Date: 20010718
Docket: 1999-1366-IT-G
BETWEEN:
BRIAN RIKLEY,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
Reasons for Judgment
Bowman, A.C.J.
[1] These appeals are from assessments for the 1990, 1991, 1992 and 1993 taxation years. The issue is whether the appellant is entitled to deduct losses incurred in chartering a C & C 51 yacht (called "Spice II") in the British Virgin Islands ("BVI"). In the evidence and argument the issue was stated to be whether the appellant had a "reasonable expectation of profit". The fundamental question that must be answered in cases of this sort is "Is there or is there not a business?"
[2] The appellant bought Spice II in 1990 and operated it during and after the years under appeal as a full service crew sailing yacht. It claimed substantial losses in those years:
1990 1991 1992 1993
$188,071.93 $232,787.89 $243,401.40 $129,798.87
Although the revenues and most of the expenses were in US dollars these figures are in Canadian dollars.
[3] Of these amounts, the following represented capital cost allowance ("CCA"):
1990 1991 1992 1993
$Cdn $86,653.22 $145,826.00 $145,826.00 $76,026.73
[4] The CCA claimed was the result of accelerated CCA allowed in respect of Canadian vessels under paragraph 1100(1)(v) of the Income Tax Regulations. Yet it is that very accelerated depreciation given as an incentive to encourage the building of vessels in Canada that in part gives rise to the losses which the Minister of National Revenue uses to justify the assertion that the appellant had no reasonable expectation of profit. This is a striking example of the difficulties to which the statement of Dickson J. in Moldowan v. The Queen, [1978] 1 S.C.R. 480, leads that one has no reasonable expectation of profit unless one can show a profit after deducting capital cost allowance. I shall not repeat what I said about that statement in Roopchan v. The Queen, 96 DTC 1338, beyond observing that the existence or non-existence of a REOP should not depend on the rates of CCA allowed or the amount of CCA claimed.
[5] The appellant was an experienced and successful businessman with a substantial income. From 1985 to 1989 he operated a bareboat charter of a yacht called Marathon Rummer in the BVI. The Minister erroneously assumed that it was called Spice I. Nothing turns on this error. Marathon Rummer was operated at a loss. The bareboat operation was an arrangement with Nova Scotia Yacht Charters under which the appellant received 60% of the revenues and Nova Scotia Yacht Charters received 40%. The operation was not a success and was abandoned in 1989. Marathon Rummer was sold in 1991.
[6] In addition to this venture the appellant had been involved in other ventures involving the manufacture and sale of boats and sails and was experienced with boats, having grown up on the Great Lakes and having been involved extensively in owning, sailing and racing yachts in North America.
[7] In 1990 the appellant bought Spice II, a fast sailing sloop with two cockpits and two staterooms. From the pictures in the advertisements it appears to have been upscale and luxurious. It had a retractable centreboard rather than a keel which enabled it to go into shallower waters than it could if it had had a keel. It sleeps six. The appellant was able to negotiate a favourable purchase price of $335,000, a reduction of over $100,000 US from the original asking price, possibly because the manufacturer, C & C Industries, was in bankruptcy.
[8] The purchase was financed in part by a marine mortgage of $279,000 US for which further security was given on the appellant's home in Hudson, Quebec. The $279,000 mortgage was subsequently reduced to $269,000 US.
[9] With Spice II the appellant decided that arrangements of the type he had with Marathon Rummer were not suitable and that he would run the business himself as a full service crew sailing yacht. The crew of Spice II consisted of a captain and a cook, who acted as hosts, operated the yacht, and provided entertainment and meals to clients.
[10] Cruises were arranged through brokers who charged a commission of 15% of the cruise fee.
[11] A great deal of advertising was done throughout the period in question, particularly through a publication, Yacht Connections, which published "The Leading Charter Yachts of the World" in several languages. This publication advertises and illustrates some very fancy yachts indeed, including Spice II.
[12] On November 4, 1991 the appellant wrote to the Government of the BVI and applied for a trade licence to operate in the BVI. With his letter he projected revenues and expenses in the first five years as follows: (US$)
1 2 3 4 5
Revenues $127,000 $140,000 $159,000 $228,000 $240,000
Expenses $126,000 $128,000 $140,300 $194,100 $205,100
(no depreciation)
[13] The actual figures in the first years (1991-1995) as reported by the appellant, were: (US$)
1991 1992 1993 1994 1995
Revenues $55,813 $70,904 $120,965 $134,467 $133,763
[14] In 1990 there were gross revenues of $6,000 and expenses of $194,071.93 for a loss of $188,071. This included CCA of $86,653 Cdn.
