Date: 19990525
Docket: 98-66-IT-I
BETWEEN:
VERNON FAIRHEAD,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
Reasons for judgment
Brulé, J.T.C.C.
[1] The appellant is appealing assessments by the Minister of National Revenue (the "Minister") for the 1992, 1993 and 1994 taxation years. By Notice of Reassessment dated February 27, 1997, the Minister disallowed these losses which were confirmed by a Notice of Confirmation dated October 29, 1997 on the basis that the Appellant did not have a reasonable expectation of profit.
Facts
[2] The appellant deducted net business losses in the amounts of $15,179, $17,313 and $12,860.84 for each taxation year. Did the appellant have a reasonable expectation of profit from the operation of his boat and from the electronic repair activity? For the taxation years 1992, 1993 and 1994, the Appellant claimed business losses with respect to the "re-enactment business" he carried on from a historical boat he purchased in 1991 named "Le Royaliste". For the 1994 taxation year, he claimed business losses respecting his electronic repair business, "Radcom Inc."
[3] In 1990, after a year of researching for the right boat, the appellant purchased a tall ship for the price of $30,000 partially financed by a loan with the Scotia Bank. This forty-foot long ship, built in 1967 and used in the charter business in Toronto, is a replica of a nineteenth century privateer. The appellant testified that this ship is valued today at over $100,000 (US). He has previously owned three other boats which he restored and sold. Over the years, he acquired the necessary skills and equipment to restore the Royaliste. However, he did not have a business plan when he purchased the boat. He knew some people in the charter business and knew of a similar boat in Kingston.
[4] At the time of the purchase of the Royaliste, the appellant's intention was to supplement his income and to provide charter services in Kingston, Ontario, where he held a full-time job. He had printed some pamphlets offering the services and had placed them in hotels. The first summer was unsuccessful mainly because it was cold. The only contract the appellant received was a $500 contract to appear in a short movie with the Royaliste. After this movie, the Canadian Museum of War asked the appellant to re-enact a sea battle during the summer of 1993. These re-enactments consist of sea battles with costumes and fire cannons. The appellant and his wife would dress up in clothes pertaining to the historical period of re-enactment. The appellant also testified that he had to make changes to the Royaliste every time he received a contract, depending on the period of the re-enactment. These expenses are incurred by the appellant.
[5] For the first two years, the Royaliste was stored in Kingston during the winter. The appellant and his family moved to Shawville, Quebec, where his wife occupied a full-time job. The appellant remained unemployed. He then decided to move the Royaliste to Shawville in order to reduce the expenses. He testified that he worked 30 to 60 hours a week on the Royaliste and spent many hours a week trying to get contracts. The Royaliste was never used for pleasure or used for family outings, because it required a crew of eight to nine people to sail it.
[6] The appellant abandoned the charter business and concentrated on getting more re-enactment contracts. He quickly established a good relationship with Mr. Suthren, Director of the Canadian War Museum. The latter introduced the Appellant to other people in this field and the Royaliste is slowly acquiring a reputation. At trial, the appellant submitted many contracts that he managed to get. In 1998, Mr. Suthren was interested in hiring the appellant along with the Royaliste for a long-term contract. This project was abandoned, after Mr. Suthren left the Museum. The appellant testified that the re-enactment business is improving and, as an example, the business made profits for the years 1996 and 1997. Also, the appellant projects that the year 2000 will be very profitable for the business.
[7] Indeed, the first few years were not very profitable. Since the appellant was new in the business of historical re-enactments, he got very few contracts. Major repairs were done on the Royaliste. The appellant testified that the costs of operation of the Royaliste are ostensibly the same regardless of the number of contracts.
[8] For the 1994 taxation year, the appellant also claimed business losses in the amount of $7,005.81 in respect of his electronic repair business, "Radcom". As he was unemployed, he received training on the operation of a small business through the Unemployment Office. He had to produce a business plan to be approved by the Office in order to remain eligible for unemployment insurance. His plan was to operate a business from his home in Shawville repairing electronic household items, such as TVs, VCRs, etc. The appellant advertised his services in the local newspaper and distributed business cards. The business was unsuccessful and the appellant terminated it after a year. The failure was mainly attributed to the sparse population in Shawville.
