[OFFICIAL ENGLISH TRANSLATION]
2000-3767(IT)I
2000-3769(IT)I
BETWEEN:
RICHARD TURCOTTE,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
Appeals heard on November 28, 2001, at Montréal, Quebec, by
the Honourable Judge P.R. Dussault
Appearances
Counsel for the Appellant: Mathieu Turcotte
Sylvie Boulanger
Counsel for the Respondent: Mounes Ayadi
JUDGMENT
The appeals from the assessments made under the Income Tax Act for the 1997 and 1998 taxation years are dismissed in accordance with the attached Reasons for Judgment.
Signed at Ottawa, Canada, this 9th day of April 2002.
|
"P.R. Dussault" |
J.T.C.C.
Translation certified true
on this 29th day of July 2003.
Sophie Debbané, Revisor
[OFFICIAL ENGLISH TRANSLATION]
Date: 20020409
Docket: 2000-3767(IT)I
2000-3769(IT)I
BETWEEN:
RICHARD TURCOTTE,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
REASONS FOR JUDGMENT
P.R. Dussault, J.T.C.C.
[1] These are appeals from assessments made under the Income Tax Act ("the Act") for the 1997 and 1998 taxation years. By those assessments, the Minister of National Revenue ("the Minister") disallowed the appellant's deduction of $24,524 and of $23,238 in business losses for each of those years, respectively, on the ground that the appellant had no reasonable expectation of profit from his activities during the years at issue.
[2] In making the assessment for 1997, the Minister assumed the facts set out in subparagraphs 12(a) to (r), except subparagraph (k), of the Reply to the Notice of Appeal in file No. 2000-3767(IT)I. Those subparagraphs read as follows:
[TRANSLATION]
(a) at all relevant times, the appellant was retired and his income basically came from pension benefits and his retirement pension;
(b) at all relevant times, the appellant carried on a horticultural activity under the name "R.F.T. Enterprises International" (hereinafter "the business");
(c) at all relevant times, the appellant resided at 4911 Boul. de Maisonneuve Ouest in Montréal and operated the business at the same address;
(d) the business was registered on September 24, 1992;
(e) the business had been operating since 1992 under the name "Happy Plants/Les plantes Heureuses" (hereinafter "the enterprise"), which specialized in growing and selling hydroponic plants;
(f) the hydroponic plants were grown in the basement of the appellant's home;
(g) the appellant has reported the following gross income and net losses since 1992:
|
YEAR |
GROSS INCOME |
(NET LOSS) |
|
|
|
|
|
1992 |
$0 |
($9,569) |
|
1993 |
$4,886 |
($17,351) |
|
1994 |
$1,228 |
($28,259) |
|
1995 |
$1,384 |
($26,044) |
|
1996 |
$1,587 |
($23,480) |
|
1997 |
$433 |
($24,524) |
(h) according to the appellant, the hydroponic plant enterprise ceased operating during the 1997 taxation year;
(i) on August 24, 1999, the auditor sent the appellant a questionnaire to determine whether he had a reasonable expectation of profit from his activities;
(j) the following information was provided by the appellant:
• he had no occupational training or practical experience when he began his plant enterprise;
• there had been no increase in gross income since the start of the business, and the appellant did not expect any in the future because he planned to cease the activity in 1997;
• about 200 plants were grown in the basement of the appellant's home;
• since retiring, the appellant had devoted about 30 to 40 hours a week to his horticultural activity;
• the appellant prepared various advertising brochures and tried to find customers at hardware stores and florists;
• the appellant has no plan to make his enterprise profitable and no expansion plans;
• the lack of financing, the limited funds available for advertising, the Canadian dollar exchange rate and the high cost of production and imported products were significant factors in the failure of this pilot project;
. . .
(l) the appellant did not include any financial statements in his tax return for the 1997 taxation year;
(m) to his notice of objection of April 11, 2000, the appellant attached financial statements showing the following distribution of his income and expenses:
|
Description |
Total |
Happy Plants |
Consulting |
|
|
|
|
|
|
Gross income |
$433 |
$433 |
$0 |
|
minus: |
|
|
|
|
Expenses |
$23,679 |
$6,531 |
$16,788 |
|
Depreciation |
$1,278 |
$271 |
$1,007 |
|
Total expenses |
$24,957 |
$6,802 |
$17,795 |
|
|
|
|
|
|
Net loss |
($24,524) |
($6,369) |
($17,795) |
(n) although the appellant said that he had ceased his horticultural activity in 1997, he claimed a net loss of $23,238 from that activity in his tax return for the 1998 taxation year, a loss that included $23,238 in expenses, and did not report any income from that source;
(o) as in the previous years, the main expense claimed for 1997 was the salary of $15,908 paid to his wife;
(p) the appellant ceased his consulting activities during the 1999 taxation year;
(q) the appellant has not shown that the expenses claimed for the year at issue in connection with the horticultural activity he carried on in the basement of his home were incurred to make a profit therefrom or with a reasonable expectation of earning income therefrom;
(r) the appellant has not shown that the expenses claimed for the year at issue in connection with his consulting activity were incurred to make a profit therefrom or with a reasonable expectation of earning income therefrom.