[15] The expenses on the statements of profit and loss are a little confusing. In 1991 a gross figure for expenses is shown of $158,684.19 US without CCA, to arrive at a loss of $102,870.46 US when the figure is converted to Canadian currency and CCA of $145,836 Cdn and office expenses of $373.20 Cdn are claimed we have a loss of $264,057.89 Cdn.
[16] In 1992 we have two groups of expenses, $84,253 US plus $193,607 US, to arrive at a loss of $206,955 US. If we remove the CCA of $126,201 US we arrive at a loss of $80,754 US.
[17] In 1993 we have two groups of expenses, $95,100 US and $133,075 US, resulting in a loss of $107,209 US. If we exclude the CCA of $65,795 US we have a loss of $41,414 US.
[18] For 1994 we have again two groups of expenses, $79,827 US and $52,954 US to arrive at a net income of $1,685 US.
[19] For 1995 a similar calculation (without CCA) yields a net profit of $479.77 US.
[20] The projections given to the Government of BVI were more sanguine than the actual results. Nonetheless, if we ignore CCA a profit was realized in 1994 and 1995. By 1994 CCA had run out on the yacht because of the accelerated straight line CCA treatment accorded to Canadian vessels. Therefore, if we follow strictly the statement of Dickson J. in Moldowan, the lack of CCA should have no bearing on the question of REOP in 1994 because CCA was fully deducted in prior years and therefore there was nothing to deduct. If, on the other hand, we read "accounting depreciation" for CCA in the obiter dictum of Dickson J., there is no evidence upon which I could decide what an appropriate rate of depreciation should be. Mr. Dubois, the assessor called as a witness for the respondent, prepared "theoretical" profit and loss statements in which he used two alternative straight line depreciation rates, one based on a life of eight years, the other on a 20 year life. Before I review his report I shall deal with several preliminary points.
(a) The losses claimed in 1985 to 1989 from the operation of the bareboat chartering business of the Marathon Rummer were as follows: (Cdn$)
1987 $47,680
1988 $60,040
1989 $27,180
The respondent contends that I should consider the losses from that business in deciding whether the operation of Spice II had a REOP. It is true that the prior history of losses in a business may be a factor but it is important to emphasize that while they may be of historical interest in the context of a prospective determination of an expectation of profit, the real question is whether there is a business.
I do not think that the bareboat charter of Marathon Rummer sheds much light on whether the chartering of Spice II is a business. It was a fundamentally different venture in association with someone else involving a different form of charter. The two operations are not comparable. The bareboat business did not work out and the appellant terminated it after several years and moved on to the Spice II operation.
(b) The respondent assumed on assessing that the appellant used Spice II for personal vacations. This was a fundamental assumption and the evidence is unequivocal and unchallenged that he did not. If he sailed or raced on vacation he chartered other sailing craft or used other persons' boats.
(c) The Crown makes some point of the fact that Spice II was put in the appellant's name personally for tax reasons on the advice of his tax accountant. This is unquestionably true. The appellant had a high income and to put Spice II into a corporation so as not to take advantage of the high CCA on Canadian built vessels to reduce his personal income would have made no sense. In fact, when he moved to the BVI in 1996 he rolled Spice II into a Canadian corporation under section 85. I see nothing sinister in taking advantage of the incentives the government provides. Doing so hardly proves there is no REOP or no business.
(d) The Crown suggests that the bank, in lending the appellant the money to buy Spice II, took additional security on his house in Hudson, Quebec, and that this shows that the bank, at least, thought the venture had no REOP. In my view, it proves no such thing. Banks take security on whatever they can get their hands on and security on a house in Canada is vastly preferable to security on a yacht that is sailing around the Caribbean. It proves nothing about what the bank might have thought of the prospects of the business, even if the bank's opinion were relevant, which it is not.
[21] I come now to the analysis made by Mr. Dubois. His conclusion was that even in 1994 when the appellant reported a profit there was no profit. He bases this conclusion on a number of considerations. Essentially the implication in his report is that the appellant artificially inflated the income from Spice II in that year either by exaggerating the revenues or understating the expenses.
