Date: 20010710
Docket: 98-2779-IT-G, 98-2781-IT-G, 98-2783-IT-G
BETWEEN:
GEORGE W. PEARY, JOHN W. SHEWAN and ILZE SHEWAN,
Appellants,
and
HER MAJESTY THE QUEEN,
Respondent.
Reasons for Judgment
Mogan J.
[1] The appeals of George W. Peary v. The Queen (File no. 98-2779(IT)G), John W. Shewan v. The Queen (File no. 98-2781(IT)G) and Ilze Shewan v. The Queen (File no. 98-2783(IT)G) were heard together on common evidence. In each appeal, the taxation years in dispute are 1993, 1994 and 1995. At all relevant times, the three Appellants were the only partners in the ownership and operation of a retail floral outlet in Mission, British Columbia, operating under the name "Wayside Flowers". In the three years under appeal, Wayside Flowers reported losses as follows:
Taxation Year Net Loss
1993 $26,123.40
1994 16,206.38
1995 22,199.80
[2] The above losses were allocated among the three Appellants as partners. Each Appellant deducted his or her allocated share of the loss from employment salary in the computation of income. The Minister of National Revenue reassessed each of the Appellants for the purpose of disallowing the deduction of such losses. The Appellants have appealed from those reassessments. The only issue is whether the Appellants, as partners, had a reasonable expectation of profit from the operation of Wayside Flowers in the years under appeal.
[3] Two of the Appellants, John Shewan and Ilze Shewan, are husband and wife. For convenience, I shall refer to each individual Appellant by his or her first name as George, John and Ilze. All three Appellants are qualified high school teachers in the Province of British Columbia. At all relevant times, John and Ilze were employed full-time as teachers at the Abbotsford High School; and George was employed full time as the principal of that school. The retail floral outlet, Wayside Flowers, was located at Mission, a town on the north side of the Fraser River about 60 kilometres east of Vancouver. Abbotsford is only 12 kilometres south of Mission and south of the Fraser River. Wayside Flowers was therefore about a 10-minute drive from the Abbotsford High School where the three Appellants were employed.
[4] At the hearing of these appeals, Ilze testified at length and George testified briefly. Also, there were entered as Exhibits R-6 and R-7 the questions and answers (respectively) of the written examination for discovery of Ilze. Exhibit R-6 contains 66 questions. In these reasons, a reference to any answer in Exhibit R-7 will cite only the number of the corresponding question.
[5] Exhibit R-2 is an Agreement of Purchase and Sale dated March 27, 1981 under which Landmore Enterprise Ltd. purchased Wayside Gardens (the pleadings refer to the operation as "Wayside Flowers") as a going concern at a price of $110,000 plus the value of all stock for resale at cost. The purchase took effect as of the opening for business on April 1, 1981. The issued shares of Landmore Enterprise Ltd. ("Landmore") were owned equally by John and George. According to Ilze, Wayside Flowers had been in the retail floral business for about 35 years when it was purchased by Landmore in 1981. The statement of adjustments (Exhibit R-1) shows that the final purchase price paid by Landmore was $120,890.
[6] Immediately after the purchase, Landmore operated Wayside Flowers as a corporate enterprise. Ilze became the de facto manager of Wayside Flowers because she was on maternity leave. Even after she went back to full-time teaching, she continued to manage the Wayside Flowers operation. Because it had operated for so many years, Wayside had an extensive list of customers, professionally printed invoices and purchase orders, and an international connection with florists through "Flowers-by-Wire" and "Teleflora". They were required to lay off some staff in 1982 but she kept some full-time staff and hired new employees in 1984. In order to build staff loyalty, they provided extra benefits like a medical plan and paid the going rate for retail work in the Fraser Valley. Exhibit A-2 is the resumé of an employee hired in 1993 who had prior experience in floral arrangements.