Appellant's position
[9] The appellant argues that the business losses claimed in both the "re-enactment business" and his "electronic repair business" should be allowed because he had a reasonable expectation of profit. With respect to Radcom, he admits that his business judgment might not be the most competent one, but he had a business motivation, as evidenced by the business plan. In regard to the Royaliste, the appellant submits that the re-enactment business was a genuine and unique business venture. He had the expectation that his business would make a profit. Also, he points out that it is normal that the expenses are higher than the revenues at the beginning of a business. However, the subsequent years proved to be profitable. He admits that he is passionate about his work of restoration of the Royaliste but this surely does not preclude him from having a profitable business.
Respondent's position
[10] Conversely, counsel for the respondent contended that no reasonable expectation of profit existed and that it is not likely that it will exist. He argued that the decision of the Federal Court of Appeal in Tonn v. The Queen, 96 DTC 6001 is not applicable in the case at bar. He submitted that there is a strong personal element in the present case and that therefore the applicable test should be the one set out in Moldowan v. The Queen, 77 DTC 5213, of the Supreme Court of Canada. This personal element, counsel contended, can simply be the love of something and need not be used personally by the taxpayer. Respecting the re-enactment business, counsel for the respondent submits that the contracts were sparse and irregular. The appellant could not predict when the business would be profitable. As to Radcom, the electronic repair business, counsel for the respondent argued that the appellant could not possibly have thought that it would be successful. The rural town of Shawville is not big enough to afford such a business and the appellant was aware of this. Furthermore, counsel for the respondent noted that the appellant abandoned this business after only one year without trying to put any effort in an attempt to make it profitable.
[11] Both counsel referred to the Federal Court of Appeal decision in Tonn v. The Queen (supra). Counsel for the appellant submitted that this decision should apply to the case at bar insofar that it stands for the principle that a subjective test should be applied in the present case and that the Court should not second-guess the taxpayer's business decision. Referring also to Tonn (supra), counsel for the respondent argued that an objective test as set forth in Moldowan (supra) should apply when there is a personal element. According to him, Tonn (supra) is limited to specific circumstances, such as when no personal element exists.
[12] The decision in Tonn (supra) has been cited countless times before this Court whenever the deductibility of business losses is raised. Subsequent decisions of both the present Court and the Federal Court of Appeal attempted to define the true import of this decision. I will not attempt to carry out this task once more. Instead, this passage from Tonn, cited by counsel for the appellant, summarizes very well the actual state of the law with respect to the phrase "reasonable expectation of profit". Linden J.A. stated at page 6009:
"The Moldowan test, therefore is a useful tool by which the tax-inappropriateness of an activity may be reasonably inferred when other, more direct forms of evidence are lacking. Consequently, when the circumstances do not admit of any suspicion that a business loss was made for a personal or non-business motive, the test should be applied sparingly and with a latitude favouring the taxpayer, whose business judgment may have been less than competent."
His honour further stated at page 6013:
"...where circumstances suggest that a personal or other-than-business motivation existed, or where the expectation of profit was so unreasonable as to raise a suspicion, the taxpayer will be called upon to justify objectively that the operation was in fact a business. Suspicious circumstances, therefore, will more often lead to closer scrutiny than those that are in no way suspect."
[13] In Watt Estate v. The Queen, 97 DTC 5459, the Federal Court of Appeal reiterated both decisions in Tonn (supra) and in the subsequent A.G. of Canada v. Mastri et al., 97 DTC 5420, the criteria applicable when interpreting the phrase "reasonable expectation of profit". In this case, the taxpayer attempted to deduct the expenses incurred in training her daughter to become an Olympic-calibre equestrian. In dismissing the appeal, Décary J.A. set forth the criteria applicable and stated at page 5460:
"With respect to the second alleged error, a fair reading of Tonn and Mastri allows us to posit: a) that a personal element may coexist with a profit motive; b) that where a personal element exists, it will prompt the Court to apply the reasonable expectation of profit test more assiduously; and c) that where the personal element is 'the dominant, motivating force', the taxpayer's burden may be considerably more onerous."
[14] One would think that the interpretation of the phrase "reasonable expectation of profit" is clear and unequivocal. Yet, counsel across the country would still appear before this Court in an attempt to argue otherwise and try to fit their case within the reasoning of Tonn. I find that Bowman T.C.C.J.'s approach to the interpretation of the phrase "reasonable expectation of profit" in Kaye v. The Queen, 98 DTC 1659, of assistance. His Honour wrote at page 1660:
"I do not find the ritual repetition of the phrase particularly helpful in cases of this type, and I prefer to put the matter on the basis "Is there or is there not truly a business?" This is a broader but, I believe, a more meaningful question and one that, for me at least, leads to a more fruitful line of enquiry. No doubt it subsumes the question of the objective reasonableness of the taxpayer's expectation of profit, but there is more to it than that .. It is the inherent commerciality of the enterprise, revealed in its organization, that makes it a business. Subjective intention to make money, while a factor, is not determinative, although its absence may militate against the assertion that an activity is a business.