[22] Mr. Dubois has concluded that a cruise for which the Maura family contracted did not take place, or, at all events a deposit of $2,400 US was counted twice in the appellant's 1994 revenues. In the result, he contends, the 1994 revenues are overstated by either $2,400 US (the amount of the deposit) or $8,950 US (the full amount of cruise fee). The evidence does not support the contention. Mr. Rickley's testimony was unchallenged. The Maura cruise took place toward the end of 1994 after two cancellations, the second of which resulted in a forfeiture of the deposit.
[23] Mr. Dubois' second concern was with the Campbell charter. It appears that no salaries were paid in September, October and November of 1994, and there were problems with the crew, Ian and Suzanne, about their salaries.
[24] Mr. Rickley explained that, during the period when he was having a dispute with the crew and their departure to work on another ship, the Thalassi, was delayed, they agreed to work on the Spice II without a salary but they were allowed to keep all tips. I do not find this arrangement unbelievable. They left on good terms and may well have already been paid by the Thalassi.
[25] The new crew, which started in December, was paid in January of the following year. Mr. Dubois concluded that the absence of salaries indicated that the Campbell cruise did not take place and even suggested that some of the moneys credited to the Campbell cruise may have been deposited there by the appellant himself. I would need cogent evidence to accept such an improbable hypothesis.
[26] I am satisfied with the explanations given by Mr. Rickley. I am also satisfied that the Campbell cruise took place.
[27] Mr. Dubois also doubts that the Burguess and Watts charters took place because on his analysis there was insufficient food purchased for them. One point of contention was a freezer that Mr. Rickley bought for Spice II. Mr. Dubois did not believe that it could be made to work. The fact is it did work and it explains why food could be purchased and stored in advance of a cruise.
[28] The Yurch charter was another one to which Mr. Dubois took exception. It took place in 1995 but Mr. Dubois objected to the fact that the income was included in 1994, which he sees as another distortion of the 1994 income. The short answer is that the money was received in 1994 and under paragraph 12(1)(a) of the Income Tax Act had to be included in income in that year even though the services were to be performed in the following year. Paragraph 20(1)(m) permits but does not require a reserve to be taken.
[29] The overall conclusion of Mr. Dubois was that revenues were overstated and expenses understated in an attempt to inflate the 1994 income so as to establish that by 1994 Spice II was showing a profit.
[30] Mr. Dubois attempted to show that Spice II did not have a profit in 1994 and, depending on whether the four charters mentioned above took place, it had a loss of either $60,979 or $21,300 Cdn. If they did not take place the respondent contends that the loss should be $60,979. If they did the respondent says there was still a loss of $21,300.
[31] I will not deal with the hypothesis that these charters did not take place. I find that they did.
[32] To arrive at the loss of $21,300 Cdn under the second hypothesis, one has to deduct from the declared profit of $2,302 the following.
(a) The deposit of $2,400 US which Mr. Dubois says was double counted. I find it was not. It was forfeited after the second cancellation.
(b) The $4,130 US for the Yurch charter which took place in 1995. This fee had to be included in the year in which it was received, 1994, by reason of paragraph 12(1)(a).
(c) The salary of $8,250 US that should have been paid for September to November. I have accepted the appellant's explanation of this.
[33] While I commend Mr. Dubois' tenacity and thoroughness his conclusions are based in large measure on conjecture and erroneous assumptions of fact.
[34] Indeed, even if I accepted that a loss of $21,300 was sustained in 1994 it would not have affected my conclusion that Mr. Rickley was carrying on a business.
[35] I am satisfied that from the inception of the business in 1990 the revenues increased during the ensuing five years, as did the number of charters. Mr. Rickley made great efforts to increase revenues and reduce expenses. I do not accept that Mr. Rickley artificially inflated the 1994 income. Indeed, Spice II is still operating although it is run by the appellant's son.
[36] It is not necessary for me to reproduce in detail the very thorough analysis of the business made by the appellant's tax advisor, Ms. Danielle Lacasse, in Exhibit A-46, described as a "Memorandum of Representations". It, as well as the evidence of Ms. Lacasse and Mr. Rickley, whom I found to be credible and impressive witnesses, demonstrate a tightly controlled and well run business that in a relatively short period of time became profitable. I have concluded that this was a genuine business and the losses are deductible.
[37] It is sufficient to summarize my reasons briefly.