[3] Only subparagraphs (c), (d), (i), (o) and (p) were admitted. The other subparagraphs were denied in their entirety, aside from subparagraph (j), the fifth and seventh points of which were admitted.
[4] In making the assessment for 1998, the Minister assumed the facts set out in subparagraphs 13(a) to (m), except subparagraph (h), of the Reply to the Notice of Appeal in file No. 2000-3769(IT)I. Those subparagraphs read as follows:
[TRANSLATION]
(a) at all relevant times, the appellant was retired and his income basically came from pension benefits and his retirement pension;
(b) at all relevant times, the appellant carried on various activities under the name "R.F.T. Enterprises International" (hereinafter "the business");
(c) at all relevant times, the appellant resided at 4911 Boul. de Maisonneuve Ouest in Montréal and operated the business at the same address;
(d) the business was registered on September 24, 1992, and its main activity was growing and selling hydroponic plants;
(e) the appellant has reported the following business income and losses since 1992:
|
YEAR |
GROSS INCOME |
(NET LOSS) |
|
|
|
|
|
1992 |
$0 |
($9,569) |
|
1993 |
$4,886 |
($17,351) |
|
1994 |
$1,228 |
($28,259) |
|
1995 |
$1,384 |
($26,044) |
|
1996 |
$1,587 |
($23,480) |
|
1997 |
$433 |
($24,524) |
|
1998 |
$5,439 |
($23,239) |
(f) according to the appellant, the hydroponic plant enterprise ceased operating during the 1997 taxation year;
(g) on August 24, 1999, the auditor sent the appellant a questionnaire to determine whether he had a reasonable expectation of profit from his activities;
. . .
(i) according to the financial statements filed with the appellant's tax return for the 1998 taxation year, the income, expenses and losses from the appellant's activities were distributed as follows:
|
Description |
Total |
Happy Plants |
Consulting |
|
|
|
|
|
|
Gross income |
$3,371 |
$1,140 |
$2,231 |
|
minus: |
|
|
|
|
Expenses |
$23,559 |
$23,559 |
$0 |
|
Depreciation |
$820 |
$820 |
$0 |
|
Total expenses |
$24,378 |
$24,378 |
$0 |
|
minus: |
|
|
|
|
Home expenses |
$2,231 |
$0 |
$2,231 |
|
Net loss |
($23,238) |
($23,238) |
$0 |
(j) to his notice of objection of April 11, 2000, the appellant attached revised financial statements showing the following distribution of his income and expenses:
|
Description |
Total |
Happy Plants |
Consulting |
|
|
|
|
|
|
Gross income |
$3,371 |
$1,140 |
$2,231 |
|
minus: |
|
|
|
|
Expenses |
$23,559 |
$0 |
$23,011 |
|
Depreciation |
$820 |
$0 |
$820 |
|
Total expenses |
$24,378 |
$0 |
$23,830 |
|
minus: |
|
|
|
|
Home expenses |
$1,140 |
$1,140 |
$0 |
|
Net loss |
($22,147) |
$0 |
($21,599) |
(k) as in the previous years, the main expense claimed by the appellant for 1998 was the salary of $15,908 paid to his wife;
(l) the appellant ceased his consulting activities during the 1999 taxation year;
(m) the appellant has not shown that the expenses claimed for the year at issue in connection with his horticultural and consulting activities were incurred to make a profit therefrom or with a reasonable expectation of earning income therefrom;
[5] Subparagraphs (b), (c), (g), (i), (k) and (l) were admitted. The other subparagraphs were denied.
[6] The appellant is a retired federal employee. He made his career as a commercial attaché at various Canadian embassies abroad. He retired from the federal government in 1991. In 1992, he worked for the Ministère des Relations internationales of Quebec. He retired in early 1993.
[7] In September 1992, the appellant registered a sole proprietorship by the name of "RFT Enterprises International Reg./Les Entreprises RFT International Enr." ("RFTI") in order, he said, to structure his hydroponics and consulting activities. The name "Happy Plants/Les Plantes heureuses" was used to designate the hydroponics side of the business.
