Date: 20010921
Docket: 2000-2563-IT-I
BETWEEN:
ROBERT G. SMALLEY,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
Reasons for Judgment
McArthur J.
[1] Robert G. Smalley (the Appellant) appeals from assessments for the 1996 and 1997 taxation years. The Minister of National Revenue (the Minister) disallowed the deduction of losses of $22,613 and $17,143 claimed by the Appellant in carrying on of what he contends was a business of selling insurance on the basis that he had no reasonable expectation of profit (REOP).
[2] The facts which I accept, are taken primarily from those set out by the Appellant and the Respondent in their written arguments. The Appellant retired in 1989 from his position as the Atlantic regional manager for Sun Life of Canada after a 36-year career in the insurance industry. Upon retirement, he provided consultant services to Sun Life from late 1989 to mid-1993 and then sold life insurance for Sun Life from late 1993 to 1997. He claimed losses as follows:
|
Year |
Gross Commissions |
Total Expenses |
Net Income (Loss) |
|
1990 |
$ 227 |
$30,727 |
($30,500) |
|
1991 |
1,693 |
17,420 |
(15,736) |
|
1992 |
0 |
17,191 |
(17,191) |
|
1993 |
0 |
21,043 |
(21,043) |
|
1994 |
171 |
19,065 |
(18,894) |
|
1995 |
165 |
21,460 |
(21,297) |
|
1996 |
213 |
22,826 |
(23,039) |
|
1997 |
285 |
19,497 |
(17,143) |
It was not until 1996 that the losses were disallowed.
[3] He had experienced selling life insurance dating back to 1953 yet was in managerial positions with Sun Life in Atlantic Canada for much of his career up to 1989 when he reluctantly retired.
[4] To supplement his pension after retirement, he acted as a consultant for Sun Life for four years. During this period, he did not sell life insurance. He ended his unsuccessful consulting business in 1993 and commenced selling life insurance from his Shediac Cape residence. This activity was as spectacularly unsuccessful as his consulting work. He lost approximately $82,000 in four years of consulting and $80,000 in four years selling insurance. Throughout these eight years, he enjoyed a comfortable pension and other income in excess of $60,000 annually.
[5] For his business plan, he completed the forms provided by Sun Life for all its sales agents, to plan their life insurance selling approach in each coming year. He was not able to meet these goals. He approached and conducted his life insurance sales business on a business-like basis. He travelled by automobile to his designated areas where he would meet by prior arrangement with "centres of influence" in order to gain leads as to prosperous clients. Of course he would also meet with prospective clients. He gave presentations to potential clients whom he had previously screened. He conducted approximately one presentation per week.
[6] After making very little income from this business in 1994, he nevertheless felt that he had established contacts and had become sufficiently known so that the business would do better in 1995. In 1995, his selling efforts were in the Moncton and surrounding area. His revenue for the year was only $165. He persevered. In 1996, he spent more time trying to sell life insurance in the Florenceville area. At the end of 1996, his results were only $213 of revenue. He testified that if he actually moved to the Florenceville area this would assist his business in breaking into the life insurance market share. His revenue for that year from selling life insurance, focused in the Florenceville area, was only $285. Therefore, after four years of trying to make this business succeed, he decided to give it up. In early 1998, he commenced work as a real estate agent in the Florenceville area and currently earns a small profit from that business. He claimed substantial losses after his first and second year in this endeavour.
[7] Both parties state that the sole issue is whether the Appellant had a reasonable expectation of profit from his life insurance sale activities in 1996 and 1997.
Position of the Appellant
[8] The Appellant argued that he did have a REOP in each of the years 1996 and 1997 from selling life insurance. The Appellant believes that he approached his activity in a committed and business-like way. He had ample experience from prior years. His motivation was to supplement his pension income and there was no personal element involved.
[9] The business failed and in hindsight, the Appellant expressed regret that he engaged in the business at all. A substantial amount of his money was lost while trying to make a success of this undertaking. The Appellant admits that upon commencing his business of selling insurance and investments in 1994, he was not properly prepared to actually go out into the field and actually sell, as his field of expertise was in administration. In retrospect, the Appellant admits his failure was due primarily to his inexperience and inflated expectations.
Position of the Respondent
[10] The Respondent submits that the Appellant's selling of life insurance had no reasonable expectation of profit. The Appellant lacked the knowledge and experience of a direct salesperson, as his background and business experience was in the management field. The Appellant did not have a business plan for the years under appeal that projected annual revenues and the anticipated rate of growth of his operation.
Analysis
[11] Whether there was a REOP is primarily a question of fact. The question is better phrased by asking whether there was a business rather than a REOP.
[12] The Respondent acknowledges that the Appellant's sale of life insurance was not a hobby that would attract greater scrutiny as indicated in Tonn v. The Queen, 96 DTC 6001. The Respondent is rightly concerned with the great disparity in total revenues of $2,754 and reported losses of $164,843 from 1990 to 1997. It would have been more realistic to challenge the reasonableness of the Appellant's expenditures by referring to section 67 of the Income Act, as suggested by Linden J.A. in Tonn, supra at page 6009.[1]
[13] The Respondent called three witnesses: Susan Buck, Jackie Lohnes and Charlotte Magasi. Ms. Buck's evidence as the auditor for the 1994 and 1995 taxation years was that they had started to audit Mr. Smalley's expenses but then reassessed him on the basis of no REOP. She testified that she had no reason to disbelieve Mr. Smalley's testimony that he discontinued his consulting business in 1993 and began his business of selling life insurance in 1994. She also testified she was not able to confirm when the shift in business pursuits had occurred. Ms. Buck also agreed that normally a start-up period is permitted for REOP cases and that a reasonable period for such would be approximately four years, although each case is different. Ms. Lohnes who was the Appeals Officer, agreed that there had been a change of business from consulting to selling life insurance. Ms. Magasi agreed that where a business had changed, a new start-up period should be allowed.
