Date: 20010803
Docket: 2000-2480-IT-I, 2000-2481-IT-I
BETWEEN:
EDWARD J. PRICE, LORRAINE L. PRICE,
Appellants,
and
HER MAJESTY THE QUEEN,
Respondent.
Reasons for Judgment
Hershfield, J.T.C.C.
[1] These appeals were heard together and are in respect of reassessments of each Appellant's 1994, 1995, 1996 and 1997 taxation years.
[2] The Appellants are husband and wife who have operated an Amway distributorship or sales business under the name of J. & L. Enterprises (J & L) in equal partnership with each other since 1991. From 1992 through 1997 each of the Appellants reported the following incomes. The gross business incomes are at the partnership level (i.e. J & L's gross income from Amway activities). The net losses are those claimed by each of the Appellants at the partner level.
Edward J. Price
Year 1992 1993 1994 1995 1996 1997
Employment $ $33,781 $51,291 $14,254
Family
allowance 418
Employment
Insurance 14,311
Interest 797 476 538 718 245 72
RRSP 7,500 36,000 20,000
Rental Income
Gross 1,700 3,250
Net -5,036 -4,936
Business Income
Gross 38,542 40,399 38,355 170,824 219,162 216,930
Net -5,436 -5,036 -5,071 -8,974 -15,280 -11,427
Total Income $10,090 $28,427 $41,822 $13,498 $20,965 $8,645
Lorraine L. Price
Year 1992 1993 1994 1995 1996 1997
Employment $11,390 $ 5,274
Employment
Insurance 395 7,661 550 2,200
Interest 957 476 59 727 166 72
RRSP 16,211 25,000 20,000
Business Income
Gross 38,542 40,399 38,542 170,824 219,162 216,930
Net -5,436 -5,036 -5,436 -8,974 -15,280 -11,427
Total Income $ 7,306 $28,427[1] $ 812 $10,164 $ 9,886 $8,645
[3] Income statements in respect of the business are as follows:
J. & L. ENTERPRISES
INCOME STATEMENT
1994 1995 1996 1997
Revenue:
Product Sales $30,800.48 $129,223.50 $166,800.86 $123,488.98
Tool Sales 6,379.45 30,861.52 $ 32,380.30 $ 49,774.57
Bonuses 1,175.99 10,739.26 19,981.35 43,667.85
Expenses:
Products 32,943.11 128,431.29 168,051.83 126,459.35
Supplies 388.19 518.61 428.66 667.01
Tools 7,401.32 35,195.41 42,437.57 55,378.35
Bonuses 277.32 5,569.75 13,601.67 34,981.99
Meals, Lodging, Travel
& Seminars 2,750.73 3,783.81 5,675.39 4,834.12
Automobile Expenses-Sch. 1 2,059.90 9,589.70 12,309.93 11,183.98
Telephone 2,215.99 4,578.99 4,578.99 3,943.15
Office 292.31 883.86 838.62 717.46
Bank Charges 169.49 222.74 260.31 291.27
Shipping 535.23 632.02
Promotion 804.54 606.93
Fees & Dues 202.05 90.01
Net Income (Loss):
Edward J. Price ($5,071.22) ($8,974.94) ($15,280.99) ($11,427.62)
Lorraine L. Price ($5,071.22) ($8,974.94) ($15,280.99) ($11,427.62)
[4] The loss of each Appellant in each of the subject years has been denied on the basis that the activity giving rise to them has no reasonable expectation of profit. In the alternative, the Respondent asserts that the losses claimed are personal expenses of the Appellants.
[5] Edward Price gave evidence on behalf of the partnership. His evidence was enthusiastic as to the business opportunity afforded by Amway product sales. Indeed he described it as "phenomenal". Amway supplies products that are used in every household. Households satisfying consumer needs through Amway can spend $1,000.00 per month or more on Amway products[2]. Building a chain of Amway product users had to have profit potential according to Mr. Price, and the Appellants, not lacking in sophistication in commercial matters, set about to mine this business opportunity. The plan was, and remains to be, to promote and develop a network of Amway promoters each using Amway products and, more importantly, each promoting further down the line additional product users. If "pyramid sales" is an apt phrase, they wanted to build a pyramid below them. Retail sales were of virtually no interest. Their business plan was to develop a limited number of groups under them, each member trained and motivated to build under them a limited number of groups, each member trained and motivated to build yet another limited number of groups under them and so on. If the chain grew and each member of each group down the line bought household products for their own use from Amway, the chain would eventually produce hundreds of thousands of dollars of gross sales for Amway, even if no one in the chain engaged in any retail sales activities[3]. J & L's business plan was to sign on, sponsor or register a chain of distributors under it where each person in the chain was an independent business owner trained and motivated to create a similar limited group of independent business owners under them. Everyone up the ladder would work with and assist people down the ladder to keep the business plan strong and growing. To keep energy and commitment levels high within the group required personal contact with people down the line; it required holding and attending meetings, attending training sessions and, generally, keeping in touch in person or by telephone with the group below to help ensure maintenance of product use and growth of the group. Keeping people in the chain motivated and committed to Amway year after year would require a fair commitment on the part of someone intending to stay at the top of a successful pyramid.