[8] According to the appellant, his interest in hydroponics resulted from the fact that it was a type of cultivation that was very popular in Europe, especially in Germany, Austria and the Scandinavian countries, where 50 percent of indoor ornamental plants were grown in that way, whereas the technique was not used in Canada.
[9] The technique involves growing a plant without potting soil in a special pot with an inner tray containing pellets of expanded clay to replace the soil. The pot contains a special nutrient solution. A water-level indicator placed in each pot ensures proper watering.
[10] The appellant said that he learned the technique himself in Europe and that, with his wife's help, he began that type of cultivation in Quebec. The appellant's wife had a great deal of experience with Japanese flower arrangement ("Ikebana") and had won several prizes at shows in both Europe and Canada. The appellant said that, although he found a few pots here that could be suitable for hydroponics, he actually had to import the necessary equipment from Germany, which necessarily increased costs, especially because of the drop in the Canadian dollar exchange rate.
[11] The experiment therefore started slowly, more as a hobby for the appellant's wife, who grew the plants in the basement of their home with the intention of eventually renting space elsewhere. The appellant said that his wife did not devote all her time to this since she also had to do the secretarial work for the consulting side of his activities, to which I will return a little later.
[12] As regards the market for the hydroponic plants, it was in 1994 that the appellant himself made more extensive efforts to find appropriate retailers. He said that the market was limited and was confined to florists because the plants were a "clean product" that could not be sold in garden centres or hardware stores. The appellant said that, the same year, he identified a network of 12 florists operating under the name "Jardins Directs" who agreed to put his plants on display in five or six of their stores. He said that he also made displays for his products himself. The arrangement with the stores was that the plants would be sold on a commission basis. The appellant also referred to another store in Place Alexis Nihon where his attempts to place his plants were met with little success. The appellant having failed to develop the market for this new product sufficiently, the experiment proved to be unsuccessful overall. Between 200 and 300 plants a year were sold, whereas he said that he would have had to sell 5,000 to cover his overhead. The appellant also referred to the economic problems that florists were generally having at the time, which could explain his lack of success.
[13] On cross-examination, the appellant admitted that he had applied for a grant in 1994 from RESO (Regroupement pour la relance économique et sociale du sud-ouest) so he could pursue his hydroponics project elsewhere than in his basement and that he had been told that his activity was too small-scale. According to the appellant, his activity needed to be at a more developed stage to receive a grant.
[14] The appellant said that, in 1996, he concluded that the experiment was not going very well and he started to turn to another market, that is, artistic arrangements, including fountains and plants for the offices of senior corporate executives.
[15] In June 1996, the appellant contacted a company called Alpha ("Alpha"), one of the largest providers of office plants. According to the appellant, Alpha expressed an interest in hydroponics, especially because of the high cost of the watering service for which it had to pay. Since hydroponics requires much less frequent watering, Alpha saw it as a way to reduce its costs, provided that the technique proved to be efficient for the large plants in which it specialized. Until then, the appellant had concentrated on growing small plants. A pilot project therefore began in the summer of 1996. Alpha lent the premises and imported the plants. The appellant invested his time but did not incur any expenses. Despite results that the appellant described as positive in terms of technical feasibility, the experiment, which he was already seeing as a good source of income for him- about $15,000 a year for work that would have required a quarter of his time- came to nothing. According to the appellant, Alpha's owner refused to commit himself because he was too busy and because the company had just taken over two competitors. Thus, despite two positive progress reports-the first in September 1996 and the last in December 1996, in which the appellant made a proposal for a co-operative agreement, without including any figures-no agreement or remuneration was negotiated with Alpha. Under pressure from the appellant, Alpha's owner finally decided in May 1997 not to commit himself.
[16] The appellant said that the $15,000 in earnings he could have expected was not the only benefit that could have resulted from an agreement since he also thought that he might be able to sell new products to Alpha's clients, especially plant arrangements with fountains for the offices of senior executives.
[17] The project with Alpha therefore ended in mid-May 1997 without the appellant being paid for anything. The appellant said that, at the end of June 1997, he also put an end to the hydroponics project as such. The remaining inventory was apparently liquidated in 1998. However, no expenses relating to the project were allegedly incurred in 1998. Exhibit A-1 filed in evidence also establishes that the hydroponics project ended on June 30, 1997. However, it should be noted that, in another document-Exhibit A-2, Tab 2, at page 2 of the questionnaire-the appellant stated that he had given up the hydroponics project for indoor ornamental plants at the end of 1998.
[18] In 1997, gross plant sales amounted to $992.52 and the gross profit was $433.27. In 1998, sales amounted to $3,207.93 and the gross profit was $1,139.51. For the same year, $2,231.25 reported as consulting fees or income must be added. The business loss claimed was $24,524 in 1997 and $23,238 in 1998.