[14] I accept the Appellant's evidence that during the years 1994 through the end of 1996, he attempted to sell life insurance in the traditional manner. He made cold calls, made contacts and followed up on them. He did not use a laptop and did not sell mutual funds. A very successful New Brunswick insurance salesman, Mr. Pickett, testified that the Appellant's approach was common in the industry during the relevant period. During the mid-1990s, the life insurance industry was changing. Many life insurance agents of Sun Life left the business. There was a movement away from branch offices and toward home offices. There was much less corporate support from Sun Life. Sun Life products were harder to sell.
[15] I agree with the Appellant's counsel that, in this case, the nature and character of the Appellant's expenses have not been questioned. Section 67 of the Act was not argued. REOP was made the only issue. The nature of the expenses may have had some relevance in determining whether there was a personal element but this was not pursued. There was reference to the Appellant claiming travelling expenses while on his honeymoon yet he later withdrew these expenses explaining it was a mistake.
[16] I find as a fact that the Appellant began to sell life insurance late in 1993. He commenced this activity with a belief that it would be profitable. It was a business. He had a REOP. The Respondent raises the question of start-up time. How long should he be permitted to, deduct these expenses which were outrageous in comparison to his income. From 1993 to the end of 1997, he reported a total of $834 in income from his business activity. For the same period, he claimed over $100,000 in losses. These losses were escalating from 1994 to 1996 inclusive.
[17] There is no question that integral to REOP is the allowance of a start-up time. See Tonn, supra, at page 6014. The question is when should the line be drawn. The Appellant commenced the new business of selling life insurance in late 1993. He had no revenue in 1993 but claimed expenses of $21,043. His losses in 1994 were $18,900, and escalated in 1995 to $21,300 (rounded to the nearest $100). During these years, his revenue for 1994 was $171 and even lower in 1995: $165. Surely, a reasonable business person with the Appellant's experience would conclude that enough was enough and it was time to close the business. I find that after December 1995, the Appellant no longer could be said to have been in business and to have a REOP. His motivation for continuing had to be for something other than selling insurance. He knew or ought to have known by the end of 1995 that his selling insurance was not a viable business. At this time, it was unreasonable if not outrageous to continue on. He is indeed fortunate that he was permitted to deduct what appears to be unreasonable expenses over several years.
[18] The appeals for the 1996 and 1997 taxation years are dismissed.
Signed at Ottawa, Canada, this 21st day of September, 2001.
"C.H. McArthur"
J.T.C.C.
COURT FILE NO.: 2000-2563(IT)I
STYLE OF CAUSE: Robert G. Smalley and
Her Majesty the Queen
PLACE OF HEARING: Fredericton, New Brunswick
DATE OF HEARING: April 18 and 19, 2001
REASONS FOR JUDGMENT BY: The Honourable Judge C.H. McArthur
DATE OF JUDGMENT: September 21, 2001
APPEARANCES:
Counsel for the Appellant: Bruce S. Russell
Counsel for the Respondent: Ifeanyichukwu Nwachuku
COUNSEL OF RECORD:
For the Appellant:
Name: Bruce S. Russell
Firm: McInnes Cooper
For the Respondent: Morris Rosenberg
Deputy Attorney General of Canada
Ottawa, Canada
2000-2563(IT)I
BETWEEN:
ROBERT G. SMALLEY,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
Appeals heard on April 18 and 19, 2001, at Fredericton, New Brunswick, by
the Honourable Judge C.H. McArthur
Appearances
Counsel for the Appellant: Bruce Russell
Counsel for the Respondent: Ifeanyichukwu Nwachukwu
JUDGMENT
The appeals from the assessments of tax made under the Income Tax Act for the 1996 and 1997 taxation year are dismissed.
Signed at Ottawa, Canada, this 21st day of September, 2001.
|
"C.H. McArthur" |
J.T.C.C.
[1] It seems to me that for most cases where the department desires to challenge the reasonableness of a taxpayer's transactions, they need simply refer to section 67. This section provides that an expense may be deducted only to the extent that it is reasonable in the circumstances. They need not resort to the more heavy-handed Moldowan test. In fact, in many cases, resorting to section 67 may well be more appropriate. This point has been made more than a few times by Bowman, T.C.C.J. In Cipollone v. Q., for example, the taxpayer attempted to deduct a variety of large expenditures as part of her "humour therapy" business. Despite the unusual nature of the business, Bowman, T.C.C.J. found the business to be bona fide and thus not a candidate for the application of Moldowan. He added:
The reason her losses were as great as they were was not because the business had no reasonable expectation of profit or because she was not expending money for the purpose of gaining or producing income from a business. I find as a fact that she was spending money in order to earn a profit and that her expectation of earning a profit was reasonable, if she had chosen to claim reasonable expenses. The problem lies not in the absence of a reasonable expectation of profit — businesses of this sort can be quite lucrative — but rather in the attempt to deduct unreasonable expenses.
Bowman, T.C.C.J.'s approach to the problem in the case above seems very sensible and might be considered in future cases such as this one.