Date: 20010315
Docket: 1999-4571-IT-I; 1999-4572-IT-I
BETWEEN:
JO-ANN ELKE, STEVEN HISCOCK,
Appellants,
and
HER MAJESTY THE QUEEN,
Respondent.
Reasons for Judgment
Bowman, A.C.J.
[1] These appeals were heard together and involve assessments for the 1994 and 1996 taxation years of Mr. Hiscock and for the 1994, 1995 and 1996 taxation years of Ms. Elke.
[2] The appellants are husband and wife. The appeals are from assessments that disallowed losses sustained by them in those years from an operation carried on by them together involving the Amway Corporation or its Canadian subsidiary, Amway of Canada. The disallowance of the losses was on the basis that the operation had "no reasonable expectation of profit" and was therefore not a business.
[3] There have been many Amway cases in this court. Occasionally the appellants win[1], more often than not, they lose[2], usually on the basis of NREOP.
[4] As I have said in many cases I do not find the ritual incantation of NREOP helpful. It is often an excuse for not analyzing a business enterprise to see whether the expenses claimed are not reasonable or otherwise not deductible. In Kaye v. The Queen, 98 DTC 1659, 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 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 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.
[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.
[5] In this case the appellants embarked on the Amway enterprise in a determined and businesslike way with enthusiasm, high hopes and fervour.
[6] To see the sort of economic results of their endeavour I set out schedules 1, 2 and 3 to the reply to Ms. Elke's notice of appeal.
SCHEDULE 1
STEVEN HISCOCK & JO-ANN ELKE
STATEMENT OF INCOME AND LOSSES CLAIMED
1994
Revenue
Sales
Wholesale 10734.12
Retail 2399.53
Tools 939.12
14072.77 14072.77
Performance Bonus
Received 642.65
Paid out -28.67
613.98 613.98
14686.75
Cost of Sales
Beginning Inventory 1585.04
Product Purchases 13598.89
Tools Purchases 2400.38
less: Ending Inventory -912.94
16671.37 -16671.37
Gross Profit (Loss) -1984.62
Expenses
Automobile 525.00
Business Meetings 1262.77
Conventions 665.27
Entertainment, Promo 767.44
License, Dues, Subscription 80.30
Office, Printing, Stationary 142.08
Postage & Shipping 28.63
Professional Services 658.05
Rent (use of home) 558.00
Repairs & Maintenance 66.19
Sales Aids & Demos 1028.69
Telephone 651.30
Tools 1490.82
Misc. 361.63
8286.17 -8286.17
Net Losses 1994 -10270.80
Losses Claimed
Steven 4475
Jo-Ann 4475
8950 -10270.80 -1320.79 discrepancy
SCHEDULE 2
STEVEN HISCOCK & JO-ANN ELKE
STATEMENT OF INCOME AND LOSSES CLAIMED
1995
Revenue
Sales
Wholesale 17633.55
Retail 4928.82
Tools 2698.18
25260.55 25260.55
Performance Bonus
Received 965.92
Paid out -56.91
909.01 909.01
26169.56
Cost of Sales
Beginning Inventory 4365.85
Product Purchases 23475.61
Tools Purchases 4457.03
less: Ending Inventory -6935.47
25363.02 -25363.02
Gross Profit (Loss) 806.54
Expenses
Automobile 525.00
Business Meetings 1522.92
Conventions 1304.16
Entertainment, Promo 349.45
License, Dues, Subscription 92.51
Office, Printing, Stationary 0
Postage & Shipping 0
Professional Services 299.60
Rent (use of home) 111.60
Repairs & Maintenance 81.14
Sales Aids & Demos 1868.70
Telephone 1667.34
Tools 1758.85
Misc. ___0___
9581.27 -9581.27
Net Losses 1995 -8774.73
Losses Claimed
Steven 4547
Jo-Ann 4547
9094 -8774.73 319.27 discrepancy
SCHEDULE 3
STEVEN HISCOCK & JO-ANN ELKE
COMPARISON OF EXPENSES CLAIMED
1994, 1995, 1996, 1997, 1998
1994 1995 *1996 1997 1998
Expenses
Automobile 525.00 525.00
Business Meetings 1262.77 1522.92
Conventions 665.27 1304.16 1121.12
Entertainment, Promo 767.44 349.45 105.55 281.95
License, Dues, Subscription 80.30 92.51 45.00 45.00