[19] According to the appellant, while his wife was the one who primarily took care of hydroponics in 1992 and 1993, he devoted himself to consulting in various fields. He referred to an aerospace project with Russia in 1992 that never came to fruition. In 1993, he was retained by the Conseil d'affaires tchèques du Québec, which had obtained a grant from the Quebec government. The appellant said that he was paid $2,000 a month to organize and manage certain activities and that he received a total of $15,000 before the Quebec government terminated the grant because the Conseil had set up its offices in Prague. The appellant argued that Revenue Canada had failed to take that income into account to establish his business income for 1994. However, he admitted on cross-examination that he himself had reported $12,314.99 in gross income and $4,987 in net income from that activity separately as professional income and not as part of his income from RFTI.
[20] From May 1997 to May 1998, the appellant was in contact with the CPI Media group, which publishes the LUX lighting journal in France, about doing a feasibility study concerning a Franco-Canadian exchange trip to bring people involved in urban lighting and in the illumination of cities and monuments into contact with one another. The appellant said that his rate basis was $60,000 to $65,000 a year and that he could have earned a great deal from the project since he could have organized the mission, participated in the publishing and perhaps represented companies in the Canadian market. However, in spite of the efforts made and the expectations, the project fell through and did not generate any income.
[21] In the fall of 1997, the appellant, through his brother, was approached by E.E.S. Financial Services Ltd. ("E.E.S."), a company that provided senior corporate executives with the services of financial planning experts. E.E.S. wanted to market a new interactive, computerized financial planning service for employees of companies other than executives. It was looking for associates to whom it could pay a fee to sell its services to employers and break into the Quebec market. In February 1998, the appellant signed a contract with E.E.S. According to him, it could have earned him some $25,000 for about 10 contracts with companies. Despite the many efforts he made with large companies, the companies showed little interest, and the appellant had to content himself with $2,231.35 in fees for a single contract with C.P. Rail.
[22] In 1998, the appellant also took an interest in the preparation of tax returns. On November 14, 1998, he obtained a certificate of competency from H & R Block at the end of a study program.
[23] The appellant said that he put an end to all of his activities in 1999 and admitted that he did not file a tax return for that year.
[24] The appellant submitted extensive documentation concerning his various projects relating to both hydroponics and his so-called consulting activities (Exhibits A-2, A-6, A-7 and A-8). Several times, he also underscored his wife's participation both in the hydroponics project and as an assistant responsible for secretarial work and logistics for the other projects in which he took an interest over the years.
[25] As indicated in subparagraph 12(g) of the Reply to the Notice of Appeal for 1997 (file No. 2000-3767(IT)I) and in subparagraph 13(e) of the Reply to the Notice of Appeal for 1998 (file No. 2000-3769(IT)I), the appellant has claimed substantial losses of more than $152,000 since 1992. The greatest expense contributing to those losses was the annual salary of about $15,000 paid to his wife over the years. It must be recalled that the consulting activities in fact generated only a total of $2,231 in income in 1998 for the period of 1992 to 1998. It is true that the appellant reported gross income of $12,314.99 and net income of $4,987 in 1994 in connection with his activities for the Conseil d'affaires tchèques du Québec. However, as mentioned above, that amount was reported as professional income and not as income from RFTI. Moreover, separate expenses were claimed against the amount received.
[26] The hydroponics project generated only a total of $12,726 in gross income over eight years. The project was abandoned in mid-1997, as was the related Alpha project. The appellant's wife allegedly stopped working on the project at that time. The appellant himself said that in 1998 he merely liquidated the remaining inventory. When he filed his 1997 tax return, he allocated all of the expenses claimed to the hydroponics activity even though he had given it up mid-year. When he objected to the assessment, the distribution was changed: 25 percent of the expenses were allocated to hydroponics and 75 percent to consulting. For 1998, 100 percent of the claimed expenses, except the use-of-home expenses, were initially allocated to the hydroponics activity. In addition, use-of-home expenses amounting to $2,231 were initially claimed against the same amount of consulting income. At the objection stage, 100 percent of the expenses, except the use-of-home expenses, were allocated to the consulting activity. Reduced use-of-home expenses of $1,140 were claimed against the same amount of hydroponics income. The changes made can be traced in Exhibit A-4. What the appellant describes as accounting errors can only make one wonder. The way he initially presented things allowed him to deduct higher use-of-home expenses of $2,231, against the same amount of consulting income, since no other expenses were claimed against that income. As Exhibit A-4 also shows, the substantial losses claimed by the appellant do not include an additional amount-either of $12,416.52 or of $11,131.45-that was accumulated until 1998 as business-use-of-home expenses and that was reported as an available carryback. We know that the deduction of such expenses is prohibited by paragraph 18(12)(b) of the Act where the taxpayer otherwise incurs losses but that paragraph 18(12)(c) allows them to be carried forward to any year in which the taxpayer has income.