[7] The employees worked from 9:00 a.m. to 3:00 p.m. without supervision. They took telephone orders locally and received orders by fax and "wire" from florists outside Mission, B.C. They cleaned the coolers where the cut flowers were stored and ordered fresh flowers. Ilze would check with the employees by phone during the day and, after school was out, she would go home and then directly to the shop. She would cash out at the end of the day; send out some invoices; and pay some suppliers. On most days, she would leave the flower shop between 6:30 and 7:00 p.m. Ilze worked a full day on Saturday as a floral designer because some of her staff was off. She did the bookkeeping on Sundays and worked full-time in the summer. She did not draw a salary or wages because the operation could not afford it.
[8] Belonging to the wire services (FTD and Teleflora) was important for the local delivery of flowers ordered from distant cities and towns, and for taking local orders for delivery in distant places. Field representatives from the wire services called and stopped by regularly to make sure that Wayside Flowers was maintaining required standards. A flower shop could be suspended by a wire service. Ilze said that she learned on-the-job. She also attended floral design workshops put on by wholesalers and wire services. She entered a competition for floral design and won in her category. She belonged to the Mission Rotary Club as a professional florist. George and John belonged to the Abbotsford Rotary Club where John was identified as "florist". Ilze said that business came from their participation in Rotary. It was a form of advertising.
[9] I am satisfied from the testimony of Ilze that she worked hard at managing Wayside Flowers and she genuinely tried to make the operation profitable. Notwithstanding her efforts, Wayside Flowers was not profitable from 1981 to 1987 when it was operated by Landmore. Exhibit R-4 is a letter dated November 12, 1988 from Kenneth P. Wiebe, a certified general accountant, writing in his capacity as accountant for Landmore. In his letter, Mr. Wiebe referred to the fact that Landmore had been losing money consistently since 1982; that such losses exceeded $100,000; and that Ilze (the "key person" operating Wayside Flowers) had not received any wage or salary for a number of years. Mr. Wiebe recommended that Wayside Flowers be sold to a partnership of participating workers who would provide personal services, and that the partnership lease the retail premises from Landmore. George and John (on behalf of Landmore) accepted Mr. Wiebe's advice. Wayside Flowers was transferred in 1988 to a partnership comprising George, John and Ilze. See Exhibit R-7, answer 17.
[10] I conclude from Mr. Wiebe's letter (Exhibit R-4) that Wayside Flowers had not enjoyed one profitable year after it was purchased by Landmore in 1981. The following passages taken from page two of Mr. Wiebe's letter speak for themselves:
6. It seemed totally obvious that if any one of the following three events were to occur, the corporation (i.e. Landmore) would be forced to declare bankruptcy:
a) Ilze Shewan would stop working or insist on a fair wage;
b) The shareholders would stop contributing funds to cover cash shortfalls.
c) Ilze & John Shewan would insist on payment of their back wages.
...
Some of the positive results of our recommendations are already evident. Although no immediate turn-around in profitability is evident, the participating partners receive some of the tax loss benefits incurred in the business.
Meetings were held with the shareholders and a program for the sale of the business and the operation of the partnership were concluded. Since the corporation was now relegated to rental income, the corporation's net income became positive and its deficit equity is now being reduced. The partnership is still incurring a loss but eventually expects to become a profitable business.
