Hammill v. Canada, 2005 DTC 5397, 2005 FCA 252

Date: 20050707

Docket: A-507-04

Citation: 2005 FCA 252

CORAM:        LÉTOURNEAU J.A.

NOËL J.A.

NADON J.A.

BETWEEN:

                                                          WILLIAM HAMMILL

                                                                                                                                            Appellant

                                                                           and

                                                    HER MAJESTY THE QUEEN

                                                                                                                                        Respondent

                                            Heard at Ottawa, Ontario, on June 28, 2005.

                                    Judgment delivered at Ottawa, Ontario, on July 7, 2005.

REASONS FOR JUDGMENT BY:                                                                                    NOËL J.A.

CONCURRED IN BY:                                                                                        LÉTOURNEAU J.A.

                                                                                                                                      NADON J.A.

Date: 20050707

Docket: A-507-04

Citation: 2005 FCA 252

CORAM:        LÉTOURNEAU J.A.

NOËL J.A.

NADON J.A.

BETWEEN:

                                                          WILLIAM HAMMILL

                                                                                                                                            Appellant

                                                                           and

                                                    HER MAJESTY THE QUEEN

                                                                                                                                        Respondent

                                                    REASONS FOR JUDGMENT

NOËL J.A.

[1]                This is an appeal from a judgment of the Tax Court of Canada (2004 DTC 3271) dismissing an appeal from reassessments made under the Income Tax Act, R.S.C. 1985, c.1, as amended (the Act), for the appellant's 1994, 1995 and 1996 taxation years. The issue at trial and on appeal relates to the deductibility of expenses totalling $1,651,766 incurred by the appellant for the purpose of selling precious gems which expenses were paid to or at the direction of a fraudulent selling agent.

[2]                The Tax Court Judge found that the expenses in question were not incurred for the purpose of earning income from a business pursuant to paragraph 18(1)(a). He went on to find that the claimed expenses were not "reasonable in the circumstances", and therefore not deductible under section 67.

The Facts

[3]                The relevant facts are set out in an agreed statement of facts which I have reproduced in its entirety:

1)          The appellant is a retired lieutenant colonel from the Canadian Armed Forces Reserve. He was a regimental commander from 1977 through 1980 and 1983 through 1986.

2)          The appellant is the co-owner of a successful clothing manufacturing company in Guelph, Ontario which employs 200 people and has annual sales in excess of $12 million. He supervises 26 salespersons over 15 sales offices and sells product himself, with about 4,500 customers.

3)          In 1987 the appellant commenced buying precious gems for the purpose of resale, from York Union, a Toronto area company. Initial contact was by telephone solicitation. Before undertaking the gem purchases, the appellant visited York Union and over the course of his business with York Union, attended its offices many times. York Union closed operations in 1990. The appellant's contact at York Union, Bill Hawkins moved to H & H Rarities, another Toronto area company. The appellant continued to purchase gems from H & H Rarities through July 1992 with a view to resale at a profit. By 1992 he had acquired stones costing $272,789. By 1994, the inventory had increased to $529,926.

4)          In 1993 when the appellant decided it was time to sell his gem inventory, he sought the advice of Bill Hawkins at H & H Rarities, a company with which he had satisfactory dealings with for several years. An individual, Peter Manning from Premier Group Investments ["Premier"] telephoned the appellant advising the appellant that he had been referred to the appellant by H & H Rarities. Premier offered its services in assisting the appellant. The appellant contacted Harold Schnap president of Premier, and over the next few years had regular contact, by telephone and face to face with representatives of Premier, including Harold Schnap, Andrew Martin and Peter Manning. The appellant verified statements made to him with others at Premier, with another gem company, International Gem Consultants, and with other gem investors.

5)          Andrew Martin was the principle [sic] contact from Premier. Andrew Martin presented the appellant with an offer from an offshore purchaser. The terms of the offer would generate a very significant profit to the appellant. In order to complete the purchase, the appellant was told that he had to pay to Premier or as directed by Premier large up front fees. These fees were variously described as performance bonds, insurance, shipping, sales commissions and administration charges.