[27] While cross-examining the appellant, counsel for the respondent also noted other inconsistencies in the way the appellant had presented certain items in his financial statements. Thus, in the balance sheet submitted for 1997 (Exhibit I-1), the appellant included a bank loan of $65,490 in his liabilities. The appellant explained that this was a software error, that his line of credit at the bank was only for $25,000 and that the amount in question was actually what he had himself invested in the business. However, in the 1998 balance sheet (Exhibit I-2), the same items are used and a bank loan of $77,665 is reported.
[28] It may also be added that both documents (Exhibits I-1 and I-2) indicate an amount of $0 at the end of both 1997 and 1998 for the item "Total Inventory for Resale" in the assets. However, Exhibit A-4 states that the year-end inventory for 1997 was $11,000. For 1998, the figure shown for the year-end inventory is $9,125. Yet the appellant testified that he sold his remaining inventory in 1998.
[29] The issue of whether the Minister was justified in disallowing the appellant's deduction of a business loss of $24,524 in 1997 and of $23,238 in 1998 on the ground that the appellant had no reasonable expectation of profit from his hydroponics and consulting activities for 1997 and from his consulting activities for 1998 must be examined in this context.
[30] Counsel for the appellant argued that the appellant had a reasonable expectation of profit from both the hydroponics project and his consulting activities in 1997. With regard to 1998, she pointed out that the only issue, as set out in paragraph 14 of the Reply to the Notice of Appeal for that year, is whether the appellant had a reasonable expectation of profit from his consulting activity.
[31] She noted that the hydroponics project was not a hobby and that the appellant considered it a promising business given the untapped market. She submitted that the appellant had the know-how and technical expertise and that he was supported in the project by his wife, who was very competent in the area. When he realized that the retail sales were not profitable, the appellant tried to break into the retail market and then redirected his efforts by working with Alpha, a very large supplier of office plants. According to her, the fact that the new direction was abandoned in 1997 after Alpha refused to commit itself further was beyond the appellant's control.
[32] Counsel for the appellant argued that the reasonable expectation of profit test is basically designed to prevent the deduction of personal expenses and that, where there is no personal aspect, it must be accepted that a taxpayer might have made a poor business decision. According to her, the appellant changed direction when he realized that sales were not increasing, and he became involved in a serious project with Alpha, which, moreover, paid most of the expenses. She submitted that a taxpayer must also be given a reasonable period of time before it can be determined that the taxpayer has no reasonable expectation of profit.
[33] Counsel for the appellant based her arguments on the Federal Court of Appeal's decision in Tonn v. Canada, [1996] 2 F.C. 73. She also referred to the same Court's decision in Kuhlmann et al. v. The Queen, 98 DTC 6652, in arguing that the burden is on the Minister to establish that the expectation of profit is irrational, absurd or ridiculous in the circumstances.
[34] Counsel for the appellant also referred to the Federal Court of Appeal's decision in Keeping v. The Queen, 2001 DTC 5358, in arguing that it is not for the courts to second-guess a taxpayer's business decisions and that the taxpayer must be given the time needed to make his or her activity profitable. In the circumstances of that case, a period of five or six years was considered necessary.
[35] In support of her arguments, counsel for the appellant also referred to the decisions in Bélec v. The Queen, 95 DTC 121, and Rikley v. The Queen, 2001 DTC 756.
[36] With regard to the consulting activities, counsel for the appellant emphasized the seriousness of each project and the fact that the appellant contacted appropriate persons. According to her, the projects had no personal element and had a good profit potential. If they did not go as planned, it was simply because the appellant was unlucky. Here again, she argued that the Minister bears the burden of proving that the appellant did not have a reasonable expectation of profit. She submitted that the expenses claimed are genuine business expenses and that the Court therefore cannot substitute its judgment for the appellant's, even if he made some poor business decisions.
[37] With regard specifically to the salary the appellant paid his wife, counsel for the appellant argued that, even where an expense is substantial, it must still be asked whether there is a reasonable expectation of profit in light of all the tests adopted by the courts and the specific circumstances of the case. She submitted that, inasmuch as a person was hired, it was obviously for the purpose of making a profit and that the appellant cannot be criticized for hiring his wife because, if he had not had any employees, he would then have been criticized for failing to make all the necessary efforts. On this point, counsel for the appellant referred to the decisions in Nichol v. the Queen, 93 DTC 1216; Kuhlmann v. The Queen, supra; and Mohammad v. Canada, [1998] 1 F.C. 165 (F.C.A.).
