeared promising, unforeseen setbacks brought about losses. There was no personal element involved. He made some honest errors in judgment. The Appellant has shown persistence and determination which cannot be regarded as completely foolhardy, given the misfortunes not of his making.
[17] His impressive list of heavy equipment has been all but paid for and is now in good working order. The Appellant, free of municipal politics, can devote his talents to the business. His daughter-in-law has proved to be a competent employee. The evidence of his accountant that the expenses are decreasing and the income is increasing cannot be ignored. The numbers cannot be taken in isolation, they must carefully be examined in relation to the facts.
[18] I find that the Appellant's business has a reasonable expectation of profit, and the expenses agreed to by counsel for both parties were spent for the purpose of gaining or producing income. Losses cannot continue indefinitely, but I accept the Appellant's evidence and the peculiar circumstances of this case, and accept that the business is now poised to enjoy profitable years.
[19] The appeals are allowed with costs, if any.
Signed at Ottawa, Canada, this 5th day of February, 1999.
"C.H. McArthur"
J.T.C.C.