6)          The sale was not completed. Andrew Martin had an explanation and a new offer. The presentation of an offer, requirement for up front fees and failure to close was repeated 4 more times. On one occasion, third parties claimed to have liens on the appellant's gem inventory. The appellant paid to have the liens removed.

7)          Each of the five offers had the following in common:

a)          Very large profit to the appellant;

b)          Up front fees;

c)          Were fraudulently created by Andrew Martin and his accomplices;

d)          Did not close.

8)          Between 1993 and 1996, the appellant made approximately 40 payments with respect to five separate offers. The appellant paid to Premier or as directed by Premier, $1,651,766.

9)          The appellant believed that the payments to or as directed by Premier were for the purpose of facilitating the sale of the appellant's gems at a profit.

10)        The following summarizes the economic results if the agreements had not been fraudulent and any of the deals had closed:

11)        In 1996, the appellant realized that Premier Investments had perpetrated a series of frauds upon him and consulted the RCMP. The appellant assisted the police. The police raided the offices of Premier and arrested the representative known to the appellant as Andrew Martin. Andrew Martin was identified as Michael Davis-Bingham, also known as Barry Davis, charged with theft over $5,000 and released on bail. The defendant fled and there is a bench warrant for his arrest. Premier's business disappeared, as have the other representatives.

12)        Andrew Martin had possession of the appellant's gem portfolio in 1996. When he was arrested and subsequently fled, the gems of the appellant also vanished. The Respondent has allowed a business loss with respect to the theft of the appellant's gem inventory.

13)        The Respondent has denied any prepaid expense deduction with respect to the payments made to or as directed by Premier.

14)        As a consequence of the denial of the deductions by the Respondent, the Respondent also denied interest expense with respect to the 1994, 1995 and 1996 taxation years.

15)        In the event that this Court allows any of the payments paid to or as directed by Premier, such deductions will be applied to the 1996 taxation year.

16)        The appellant was engaged in business by virtue of being engaged in an adventure in the nature of trade.

17)        The amounts paid to or as directed by Premier were paid by a combination of bank draft, wire transfer and cash. All amounts paid were verified by the RCMP.

18)        Generally Premier did not provide receipts, invoices or other commercial documents to evidence payments made by the appellant.

19)        The following represent exceptions to the lack of supporting documentation. References are to the appellants Document Book:

[4]                In addition, the Tax Court Judge made a number of findings of fact which are not contested as set out below.

[5]                At all relevant times, the appellant stored the gems either at his home or office until he handed them over to Andrew Martin who later absconded with them. The gems were never insured (Reasons, pages 6, 17).

[6]                In the course of five distinct purported purchase offers presented by Andrew Martin, the appellant made substantial payments without questioning their purpose or legitimacy and for which he did not require receipts (Reasons, page 8, paragraph 14).

[7]                The appellant first made a payment of $360,540 in 1993 to Andrew Martin for a "performance bond" and "other fees". The sale never occurred and the appellant was never reimbursed the amount of $360,540 (Reasons, pages 2-6).

[8]                Despite having lost $360,540, the appellant made a further payment of US$78,000 for a "performance bond and service charges" relating to a second purchase offer which turned out to be as ephemeral as the first. Despite having lost $360,540 in the first, failed transaction, the appellant could not provide an explanation as to why he would have proceeded with the second expenditure of US$78,000. The appellant went on to pay additional funds with respect to the second transaction, for a total of $139,410 (Reasons, pages 8-9, paragraph 17).

[9]                The appellant made similar payments with respect to three other subsequent fictitious purchase offers without making any serious enquiries as to the nature of the payments or the offers (Reasons, pages 57-58, paragraphs 155-157).

[10]            The five potential transactions never occurred and the money was never returned to him. By the fifth failed transaction, the appellant had made up front payments of $1,651,766. The payments continued long after the appellant failed to be reimbursed for the previous payments he had made (Reasons, pages 8, 15, 18, paragraphs 14, 43, 57).