[11] Although Wayside Flowers (as a retail floral outlet) was transferred from Landmore to the three Appellants as partners in 1988, it continued to operate at a loss from 1988 right through to the three years under appeal. Ilze confirmed in her examination for discovery (Exhibit R-7, answer 19) that, from 1987 to 1995, Wayside Flowers reported losses as follows:
|
Taxation Year |
Gross Income |
Expenses |
Net Income (Loss) |
|
1987 |
$65,413.00 |
$89,922.00 |
($24,509.00) |
|
1988 |
58,425.00 |
90,669.00 |
(32,244.00) |
|
1989 |
96,346.00 |
131,666.00 |
(35,320.00 |
|
1990 |
130,194.00 |
148,538.00 |
(18,344.00) |
|
1991 |
134,299.00 |
174,109.00 |
(39,810.00) |
|
1992 |
124,974.00 |
133,868.85 |
(8,895.75) |
|
1993 |
95,606.00 |
121,729.40 |
(26,123.40) |
|
1994 |
87,741.00 |
103,947.38 |
(16,206.38) |
|
1995 |
74,850.00 |
97,049.80 |
(22,199.80) |
|
TOTAL |
$867,848.00 |
$1,091,530.30 |
($223,652.33) |
The above losses were allocated among the three partners as follows:
|
Taxation Year |
George |
John |
Ilze |
Total |
|
1987 |
($8,188.00) |
($9,246.00) |
($7,075.00) |
($24,509.00) |
|
1988 |
(8,005.00) |
(13,210.00) |
(11,029.00) |
(32,244.00) |
|
1989 |
(9,453.00) |
(14,505.00) |
(11,362.00) |
(35,320.00 |
|
1990 |
(3,335.00) |
(15,010.00) |
1.00 |
(18,344.00) |
|
1991 |
(8,976.00) |
(15,417.00) |
(15,417.00) |
(39,810.00) |
|
1992 |
4,028.89 |
(7,419.90) |
(5,504.74) |
(8,895.75) |
|
1993 |
(4,847.84) |
(11,551.93) |
(9,723.63) |
(26,123.40) |
|
1994 |
(3,601.68) |
(6,210.76) |
(6,393.94) |
(16,206.38) |
|
1995 |
(3,249.18) |
(9,557.21) |
(9,393.41) |
(22,199.80) |
[12] As stated above, the three years under appeal are 1993, 1994 and 1995. In those years, each Appellant deducted in computing income his or her allocated share of partnership loss shown in the above table. The share of partnership loss deducted by each Appellant was disallowed as a deduction in the reassessments under appeal on the basis that Wayside Flowers did not have a reasonable expectation of profit in any one the years under appeal. In Moldowan v. The Queen, 77 DTC 5213, Dickson J. wrote the reasons for judgment for the Supreme Court of Canada and stated at page 5215:
Although originally disputed, it is now accepted that in order to have a "source of income" the taxpayer must have a profit or a reasonable expectation of profit. Source of income, thus, is an equivalent term to business: ...
There is a vast case literature on what reasonable expectation of profit means and it is by no means entirely consistent. In my view, whether a taxpayer has a reasonable expectation of profit is an objective determination to be made from all of the facts. 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. The factors will differ with the nature and extent of the undertaking: ...
The principle taken from the decision of the Supreme Court in Moldowan is that a particular activity carried on by a taxpayer (or a number of taxpayers in partnership) will not be regarded as a "source of income" or as a "business" for income tax purposes unless that activity has a profit or a reasonable expectation of profit.
[13] The Federal Court of Appeal in Tonn et al v. The Queen, 96 DTC 6001 stated that the "reasonable expectation of profit" test taken from Moldowan should be applied sparingly when the circumstances indicated that a business loss was not made for a personal or non-business motive. The Federal Court of Appeal seemed to be concerned with a situation which was not purely commercial - a situation in which the taxpayer claiming the loss had a personal involvement like renting out part of the taxpayer's dwelling or renting a future retirement home "in some balmy southern climate".
[14] Subsequent decisions of the Federal Court of Appeal have restricted the application of Tonn. In Attorney General of Canada v. Mastri, 97 DTC 5420, Robertson J.A. quoted a lengthy passage from Tonn and then stated at page 5423:
... It is simply unreasonable to posit that the Court intended to establish a rule of law to the effect that, even though there was no reasonable expectation of profit, losses are deductible from other income sources unless, for example, the income earning activity involved a personal element. The reference to the Moldowan test being applied "sparingly" is not intended as a rule of law, but as a common-sense guideline for the judges of the Tax Court. In other words, the term "sparingly" was meant to convey the understanding that in cases, for example, where there is no personal element the judge should apply the reasonable expectation of profit test less assiduously than he or she might do if such a factor were present. It is in this sense that the Court in Tonn cautioned against "second-guessing" the business decisions of taxpayers. ...