Office, Printing, Stationary 142.08 0 8.68 26.22
Postage & Shipping 28.63 0
Professional Services 658.05 299.60 175.00
Rent (use of home) 558.00 111.60 321.31
Repairs & Maintenance 66.19 81.14
Sales Aids & Demos 1028.69 1868.70
Telephone 651.30 1667.34 269.40
Interest 105.40 151.00
Tools 1490.82 1758.85
Capital Cost Allowance – class 12 1536.00
Supplies 895.36
Advertising 288.64
Travel 591.56
Misc. 361.63 0 13.20 66.51
Total Expenses 8286.17 9581.27 * 3256.26 2790.64
*1996: The Appellant did not provide income and expense statements for 1996.
[7] The appellants kept careful books, attended all of the required seminars and spent a good deal of time in the activity. They are intelligent, enthusiastic and thoroughly decent and honourable people. Nonetheless, from 1991 to 1998 they have sustained nothing but losses, except in 1997 when a profit of $469 was realized, largely because of not claiming many of the expenses claimed in earlier years.
[8] Paragraph (f) of section 21 of the reply to Ms. Elke's notice of appeal is as follows:
[T]he Appellant claimed 50% of the following net business losses from 1991 to 1996 and reported 50% of the net business income for 1997 and 0 in 1998 from the Partnership Activities:
TAXATION GROSS GROSS NET
YEAR INCOME PROFIT EXPENSES (LOSS)
1991 2,049 (3,690)
1992 11,912 (10,564)
1993 13,263 (9,292)
1994 14,547*** 1,288* 8,286 (8,950)
1995 34,428 2,530* 9,581 (9,094)
1996 32,397 ** ** (10,052)
1997 15,453 4,195* 3,256 +469
1998 17,462 3,910 2,790 0
* revised by the "Tools" amount
** 1996 information not provided by the Appellant when requested
*** $10,734 of the $14,547 had zero mark up for potential profit
[9] The simple fact is that the Amway operation as carried on by the appellants and many other people is not in reality a commercial operation involving the sale of household products. It is simply a façade behind which an elaborate and sophisticated scheme (euphemistically called "network marketing") is operated in which organizations like Amway make substantial amounts of money by selling people like the appellants products plus a hope of making large profits by recruiting more people. While I would hesitate to use the expression "pyramid scheme", if such terminology implies illegality, the scheme has number of attributes that are not dissimilar to those in a typical pyramid scheme at least in the colloquial sense of the term.[3] The real money that such people as the appellants expect and that they are induced to believe they can make is not in selling household products but in recruiting more people to whom more products are sold whereby they hope to earn a performance bonus.
[10] To take 1994 as an example, gross sales included $10,734.12 of wholesale sales. These wholesale sales were made to people whom they were trying to recruit and had no mark up. A large portion of the retail sales were consumed by the appellants and had no mark up. The "tools" (video tapes, books and other promotional material) had no mark up.
[11] The ostensible purpose of these uneconomic purchases and sales was to recruit more people down the line and thereby earn performance bonuses — which, it was said, was where the real money lay. Yet the performance bonuses in 1994 were $613.98 ($642.65 net of $28.67 paid as performance bonuses to people they recruited). In 1995 performance bonuses received were $965.92.
[12] In 1995 their opening inventory was $4,365, products purchased cost $23,475, tools (promotional material) purchased cost $4,457. These expenditures, plus other expenses, were laid out to acquire products that in large measure were sold at no mark up, yielded no profit, and were apparently made to earn minimal performance bonuses.