[11]            The purchase offers were all made by different companies, on dubious looking stationary, reflecting confusing and often unintelligible language. The appellant never seriously questioned these practices and continued paying the amounts requested in the letters (Reasons, pages 7- 9, 11, 14, 15, 17, 58, paragraphs 10, 17, 20-22, 28, 42, 44, 51, 156).

[12]            The total payment of $1,651,766 was made by the appellant under the guise of the following requirements: the "certification" of his inventory; performance bonds for which the funds were never returned; the removal of liens that never existed; various administration fees for which he could not provide an explanation; payments relating to a "tax situation" to which the appellant could not ascribe any meaning (Reasons, pages 7, 16-18, 19, 23, paragraphs 9, 49, 50, 54, 59, 60, 74).

The Reassessments Under Appeal

[13]            The effect of the reassessments under appeal was to allow the appellant to deduct the loss resulting from the theft of his inventory ($529,926) but deny the deduction of the "selling" expenses totalling $1,651,766 on the ground that the appellant had been unable to establish that they were incurred for the purpose of earning income from a business within the meaning of paragraph 18(1)(a). At the confirmation stage, the Minister of National Revenue added as an alternative ground of assessment, that these expenses were not "reasonable in the circumstances" as required by section 67 (Appeal Book, Vol. I, page 242).

Relevant Statutory Provisions

[14]            Paragraph 18(1)(a) and section 67 provide respectively:

Decision Under Appeal

[15]            In finding that the expenses in question were not incurred for the purpose of earning income from a business within the meaning of paragraph 18(1)(a), the Tax Court Judge relied on the fact that the appellant could not have been involved in any business as he had been the victim of a fraud from beginning to end.

[16]            The Tax Court Judge went on to hold that the appellant had not done his homework and was motivated by greed:

[123] In the present case there was no business structure in place; there was no possibility of a secondary sale; there was no framework of a business and the expenses which purportedly related to the possible sale were fraudulently claimed by the perpetrators from the beginning because there was no way that the gems could be sold as contemplated by the Appellant. It would be reasonable to conclude that if the Appellant had sought to do so he should have been able to find this out before he even became involved to any extent in purchasing the gems. He did no homework in this regard. He became a willing victim from the beginning, relying only upon his unsupported conclusion that he could earn a substantial profit from the ultimate sale of the gems and believing implicitly in the lies of Andrew Martin.

[17]            After having concluded his analysis of paragraph 18(1)(a), the Tax Court Judge examined the application of section 67. He stated:

[138] The Court can see no reason to conclude that section 67 does not apply in defalcation cases and it can see no reason why it should not apply in the case at bar. This Court can envision the situation in a defalcation case where the actions of the taxpayer could be considered to be unreasonable under section 67. Take the situation where a taxpayer continues to pursue recovery of a defalcated amount but is aware that every reasonable indication points to the fact that the amount is not recoverable. One could not conclude that thereafter expenditures made by the taxpayer to recover what would reasonably appear to be unrecoverable, would still be deductible.

...

[152]...The Court agrees that section 67 stands alone and it must stand for the proposition that in order for the expenses to be deductible, under all of the circumstances, they must be reasonable, regardless of how liberally one interprets the provisions of paragraph 18(1)(a) nor how liberally the Court considers the question as to whether or not the expenditures were made for the purposes of producing income from a business or property. Even if this is a subjective test, there has to be a limit to how far a taxpayer can go in saying, "I thought I was involved in business, I thought the expenditure was reasonable and I made the expenditure with the intention of gaining or producing income".

[18]            The Court later explained why no part of the "selling" expenses incurred by the appellant could be allowed under section 67:

[169] Counsel for the Respondent appeared to indicate that there might have been some basis for making the payments to the extent of $360,540, bearing in mind that the inventory cost at that point was $292,788 and the selling price on the first agreement was $2,218,800. However, he argued that any payments made thereafter were unreasonable.

[170] The problem with that submission is that the Court would have to determine that there was a reasonable basis for the Appellant to have acted as he did up to that point in time. Neither counsel attempted to point to any actions of the Appellant up to that point in time which could have been considered to be reasonable and the Court is satisfied that the Appellant acted throughout in much the same manner.