(a) If it was not a business what was it? It was no hobby. There was no personal element. The REOP principle should be applied with great caution in such circumstances. (Tonn et al. v. The Queen, 96 DTC 6001; Keeping v. The Queen, 2001 F.C.A. 182; Bélec v. The Queen, 95 DTC 121; and Walls v. The Queen, 2000 DTC 6025 (under appeal to S.C.C.).)
(b) The Minister should not second guess the appellant's business judgement. That is precisely what the Minister has tried to do here. (Keeping; Tonn; Nichol v. The Queen, 93 DTC 1216; Kuhlmann et al. v. The Queen, 98 DTC 6652; Bélec; and Smith v. The Queen, 96 DTC 1886.)
(c) By any objective standard the operation looks like a business and is operated in a businesslike way on recognized business principles. As was said in Kaye v. The Queen, 98 DTC 1659, at p. 1660:
[4] 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. How can it be said that a driller of wildcat oil wells has a reasonable expectation of profit and is therefore conducting a business given the extremely low success rate? Yet no one questions that such companies are carrying on a business. 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.
[5] 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 as orderly, businesslike way and in the way that a business person would normally be expected to do.
[6] This leads to a further consideration — that of reasonableness. The reasonableness of expenditures is dealt with specifically in section 67 of the Income Tax Act, but it does not exist in a watertight compartment. Section 67 operates within the context of a business and assumes the existence of a business. It is also a component in the question whether a particular activity is a business. For example, it cannot be said, in the absence of compelling reasons, that a person would spend $1,000,000 if all that could reasonably be expected to be earned was $1,000.
[7] 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.
(d) The Minister applied the REOP test in the first year of the business. The taxpayer is entitled to a reasonable period to get the business established (Keeping). At least five years is not unreasonable in a business of this type where the charter operation has to build up its reputation, clientele, and goodwill over a period of years.
(e) The appellant took advantage of certain favourable tax provisions relating to accelerated CCA on Canadian built vessels. This cannot be used to enhance the Minister's REOP argument.
(f) There is nothing irrational, absurd or ridiculous in the appellant's expectation of profit (Kuhlmann).
[38] In short this strikes me as an ordinary commercial operation and, notwithstanding the consummate skill with which Me Labbé, counsel for the respondent, presented the Crown's case, I can see no justification for applying the REOP principle in this case.
[39] The appeals are allowed with costs and the assessments for the 1990, 1991, 1992 and 1993 taxation years are referred back to the Minister of National Revenue for reconsideration and reassessment to allow the deduction of the losses claimed from the business of chartering Spice II.
Signed at Toronto, Canada, this 18th day of July 2001.
"D.G.H. Bowman"
A.C.J.
COURT FILE NO.: 1999-1366(IT)G
STYLE OF CAUSE: Between Brian Rikley and
Her Majesty The Queen
PLACE OF HEARING: Montréal, Quebec
DATE OF HEARING: June 18, 19 and 20, 2001
REASONS FOR JUDGMENT BY: The Honourable D.G.H. Bowman
Associate Chief Judge
DATE OF JUDGMENT: July 18, 2001
APPEARANCES:
Counsel for the Appellant: André P. Gauthier, Esq.
Josée Vigeant
Counsel for the Respondent: Nathalie Labbé
COUNSEL OF RECORD:
For the Appellant:
Name: André P. Gauthier, Esq.
Firm: Heenan Blaikie
Montréal, Quebec
For the Respondent: Morris Rosenberg
Deputy Attorney General of Canada
Ottawa, Canada
1999-1366(IT)G
BETWEEN:
BRIAN RIKLEY,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
Appeals heard on June 18, 19 and 20, 2001 at Montréal, Quebec, by
The Honourable D.G.H. Bowman
Associate Chief Judge
Appearances
Counsel for the Appellant: André P. Gauthier, Esq.
Josée Vigeant
Counsel for the Respondent: Nathalie Labbé
JUDGMENT
It is ordered that the appeals from assessments made under the Income Tax Act for the 1990, 1991, 1992 and 1993 taxation years be allowed and the assessments be referred back to the Minister of National Revenue for reconsideration and reassessment to allow the deduction of the losses claimed from the business of chartering Spice II.
Signed at Toronto, Canada, this 18th day of July 2001.
|
"D.G.H. Bowman" |
A.C.J.