One cannot view the reasonableness of the expectation of profit in isolation. One must ask "Would a reasonable person, looking at a particular activity and applying ordinary standards of commercial common sense, say 'yes, this is a business'?" In answering this question the hypothetical reasonable person would look at such things as capitalization, knowledge of the participant and time spent. He or she would also consider whether the person claiming to be in business has gone about it in an orderly, businesslike way and in the way that a business person would normally be expected to do."
His Honour concludes at page 1660:
"Ultimately, it boils down to a common sense appreciation of all of the factors, in which each is assigned its appropriate weight in the overall context. One must of course not discount entrepreneurial vision and imagination, but they are hard to evaluate at the outset. Simply put, if you want to be treated as carrying on a business, you should act like a businessman."
[15] It appears that the ultimate decision is one of appreciation of all the facts. The appellant was a credible witness and I accept his testimony. With respect to the "re-enactment business", I think that a genuine business exists. The appellant owned three other boats in the past but he never claimed to be carrying on a business. He testified that his intention was to operate a charter business. He knew people operating a similar business in Kingston. His market research might not have been as extensive as one would wish, nonetheless a reasonable person would likely believe that a charter business in Kingston, "the sailing capital of Canada", would be a viable and profitable one. Contrary to counsel for the respondent's submission that the fact the appellant did not pursue the charter business is indicative of a lack of reasonable expectation of profit, the Court is of the view that the appellant did act as a reasonable businessman. It would be absurd to find otherwise, expecting someone like the appellant to refuse other types of contracts while suffering losses.
[16] Although the appellant has a passion for boating and woodworking, he testified that the Royaliste could not be used for recreational purposes for himself or his family. The Royaliste requires a crew of eight or nine people to operate. It was stored on the appellant's farm and had to be brought by car to a dock. Long preparation is needed before sailing the boat.
[17] Counsel for the respondent also argued that a strong personal element exists in the case at bar. He claimed that the personal element is the personal satisfaction the appellant gets from working on the boat. I think that this argument is devoid of merit. The personal element referred to in Tonn (supra) is personal benefit derived from the property or the business. The appellant does not contest that he has a passion for woodworking. However, it would be ridiculous to think that to dress up in costumes, adapt the vessel to different battle scenes and to re-enact sea battles could be a passion.
[18] Lastly, counsel for the respondent submitted many decisions in which the taxpayer owned a yacht and claimed to be operating a charter business. In my opinion, these decisions do not apply to the case at bar because the appellant is not operating a charter business. Moreover, he is operating a unique re-enactment business. He demonstrated that this business could become profitable, as shown by the slow but steady income over the years.
[19] With respect to the electronic repair activity, the Court is of the view that the appellant did not carry out a business and did not have a reasonable expectation of profit. Even though a business plan was produced, I do not think that it is indicative of any real intention to carry on a profitable business. The business plan was drafted for other purpose than a business one. Presumably, it was drafted to satisfy the requirements of the unemployment program the appellant participated in. Therefore, a strong personal element led to the creation of Radcom. The objective and more stringent test set out in Moldowan (supra) is applicable.
[20] As pointed out by counsel for the respondent, the appellant lived in the town of Shawville for over twelve years. He is cognizant of the small population and the remoteness of the town from major cities. No reasonable man would carry on such a business in a town where this type of business is not required. I also note that the advertisement the appellant purported to have published in the local newspaper for this business only refers to "amateur, commercial and digital communications – sales, service, consulting". This description appears to be too vague and I seriously doubt if it really attracted any clients.
Conclusion
[21] For these reasons, the appeal is allowed with respect to the business losses incurred in the re-enactment business for the 1992, 1993 and 1994 taxation years. With respect to the expenses incurred for the electronic repair activities, Radcom, the appeal is dismissed and the losses in the amount of $7,004.81 are disallowed.
Signed at Ottawa, Canada, this 25th day of May 1999.
"J.A. Brulé"
J.T.C.C.