[13] Many of the conventions and business meetings have the purpose, and, evidently, the effect of keeping people like the appellants in a high state of expectation and enthusiasm. The cost of these conventions and business meetings, at which they are regaled with large doses of inspirational pep talks, is vastly disproportionate to any money that they can reasonably expect to make.
[14] In ten years the appellants recruited 15 people, and only five stayed with the organization.
[15] It is a measure of Amway's success (or that of the promotional organization that purports to be independent) that people like the appellants still enthusiastically endorse the system. I asked the appellants if they thought they had been conned or sold a bill of goods and they strongly denied it. Nonetheless, in Exhibit A-2, The Amway Business Review of January 1998, the following appears:
An independent survey conducted on behalf of Amway of Canada, Ltd. indicated that based on their annual compensation, the average monthly compensation for a participant in the Amway Sales and Marketing Plan was $66. A participant is one who has been a distributor for at least one year and has attempted to sell products to others, or has attempted to sponsor others, or has actually sold products or sponsored others. The survey also indicated that people who have been distributors for at least one year and who have actually sold products and sponsored others had an average monthly compensation of $98.
[16] The appellants argue that the figure is misleading because it is averaged over a lot of inactive representatives. That may be, but it hardly supports the glowing predictions of profits anticipated by the appellants.
[17] Contrary to what the appellants believe I think they have been seriously misled. I do not think that this "network marketing" scheme that Amway has enticed them into is a viable commercial activity at all. They are the victims of a cynical and manipulative form of conartistry that succeeds not because of its inherent commerciality but because of a combination of promises of large profits, zealous fervour and humbug. In Lebel v. R., [2000] 2 C.T.C. 2626 at 2628 I dealt with a somewhat similar scheme, as follows:
Jewelway. This was a sort of pyramid scheme under which the appellant would buy "positions". On one face of it, it appeared that he was buying jewellery which he was supposed to sell but this was not the essence of the scheme. He still has the jewellery. The essence of the scheme was to persuade other people to join on the same basis as he did, and they would then induce others to join. He initially bought seven positions for $350 each.
Over the years he managed to persuade 12 people to join, although he approached hundreds. He stated that some people were making as much as $70,000 per month. It may be that some of the original promoters were doing well, but on a part-time basis the appellant, on any rational view of the matter, had no real hope of succeeding. The scheme struck me as somewhat harebrained and while I accept that what may appear to be harebrained schemes may sometimes have the potential of achieving a measure of commercial success, it is usually the original proponents or promoters of the scheme (for example, Charles Ponzi) who succeed in making money, not the victims. I do not think this activity can be called a business.
[18] While the perpetrators of such schemes may very well be carrying on a business, it is hard to say the same for their victims. I do not think that well-meaning and honourable people like the appellants will ever rise up high enough in the pyramid to become part of the money making upper echelons. There is no reason to believe that if they do not cut their losses and get out now they will not continue to be victimized for as long as they allow themselves to be hoodwinked and mesmerized.
[19] The appeals are dismissed.
Signed at Ottawa, Canada, this 15th day of March 2001.
"D.G.H. Bowman"
A.C.J.
[1] Nordick v. The Queen, 99 DTC 371.
[2] Severson v. R., [2000] 2 C.T.C. 2348; Nordstrom v. R., [1999] 3 C.T.C. 2253.
[3] Illegal pyramid schemes for the purposes of the Criminal Code are described in Regina v. MacKenzie, Ennis and Meilleur, (1982) 36 O.R. (2d) 562 (Ontario C.A.). The expression is used in section 55.1 of the Competition Act and is to be contrasted with "multi-level marketing plan" in section 55 of that act. I am not suggesting that the Amway arrangements fall into the category of schemes described by the Ontario Court of Appeal or in the Competition Act. I am saying that people who are taken in by them are victims, not entrepreneurs.