Date: 20010419
Docket: 98-485-IT-I
BETWEEN:
MURRAY STEPHEN,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
Reasons for Judgment
Bowman, A.C.J.
[1] These appeals are from assessments for the 1992, 1993 and 1994 taxation years, by which the Minister of National Revenue denied the deduction of losses of $13,914.17, $8,561.81 and $7,795.05 in the calculation of the appellant's income. Except for a period in which he was unemployed in 1992 the appellant was employed full time as a millwright. The basis of disallowance is that the appellant was not carrying on a business or, to use the phrase that is ritually intoned in these cases, that he had "no reasonable expectation of profit".
[2] The activity which the appellant contends is a business the losses from which he wishes to deduct in computing income is the manufacture and sale of wooden objects such as toy trains and trucks, animals, rocking horses, lawn ornaments, doll houses.
[3] Exhibit A-4 is a group of photographs of some of the articles that the appellant has produced. It is clear that the appellant is a skilled and prolific artisan.
[4] The appellant started doing woodworking in the 1980s. It started as a hobby but in 1989 he decided to turn it into a commercial activity.
[5] The so-called assumptions pleaded in the reply to the notice of appeal are as follows.
6. In so assessing the Appellant, the Minister made the following assumptions:
a) at all material times the Appellant was employed full time with the exception of 1992 when he was unemployed for a period of time during that year;
b) woodworking was the Appellant's hobby. He began operating the Activity when he thought that he could make the toys shown in the pattern books he read;
c) since the Activity started in 1989, the Appellant reported the following income (losses) from the Activity, respectively, as business losses:
1990 1991 1992 1993 1994 1995
Gross Income $914 $3,190 $4,747 $2,946 $2,865 $1,660
Expenses $4,455 $13,038 $18,661 $11,507 $10,660 $8,200
Net Loss Reported $3,541 $9,838 $13,914 $8,561 $7,795 $6,540
d) the declining gross sales receipts of the Activity are only fractions of the cost of goods sold, as well as being 30% to 50% of motor vehicle expenses and capital cost allowance in each year of its operation:
1990 1991 1992 1993 1994 1995
Cost of Goods Sold $2,688 $3,337 $6,423 $3,041 $4,317 $2,238
Motor Vehicle & CCA $5,791 $7,710 $6,066 $4,986 $5,032
e) the Appellant also claimed, as expenses incurred on the Activity, meals and entertainment expenses, office expenses, supplies and small tools purchases and rental of stalls. The total amount spent each year on these items alone adds up to more than the gross revenue received in each taxation year of operation;
f) the Appellant maintained no records to relate automobile usage and meal expenses to the Activity;
g) the majority of sales were made through craft shows. For the 1992, 1993 and 1994 taxation years, the Appellant attended 12, 7 and 6 craft shows, respectively;
h) the Activity was advertised only in 1993 when $108 was claimed in this respect, and was not advertised in any other years from 1990 to 1995;
i) the Activity is undercapitalized;
j) the Appellant has no training in the Activity;
k) before starting the Activity, the Appellant prepared no business plan to determine if it would be profitable;
l) the Appellant has made no plans for any material changes to the Activity since the start up of the Activity;
m) the Appellant did not have a reasonable expectation of profit from the Activity during the 1992, 1993, and 1994 taxation years;
n) the expenses claimed in relation to the Activity were personal or living expenses of the Appellant; and
o) the expenses made were unreasonable in the circumstances.
[6] Many of the assumptions are factually correct. Some are merely argumentative window-dressing. I find assumptions (i), (j), (k) and (l) particularly unacceptable. Precisely the words in those paragraphs appear in virtually every reasonable expectation of profit case that I have heard. They represent a mindless recitation of hackneyed and stereotypical language that has nothing to do with the case. They could not conceivably have formed a factual basis for the assessments. It is obvious that whoever drafted the reply indiscriminately plucked phrases from other cases (likely Moldowan v. The Queen, [1978] 1 S.C.R. 480) that looked nice and sprinkled them into the reply as assumptions. It cannot be emphasized too strongly that in pleading assumptions in a reply that have the effect of defining the burden that lies on the appellant the respondent has a serious responsibility to set out honestly the true basis of the assessment and not concoct fanciful boilerplate.
[7] That said, I still have to decide whether the assessments are right or wrong.
[8] In Kaye v.R. [1998] 3 C.T.C. 2248 the following was said:
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 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 not 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 an 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.
[9] It is the reasoning in paragraph 6 of the Kaye decision that I find particularly apposite here. If one looks at the figures in paragraphs (c) and (d) of the assumptions it is difficult to conclude that a reasonable person would spend that sort of money to obtain the modest revenues produced as set out in paragraph (c).
[10] Section 67 of the Income Tax Act is premised upon the existence of a business and requires a curtailment of deductions to the extent that the expense claimed is unreasonable. Quite apart from section 67 unreasonableness impinges on the question of the existence of a business because it calls into question the inherent commerciality of the enterprise. This is particularly true where the expenses claimed are vastly disproportionate to the revenues, actual or reasonably expected. I think that is true here where the motor vehicle expenses, office expenses, capital cost allowance, and travelling expenses are multiples of the gross revenues.
[11] There are other factors that seem inconsistent with the existence of a business. The automobile expenses are a guesstimate. No log was kept of business use and 50% of the expenses were claimed as business expenses. The same can be said of meals and entertainment. The pricing was haphazard. Usually it was twice the cost of material with no account taken of the time spent to create an article.
[12] There is something commercially inplausible about spending over $40,000 on material, tools and travelling in the expectation of making a profit by going to 25 craft shows in three years and selling about $10,000 worth of articles.
[13] The accounting records also left a great deal to be desired. I found it passing strange that in the profit and loss statement nothing is recorded for opening or closing inventory. This would imply that the appellant sold in the year exactly what he produced.
[14] Counsel for the appellant invited me to find as a fact that Mr. Stephen intended to carry on a business. I have no hesitation in doing so. It has been amply proved. Unfortunately that is not enough. As Couture C.J. said in P. Zolis v. M.N.R., [1987] 1 C.T.C. 2199 at 2201:
The aspirations or ambitions that a taxpayer may have entertained in respect of an activity in which he was engaged are not alone sufficient to bring it within the strict meaning of business in the relevant legislation no matter how genuine they might have been.
[15] Counsel for the appellant openly admitted that the expenses claimed were unreasonable, a conclusion that I would probably have reached anyway. He invites me then to reduce the expenses that I considered unreasonable, and he started by suggesting I disallow the CCA on the truck. While I commend counsel for his candour and for the skill with which he put forward the argument, I find this solution rather arbitrary. There is really no basis on which I could recast the expenses to make them reasonable in relation to the revenues produced. If I did I would probably conclude that any expenses beyond the revenues produced were unreasonable, and so I would in all likelihood arrive at precisely the same conclusion using the reasonableness route as I would using the reasonable expectation of profit route. As I said above, reasonableness within section 67 operates within the context of a business and it also operates, at least in extreme cases, outside of section 67 at the liminal stage of determining whether a business exists. That is the situation here.
[16] The appeals are dismissed. Since, after starting the case in the general procedure, the appellant elected to move it to the informal procedure there will be no order for costs.
Signed at Vancouver, Canada, this 19th day of April 2001.
"D.G.H. Bowman"
A.C.J.