[6] J & L had up to six registrants or sponsored distributors directly under it during the subject period. The registrants under such direct sponsors in 1994 were between 50 and 60 people that the Appellants called independent business owners; i.e. persons whose "business" was promoting successful groups under them. By 1997 the people under J & L had grown to 119 and today stands at over 200. Mr. Price admitted, however, that only one group (one chain) below J & L had reached sales levels capable of contributing to the bonus levels that J & L sought to achieve[4].
[7] Mr. Price testified that net bonuses were a better method of reporting an independent business operator's earnings and that since 1999 Amway has changed its financial reporting so as to recognise only net bonuses. In fact changes have apparently streamlined the ordering process as well in that down the line distributors can order direct without upstream product purchases and sales being reported by upstream distributors along the chain. Net commissions are tracked and paid at each level. During the assessment years net bonuses increased each year from under $1,000.00 in 1994 to almost $9,000.00 in 1997. Although no figures were tendered for 1998, net bonuses in 1999 were just over $16,000.00. In 1999, J & L still showed a loss of $1,770.00 although expenditures in categories of expenses that might reflect personal expenses were actually down from those incurred in the assessment years (automobile expenses were $7,307.00; meals, lodging, travel and seminars were $3,738.00 and telephone was $2,207.00).
[8] Although, Mr. Price testified that he spent considerably more than 15 hours a week building J & L's business, he had filled out a questionnaire on the audit of the subject years stating that he only spent about 15 hours per week on the business. He acknowledged that both he and his wife were retired and drawing from their RRSPs. He admitted he played about 100 rounds of golf a year and used his vehicle to and from the course and for other daily personal matters but he claimed his vehicle 100% as business use. He testified that he travelled frequently by car on business, including trips to see his daughter and a childhood friend, both of whom he testified were involved in the Amway distributorship business. The extent of such involvement was not elaborated on and I am left with the impression that Mr. Price seeks to deduct 100% of the cost of visits to family and friends if he signs them up to use and promote Amway products. He admitted, on cross-examination, that one expense claimed in relation to his "at home meetings" with distributors, involved a claim for recovering his pool table. His justification for claiming the expense was that the pool table afforded entertainment during meetings with Amway distributors. In general Mr. Price's testimony indicated a fairly casual attitude in distinguishing business versus personal expenses. That is, in general, expense claims seemed to lack the discipline required to distinguish with exactness business from personal expenditures. He said for example that his wife sometimes used her car for the business but he didn't claim her automobile expenses so that "over" claiming his car was intended to work out much the same as proper claims on each of their cars. Further, little attempt seems to have been made at the time an expense was incurred to ascertain its connection to business profits or its reasonableness in relation to the business. Accordingly, I am not satisfied that all of the expenses claimed were bone fide business expenses; rather, a portion of them were personal. It would have been helpful if the audit was more rigorous on this issue. Denying, as personal, the portion of expenses claimed that equal losses is not helpful in my view and my denying all expenses as personal would be to invoke a judicial assessment more onerous than the assessment.
[9] There is no doubt that J & L operates a genuine business. Its net bonuses are a taxable source of income from a commercial enterprise operated as such and any personal element to its operation is not of a nature or extent that would invoke a reasonable expectation of profit test particularly in a case such as this where the expectation of profit is quite rational[5]. Developing a network of over 200 Amway consumers is not a hobby being worked on as a personal pastime. The difficulty of the case lies in identifying the "profit" (loss) properly attributable to the business.