Similarly, in Stewart v. The Queen, 2000 DTC 6163, Rothstein J.A. stated at page 6164:
It is argued by the appellant that Moldowan has no application unless the particular activity or property has an element of personal use. We do not think Moldowan is necessarily so limited. The Moldowan principle is that in order to have a source of income, the taxpayer must have a profit or a reasonable expectation of profit. No subsequent Supreme Court authority has altered the Moldowan principle.
[15] Following the decisions of the Federal Court of Appeal in Tonn, Mastri and Stewart, I think it is still good law to ask whether a particular activity has a reasonable expectation of profit. This is what Dickson J. (as he then was) described as "an objective determination" (Moldowan, page 5215). When a trial judge in this Court determines that a particular activity does not have a reasonable expectation of profit, and that the taxpayer does not have a personal involvement in the activity, the Federal Court of Appeal is concerned that the trial judge not "second-guess" the business judgment of the taxpayer. This is particularly important when losses have been disallowed in the first years of the taxpayer's operation of the activity, as was the case in Tonn. In my opinion, however, it is less important when the activity has a long history of losses prior to the years in dispute when certain losses have been disallowed.
[16] Having regard to all of the evidence, I conclude that Wayside Flowers, as a retail floral outlet, did not have a reasonable expectation of profit at any time in 1993, 1994 or 1995. The first table in paragraph 11 above shows that Wayside Flowers accumulated aggregate losses of $223,652 over a nine-year period ending with the three years under appeal. That is an average loss of approximately $25,000 per year in circumstances when the manager (Ilze) was not paid any salary or wages. In Moldowan, Dickson J. referred to "the profit and loss experience in past years". The years under appeal are not the first years of ownership as in Tonn. Indeed, the Appellants did not start Wayside Flowers from scratch but purchased it as a long established business. The Appellants led evidence to show that they were earnest in their endeavours but they did not lead any evidence to show how they could turn Wayside Flowers around in 1993, 1994 or 1995 after such a long and consistent history of losses. According to Ilze, Wayside Flowers was closed down in 1997 or 1998.
[17] Returning to Mr. Wiebe's letter of November 12, 1988 (Exhibit R-4), I conclude that Wayside Flowers had no reasonable expectation of profit even in 1988 because (i) there were prior losses back to 1982 which could have been carried forward and applied against future profits if earned in a reasonable number of years; (ii) instead of relying on the carry forward of prior losses, the losing enterprise was transferred to the three Appellants as partners; and (iii) if Ilze (the "key person" in Wayside) had stopped working or insisted on a fair wage, Landmore would have been bankrupt. It appears that there was not a profitable activity (i.e. Wayside) to sell in order to avoid insolvency.
[18] There is no obvious personal involvement of any particular Appellant in the commercial activity of Wayside Flowers but there are two circumstances which disturb me. First, Ilze stated in her examination for discovery that there was a partnership agreement (Exhibit R-7, answer 39) but no copy of that agreement was entered in evidence. One of the important purposes of any partnership agreement is to define the way in which a partnership profit or loss will be shared and allocated among the partners. Looking at the second table in paragraph 11 above, I cannot find any consistency in the way that losses are allocated. See for example 1990 when a loss of $18,344 was allocated exclusively to George and John. See also 1992 when a loss of $8,895 was expanded to $12,923 and allocated to John and Ilze when George reported a profit of $4,028 to bring the net loss back down to $8,895. In 1994, Ilze's allocated loss was a little greater than John's but, in 1995, John's allocated loss was a little greater than Ilze's. The allocation of losses seems arbitrary.
[19] The second circumstance which disturbs me is the fact that the partnership (Wayside Flowers) paid rent to Landmore to help pay down the mortgage on the original retail site purchased in 1981. Also, Exhibit A-10 is a series of documents describing a transaction in 1991 when the three Appellants purchased a property in Mission, B.C. identified as 7057-7059 Mershon Street. The Notice of Appeal for each Appellant indicates that cash was "diverted" out of Wayside Flowers to pay off the mortgage on Mershon Street. Paragraph 2 of the Notice of Appeal states in part:
2. ... That Revenue Canada reviewed nine years of operation in isolation of other monetary facts of the operation of Wayside Flowers such as the acquisition of property in anticipation of the future growth and eventual expansion of the Mission retail town centre to the "waterfront development area". That this property acquisition decision by the Appellant diverted from cash flow of Wayside Flowers the sum of $1,000 per month ($12,000 per annum) towards the servicing of the property purchase mortgage of the subject property. That this cash flow, if not diverted, would have produced a significant taxable profit of the operations of Wayside Flowers for the years under review.