[38] Counsel for the respondent argued that it is not for the Minister to prove that the appellant had no reasonable expectation of profit and that it is rather the appellant who must prove objectively that he had such an expectation.
[39] For the years at issue, he noted that the appellant initially allocated all of his expenses to the hydroponics activity and then allocated them in a completely different manner at the objection stage. He also pointed out the different way the appellant did his accounting for 1994, when the consulting income and the related expenses were recorded completely separately from the hydroponics activity and the net amount was reported as professional income.
[40] Counsel for the respondent submitted that the hydroponics activity was a hobby. He stressed that it began as a hobby and that it was confined to the basement of the home, which made it possible to deduct a $15,000 salary paid to the appellant's wife as well as certain home-related expenses. According to him, those are personal elements that must be taken into account. He submitted that the appellant's expectation of profit was unreasonable. Even though the appellant had some knowledge, he had no experience with this new product, which had to be imported and for which he had to find a market. He argued that the high costs and the low sales volume, that is 200 to 300 plants a year compared with the 5,000 needed for the appellant to cover his costs, as well as the lack of grants are additional factors to be considered. Counsel for the respondent also noted that the appellant had no business plan and was given all the time he needed to adapt (from 1992 to 1996), which he did not do, since the salary paid to his wife, the greatest expense, was never changed.
[41] With regard to the appellant's other projects, counsel for the respondent took the view that they were merely attempts to find business opportunities that yielded almost nothing concrete and that certainly do not make it possible to assert that the appellant had a reasonable expectation of profit in view, inter alia, of the expense of $15,000 for the salary paid to his wife year after year.
[42] Counsel for the respondent noted that a taxpayer's time, effort and reputation are not sufficient to establish that the taxpayer had a reasonable expectation of profit.
Analysis
[43] To begin with, it is important to note that it is wrong to claim that the burden is on the Minister, or rather the respondent, to prove that the appellant did not have a reasonable expectation of profit. Contrary to what counsel for the appellant argued, the Federal Court of Appeal's decision in Kuhlmann, supra, can certainly not be cited as an authority on that point. In that case, the burden of proof was reversed basically because of a late change in the basis of the assessments made by the Minister. Décary J.A. explained this situation as follows at paragraph 2 of the reasons for judgment:
2 A novelty in the two appeals before us is that as a result of a last-minute change in the basis of the assessments made by the Minister, it is the Minister who has the burden of proving that the partnership formed by the appellants ('Southern Cross Stables' or 'SCS') did not have a reasonable expectation of profit in the four taxation years under appeal, i.e. 1986, 1987, 1988 and 1989. The Minister had originally relied on section 31 of the Income Tax Act (loss from farming) which implies that there is a business and a reasonable expectation of profit.
[44] In Tonn, supra, Linden J.A. of the Federal Court of Appeal, after looking at the relevant case law, stressed the need to distinguish various situations for the purposes of applying the test taken from the Supreme Court of Canada's judgment in Moldowan v. The Queen, [1978] 1 S.C.R. 480. Thus, at paragraph 39 of the reasons for judgment, he stated:
. . . I otherwise agree that 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. However, 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.
[45] At paragraph 40, Linden J.A. then began his analysis by setting out the tests used by the courts as follows:
. . . A variety of factors have been proposed over the years by which objective reasonability might be demonstrated in given circumstances. In the original Moldowan decision, these factors were enumerated as follows:
The following criteria should be considered: the profit and loss experience in past years, the taxpayer's training, the taxpayer's intended course of action, the capability of the venture as capitalized to show a profit after charging capital cost allowance. The list is not intended to be exhaustive.56
Another listing of the factors to be assessed was set out in Sipley (P.D.) v. Canada:
The objective test includes an examination of profit and loss experience over past years, also an examination of the operational plan and the background to the implementation of the operational plan including a planned course of action. The test further includes an examination of the time spent in the activity as well as the background of the taxpayer and the education and experience of the taxpayer.57
Finally, Landry (C.) v. Canada suggests the following items to consider:
Apart from the tests set out by Mr. Justice Dickson, the tests that have been applied in the case law to date in order to determine whether there was a reasonable expectation of profit include the following: the time required to make an activity of this nature profitable, the presence of the necessary ingredients for profits ultimately to be earned, the profit and loss situation for the years subsequent to the years in issue, the number of consecutive years during which losses were incurred, the increase in expenses and decrease in expenses in the course of the relevant periods, the persistence of the factors causing the losses, the absence of planning, and failure to adjust. Moreover, it is apparent from these decisions that the taxpayer's good faith and reputation, the quality of the results obtained and the time and energy devoted are not in themselves sufficient to turn the activity carried on into a business.58
These quotations suggest that the list of relevant factors is growing and that it may continue to grow. What this indicates is that a detailed look at the business in the context of its operations is what is required, and that reasonableness is to be assessed on the basis of all the relevant factors, both the already listed ones and any new ones that may be helpful.