[10] The Respondent's counsel argued that if the Appellants' activity was not profitable after seven years, expressions of optimism as to profitability were simply not reasonable or even rational. On this point she referred to McClure et al v. M.N.R.[6], where Judge Taylor noted that in most cases there should be a fairly immediate prospect of showing an excess of revenue over expenditures. Expenditures incurred before this point of immediate prospects Judge Taylor referred to as pre-start-up costs, which are costs associated with establishing a capital and asset base or with personal or living expenses. I would agree that pre—start-up expenses are personal. I do not agree that on the facts of this case that a bone fide business had not commenced by 1994. That prospects of revenues exceeding expenditures never materialized even after considerable time cannot in itself cause ongoing expenses to thereby be non-deductible "pre-start-up costs". Indeed, the expenses claimed in the case at bar, giving rise to the losses, are post start-up losses[7]. The Respondent's counsel also relied on Elke v. Canada[8] and the finding of this Court that persons involved in these pyramid sales schemes were victims of the hype of potential profits that could never be realized. The Appellants in this case are not such victims in my view. If anything they are attempting to recruit victims with a view to profit[9].
[11] The Appellants assert that neither the reassessment nor audit denied particular expenses as personal and that accordingly the appeal should be allowed if it is found that the common law reasonable expectation of profit test, which denies losses, does not apply in this case. While it is true that an audit that scrutinizes personal expenses affords this Court a better opportunity to determine appropriate expense treatment, this Court cannot ignore clear cases of abusive expense claims. On listening to Mr. Price, I have no doubt that a good part of the expenses claimed by J & L under the headings "Meals, Lodging, Travel and Seminars", "Automobile Expenses" and "Telephone" were personal. Further, given Mr. Price's testimony it appears that personal use or consumption of Amway products and materials during the subject years, which I have found to be $9,000.00 per year, is included in J & L's cost of goods expenses. Accordingly, I allow the appeals in respect of the 1995, 1996 and 1997 years but deny J & L the following expenses in each of those years:
Cost of goods Acquired: $9,000.00
Meals, Lodging, Travel and Seminars: 50% of the amount claimed
Automobile Expenses: 50% of the amount claimed
Telephone: 20% of the amount claimed.
Further, in respect of each such year, office expenses claimed are disallowed pursuant to subsection 8(12) of the Income Tax Act.
[12] The appeals in respect of the 1994 year are dismissed as denying the expenses in that year on the foregoing basis would increase the assessment which is beyond the jurisdiction of this Court.
Signed at Ottawa, Canada, this 3rd day of August 2001.
"J.E. Hershfield"
J.T.C.C.
COURT FILE NO.: 2000-2480(IT)I
STYLE OF CAUSE: Edward J. Price and
Her Majesty the Queen
PLACE OF HEARING: Kamloops, British Columbia
DATE OF HEARING: May 10, 2001
REASONS FOR JUDGMENT BY: The Honourable Judge J.E. Hershfield
DATE OF JUDGMENT: August 3, 2001
APPEARANCES:
For the Appellant: The Appellant himself
Counsel for the Respondent: Nadine Taylor
COUNSEL OF RECORD:
For the Appellant:
Name:
Firm:
For the Respondent: Morris Rosenberg
Deputy Attorney General of Canada
Ottawa, CanadaCOURT FILE NO.: 2000-2481(IT)I
STYLE OF CAUSE: Lorraine L. Price and
Her Majesty the Queen
PLACE OF HEARING: Kamloops, British Columbia
DATE OF HEARING: May 10, 2001
REASONS FOR JUDGMENT BY: The Honourable Judge J.E. Hershfield
DATE OF JUDGMENT: August 3, 2001
APPEARANCES:
Agent for the Appellant: Edward J. Price
Counsel for the Respondent: Nadine Taylor
COUNSEL OF RECORD:
For the Appellant:
Name:
Firm:
For the Respondent: Morris Rosenberg
Deputy Attorney General of Canada
Ottawa, Canada
2000-2480(IT)I
BETWEEN:
EDWARD J. PRICE,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
Appeals heard on common evidence with the appeals of Lorraine L. Price
(2000-2481(IT)I) on May 10, 2001 at Kamloops, British Columbia, by
the Honourable Judge J.E. Hershfield
Appearances
For the Appellant: The Appellant himself
Counsel for the Respondent: Nadine Taylor
JUDGMENT
The appeal from the assessment made under the Income Tax Act for the 1994 taxation year is dismissed.
The appeals from the assessments made under the Income Tax Act for the 1995, 1996 and 1997 taxation years are allowed, without costs, and the assessments are referred back to the Minister of National Revenue for reconsideration and reassessment in accordance with the attached Reasons for Judgement.