In other words, there may have been what Tonn referred to as a "personal element" in the operation of Wayside Flowers. The partners may have been using cash from Wayside in the guise of rent to Landmore in order to pay down the purchase price of a real property investment. There was an obligation on the Appellants to prove that losses were not being inflicted on Wayside Flowers in order to permit the financing of a real estate purchase outside the partnership. That obligation was not discharged.
[20] The appeals are dismissed, with costs. Because the pleadings are almost identical, and the appeals were heard on common evidence, costs will be determined as if there were only one appeal.
Signed at Ottawa, Canada, this 10th day of July, 2001.
"M.A. Mogan"
J.T.C.C.
COURT FILE NOS: 98-2779(IT)G, 98-2781(IT)G and 98-2783(IT)G
STYLE OF CAUSE: George W. Peary, John W. Shewan and
Ilze Shewan
PLACE OF HEARING: Vancouver, British Columbia
DATE OF HEARING: July 12, 2000
REASONS FOR JUDGMENT BY: The Honourable Judge M.A. Mogan
DATE OF JUDGMENT: July 10, 2001
APPEARANCES:
Agent for the Appellants: John W. Shewan
Counsel for the Respondent: Lisa MacDonell
COUNSEL OF RECORD:
For the Appellants:
Name: N/A
Firm:
For the Respondent: Morris Rosenberg
Deputy Attorney General of Canada
Ottawa, Canada
98-2779(IT)G
BETWEEN:
GEORGE W. PEARY,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
Appeals heard on common evidence with the appeals of John W. Shewan (98-2781(IT)G) and Ilze Shewan (98-2783)(IT)G), on July 12, 2000,
at Vancouver, British Columbia, by
the Honourable Judge M.A. Mogan
Appearances
Agent for the Appellant: John W. Shewan
Counsel for the Respondent: Lisa MacDonell
JUDGMENT
The appeals from assessments of tax made under the Income Tax Act for the 1993, 1994 and 1995 taxation years are dismissed, with costs.
Signed at Ottawa, Canada, this 10th day of July, 2001.
|
"M.A. Mogan" |
J.T.C.C.
98-2781(IT)G
BETWEEN:
JOHN W. SHEWAN,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
Appeals heard on common evidence with the appeals of George W.Peary (98-2779(IT)G) and Ilze Shewan (98-2783(IT)G), on July 12, 2000,
at Vancouver, British Columbia, by
the Honourable Judge M.A. Mogan
Appearances
For the Appellant: The Appellant himself
Counsel for the Respondent: Lisa MacDonell
JUDGMENT
The appeals from assessments of tax made under the Income Tax Act for the 1993, 1994 and 1995 taxation years are dismissed, with costs.
Signed at Ottawa, Canada, this 10th day of July, 2001.
|
"M.A. Mogan" |
J.T.C.C.
98-2783(IT)G
BETWEEN:
ILZE SHEWAN,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
Appeals heard on common evidence with the appeals of George W. Peary (98-2779(IT)G) and John W. Shewan (98-2781(IT)G), on July 12, 2000,
at Vancouver, British Columbia, by
the Honourable Judge M.A. Mogan
Appearances
Agent for the Appellant: John W. Shewan
Counsel for the Respondent: Lisa MacDonell
JUDGMENT
The appeals from assessments of tax made under the Income Tax Act for the 1993, 1994 and 1995 taxation years are dismissed, with costs.
Signed at Ottawa, Canada, this 10th day of July, 2001.
|
"M.A. Mogan:" |
J.T.C.C.