[Notes omitted.]
[46] In the case at bar, there is no doubt that a number of personal elements are present. First, the losses claimed by the appellant had the effect of considerably reducing his pension income and generating a tax refund for each of the years at issue. The expenses claimed, apart from the use-of-home expenses, include telephone expenses, motor vehicle expenses, the capital cost allowance related thereto, vehicle leasing costs and expenses for travel and business trips. By nature, all of those expenses may have a personal element. Next, there are the use-of-home expenses, which were recorded so that they could possibly be carried over. As mentioned earlier, the appellant had initially deducted part of those expenses from his consulting income of $2,231 in 1998. Subsequently, he claimed a reduced amount against the hydroponics income. Finally, there is the salary of about $15,000 that the appellant paid his wife every year. Although that salary was reported by the appellant's wife, the fact remains that it was likely to confer a personal tax benefit on him because of income splitting while keeping the amount for the couple's benefit. It is obvious that a situation such as that cannot be compared to the payment of a salary to an unrelated person.
[47] As counsel for the respondent pointed out, the context in which those expenses were claimed and the way they were initially claimed by the appellant for 1997 and 1998, as well as the change made at the objection stage, must also be noted. Moreover, it must be recalled that the gross hydroponics income for 1997 was only $433, while the net loss claimed was $24,524. No consulting income was reported in 1997. In 1998, the appellant reported a total gross income of $3,371, of which $1,140 was from hydroponics and $2,231 was from consulting. The net loss initially claimed for that year for the hydroponics was $23,238, which was disallowed, in addition to the amount of $2,231 claimed as use-of-home expenses against the consulting income. The changes made by the appellant at the objection stage have been indicated above. I simply do not believe that the initial allocation of the expenses between the hydroponics activity and the consulting activity for the years at issue was the result of an error that was simply corrected at the objection stage.
[48] According to the appellant, the hydroponics project that began in 1992 ended in June 1997, and his wife stopped looking after it at that time. He said that he himself had subsequently sold the remaining inventory, which he finished doing in 1998. However, Exhibit A-4 indicates that there was a significant inventory at the end of 1998. Since the appellant did not file a return for 1999, we do not know what became of it. Moreover, Exhibit A-2 contains documents indicating that the hydroponics activity did not end in June 1997 but continued at least for a good part of 1998. This should normally have resulted in certain expenses. In any event, the fact that more sales were made in 1998 than in 1997 should normally have led to a minimum amount of expenses. Yet the appellant, after initially allocating all of the year's expenses (aside from the use-of-home expenses) to hydroponics, allocated all of them to the consulting activity at the objection stage. In his testimony, the appellant also said that no expenses had been incurred in liquidating the inventory in 1998. It is quite difficult to understand and accept that statement.
[49] The changes made to the allocation of expenses for 1997 also raise questions. Initially, all of the expenses were allocated to hydroponics. Subsequently, at the objections stage, 25 percent of the expenses were apportioned to hydroponics and 75 percent to consulting.
[50] The way the appellant reported his consulting income and claimed separate expenses against that income in 1994 is also questionable. The fact that he presented his various activities sometimes as separate activities and sometimes as different aspects of RFTI most certainly contributes to maintaining some confusion.
[51] As mentioned earlier, in the financial statements submitted (Exhibits I-1 and I-2), the appellant included in his liabilities an amount that he actually considers to have been his investment in the business and indicated it as a bank loan. The explanation he gave is that this resulted from a software error. As in explaining the changes made to the allocation of expenses for 1997 and 1998, the appellant resorted to the overly facile explanation that there had been a software or accounting error. It is difficult to accept this kind of explanation when the same errors recur from one year to the next with respect to several items. This state of affairs leads more to the conclusion that there was, to say the least, an obvious lack of transparency that cannot help but affect credibility.
[52] The very nature of the appellant's activities also calls for several comments.