Signed at Ottawa, Canada, this 3rd day of August 2001.
|
"J.E. Hershfield" |
J.T.C.C.
2000-2481(IT)I
BETWEEN:
LORRAINE L. PRICE,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
Appeals heard on common evidence with the appeals of Edward J. Price (2000-2480(IT)I) on May 10, 2001 at Kamloops, British Columbia, by
the Honourable Judge J.E. Hershfield
Appearances
Agent for the Appellant: Edward J. Price
Counsel for the Respondent: Nadine Taylor
JUDGMENT
The appeal from the assessment made under the Income Tax Act for the 1994 taxation year is dismissed.
The appeals from the assessments made under the Income Tax Act for the 1995, 1996 and 1997 taxation years are allowed, without costs, and the assessments are referred back to the Minister of National Revenue for reconsideration and reassessment in accordance with the attached Reasons for Judgement.
Signed at Ottawa, Canada, this 3rd day of August 2001.
|
"J.E. Hershfield" |
J.T.C.C.
[1] The Reply to the Notice of Appeal sets this amount out as Mrs. Price's Total Income for 1993. Such amount however does not appear to be correct.
[2] Mr. Price admitted they could have spent up to $12,000.00 per year on Amway products and materials during the years in question. Although he hedged his estimates considerably and was evasive on the point, giving a range of between $6,000.00 and $12,000.00 per year, their average annual use or consumption of Amway products and materials was not likely less than $9,000.00. Taking such average for each year in question is to give the Appellants the benefit of some doubt.
[3] The Appellant, Edward Price, admitted that this was contrary to Amway principles, which if enforced, would limit bonuses payable if there were no retail sales. The Amway rule known as the "10 customer rule" provides that a sponsoring distributor must make not less than one sale to each of 10 different retail customers during a given month in order to earn the right to obtain performance bonuses on the volume of products sold through him. Mr. Price testified that this rule was not enforced.
[4] A pro forma was introduced as an exhibit that projected net bonuses of $138,000.00 per year. Such earnings required J & L to have three groups under it having monthly point value sales of at least $13,000.00 each. Mr. Price testified however that there was only one group under J & L presently capable of contributing to these bonus levels and even that group was itself having difficulty sustaining on a regular basis monthly point value sales of 7,500 which was the level marking platinum status. While J & L had achieved platinum status on several occasions in recent years, it has not been able to maintain that status on a regular and continuing basis. The gross dollar sales in 1997 of J & L's groups was just over $123,000.00 and that resulted in net bonuses (bonuses earned less bonuses shared with down the line independent business owners) of under $9,000.00 for that year which was the best net bonus year of the years reassessed.
[5] In this regard I refer simply to my analysis of the reasonable expectation of profit test in Spearing v. R., [2001] 1 C.T.C. 2689.
[6] (1988), 88 D.T.C. 1504 at 1514
[7] In Spire Freezers Ltd. v. Canada, [2001] S.C.J. No. 11 at para. 26, in the context of a partnership, it was found that start-up losses do not negate partnership (ie: that there is a genuine business undertaken with a view to profit in the future) and that "The law of partnership does not require a net gain over a determined period in order to establish that an activity is with a view to profit." J & L is a partnership operating with a view to profit in the subject years. There was an ongoing business being pursued. That future anticipated profits may not come to be or not be sufficient to offset prior losses does not alter the fact that there is a business in respect of which losses may be claimed.
[8] [2001] 1 C.T.C. 2453
[9] Respondent's counsel also referred to several other cases including Keeping v. R., [1999] 3 C.T.C. 2077; reversed [2001] F.C.J. No. 899; Nordstrom v. R., [1999] 3 C.T.C. 2253; and Koczkur v. R., (2000) 2 C.T.C. 2414. In Nordstrom, Judge Bowie found that objectively there was not even a remote prospect of profit in the foreseeable future. In both Koczkur and Keeping Judge Beaubier found the appellants had no business plan, no training or experience and insufficient time to devote to the activity. These findings are distinguishable from the case at bar. Mr. Price has a rational plan with the time to devote to it. He has an accounting and business background and his "sales" skills were apparent at the trial. He has sold me at least that his efforts might well be or become profitable and the 1999 income statements go a long way in verifying that. The issue is whether he (J & L) has understated that profit potential given the rather casual if not reckless manner in which expenses have been claimed.