[53] The appellant started the hydroponics activity as a hobby. As a result of some knowledge he had acquired and his wife's experience, he began that form of cultivation, which is popular in Europe, here. Having no real business plan or actual knowledge of the potential demand for plants grown in that way, he took on the local market, which, quite obviously, did not meet his aspirations. The strictly commercial activity was never on as large a scale as he wanted. If 5,000 plants must be sold every year to cover one's costs and one is able to sell only 200 to 300 plants, and if this goes on for several years, it is quite clear that it is difficult to argue that one still has a reasonable expectation of profit.
[54] Thus, in 1996, after several years of efforts, the appellant himself concluded that the retail sale of ornamental hydroponic plants was not making progress. On this point, it will be recalled that the gross income was $1,228 for 1994, $1,384 for 1995 and $1,587 for 1996. The appellant carried on all the same, and in the summer of 1996 he tried to join forces with Alpha, a company that specialized in supplying office plants. Although the appellant said that he had demonstrated the feasibility of using the hydroponics technique to grow large office plants by means of a pilot project that ended in December 1996, Alpha refused to embark upon a business partnership with him and informed him of its decision in May 1997. Thus, despite his hopes of taking hydroponics in another direction and earning substantial income as a result, the appellant received absolutely no income from that experiment with Alpha and apparently put a complete end to his hydroponics project at the end of June 1997. It must be noted that, despite the abandonment of the project and the fact that the appellant's wife stopped devoting at least part of her time to it, the expenses and therefore the losses claimed by the appellant for the year are just as high as for the previous years.
[55] Given the number of previous years of losses, the acknowledgement of failure in 1996, the uncertainty of a business partnership with Alpha and the scrapping of the entire hydroponics project in June 1997, it is my view that in 1997 the appellant did not have a reasonable expectation of profit from the activities relating to that project.
[56] What about the appellant's various other activities, which he has grouped together as "consulting" activities? First of all, they were very diverse activities, some of which had little to do with actual consulting or with the appellant's previous professional activities. While the first activities referred to by the appellant for the period of 1992 to 1994 had a fairly direct connection with his former duties, personal financial planning for employees of companies and the preparation of tax returns had no such connection. Despite numerous steps taken in various directions for a variety of projects, it must be acknowledged that, on the whole, few concrete results were obtained.
[57] In 1997 and 1998 specifically, the project with the French company CPI (LUX journal) never came to anything, and the appellant got nothing out of it. The appellant's mere assertion that such a project could have generated so many thousands of dollars of income for him is not enough to say that there was a reasonable expectation of profit, since the steps taken remained at the preliminary stage, before the financial terms were negotiated and accepted or even discussed. This comment also applies to the project with Alpha discussed previously.
[58] As for the project with E.E.S., it represented a new direction for the appellant, who in fact had to test a new service in an unknown market. Despite his efforts, the financial planning service offered to companies for their employees found only one taker, and the appellant earned a modest income of $2,231 therefrom. The appellant, who said that he could have made a substantial profit of $25,000 or so by entering into about 10 contracts with large companies, did not show in any way that that was a realistic expectation based on a serious study of the potential market. In short, it was another activity that led nowhere, and the appellant once again turned in another direction. He registered for courses with H & R Block and in November 1998 obtained a certificate of competency to prepare tax returns. We do not know whether that activity led to anything since he did not file a tax return for 1999. In any event, he said that he ceased all his activities at the end of 1999, and RFTI's registration was struck off on April 28, 2000 (Exhibit A-5).
[59] It cannot be concluded from all of this that the failures were merely the result of bad luck. The appellant's lack of experience and lack of knowledge of the market must be emphasized, as must the lack of control over expenses that led to losses that were totally disproportionate to the reported income.
[60] During every year from 1992 to 1998, the appellant, regardless of the activity in which he was engaged, claimed substantial losses that often amounted to more than $20,000 and sometimes to more than $25,000 a year. For 1997 and 1998, irrespective of which activity the expenses were allocated to, it can be seen that they are basically the same expenses, which he assigned sometimes to one activity and sometimes to the other. A number of the expenses claimed, including his wife's salary, have an undeniable personal element. The appellant was allowed all of his losses from 1992 to 1996. The deduction of the losses claimed for 1997 and 1998 was disallowed. There comes a time when a taxpayer must show that the continuation of his or her activities is justified by a strictly business motivation and supported by a realistic business plan allowing for a reasonable expectation of profit and is not designed to conceal the deduction of certain expenses that may, moreover, have a personal element. In my view, the appellant has not shown this with the required degree of proof, that is, the balance of probabilities.
[61] As a result of the foregoing, the appeals are dismissed.
Signed at Ottawa, Canada, this 9th day of April 2002.
|
"P.R. Dussault" |
J.T.C.C.
Translation certified true
on this 29th day of July 2003.
Sophie Debbané, Revisor