[19]            While the Tax Court Judge sympathised with the appellant's situation, he was not ready to have the Canadian taxpayers assume the burden of his losses:

[179] At the end of the day, the Court is satisfied that the expenses in issue in this case cannot be deducted because they are prohibited by the provisions of paragraph 18(1)(a) and section 67 of the Act. The Court finds that these expenses were not made or incurred by the taxpayer for the purpose of gaining or producing income from a business or property and the Court is satisfied that these expenses were not reasonable under the circumstances.

Arguments in Support of the Appeal

[20]            In support of his appeal, the appellant submits that the Tax Court Judge erred in concluding that the expenses were prohibited by paragraph 18(1)(a) when regard is had to the decision of the Supreme Court in Stewart v. The Queen, 2002 DTC 6969. There was in this instance no personal element to the transactions, and it is common ground that the expenses were paid for the purpose of selling the appellant's gems. According to Stewart, supra, no matter how unreasonable the appellant's actions are perceived to be, the Tax Court Judge could not hold that his particular activity did not amount to a business.

[21]            The appellant adds that the fact that he was engaged in an "adventure in the nature of a trade" was conceded by the Minister throughout. When regard is had to the extended definition of "business" under section 248 of the Act, this amounts to a concession that the appellant was engaged in a business and it was not open to the Tax Court Judge to hold otherwise.

[22]            The appellant further argues that losses resulting from fraud have often been recognized for income tax purposes (Parkland Operations Limited v. The Queen, 90 DTC 6676, Cassidy's Limited v. M.N.R., 89 DTC 686, Agnew v. The Queen, 2002 DTC 2155). It is submitted that the Tax Court Judge erred in not treating this matter as a defalcation case (reference is also made to Interpretation Bulletin, IT-185R).

[23]            Turning to section 67, the appellant points out that this provision only becomes relevant to the analysis if a business is found to exist and if the expenditure was incurred to earn income from that business in the first place. The reasonability of an expense must be analysed in context. In this case, the appellant submits that the "selling" expenses were reasonable when regard is had to the high profits which were anticipated.

[24]            The appellant adds that the purpose of section 67 is to measure the reasonableness in terms of its magnitude or quantum (Mohamad v. the Queen, 97 DTC 5503). According to the appellant, there is no authority for the proposition that expenditures can be disallowed in whole pursuant to section 67.

Analysis and Decision

[25]            This appeal raises two issues, the first being whether the claimed expenses were incurred to earn income from a business within the meaning of paragraph 18(1)(a) and if so, whether these expenses were "reasonable in the circumstances" so as to overcome the prohibition embodied in section 67 of the Act.

[26]            At the very beginning of his analysis, the Tax Court Judge makes a finding of fact which has gone largely uncontested and which, in my view, is fatal to the appellant's case on the first issue. He said (paragraphs 114 and 115):

[114]      As far as the Court is concerned there is no question that the Appellant was the victim of a substantial fraud from the beginning to the end. The Court is satisfied that this fraud commenced when the Appellant was contacted about profits to be made from buying and selling gems and this fraud continued with the purported efforts of the perpetrators to sell the gems. The Court is not satisfied that the evidence supports the figure of $529,926 agreed to by the parties in the value of the inventory because the indicia of the value by way of certificates produced into evidence by the Appellant as well as the evidence given by the Appellant were insufficient to establish this figure as a fair market value. They did not adequately describe the gems, the quality of the stones, the weight of the gems or the qualities or imperfections, to the extent that these certificates could be relied upon.

[115]      However, the Minister allowed the Appellant to deduct the inventory loss as claimed and therefore the evaluation is not relevant except to the extent that it indicates that the fraud, in all likelihood, extended to the amount paid for the gems in the first place. [my emphasis]

The Tax Court Judge later reiterated that "... the whole transaction was a fraud from its inception" (paragraph 127).

[27]            This finding by the Tax Court Judge that the appellant was the victim of a fraud from beginning to end, if supported by the evidence, is incompatible with the existence of a business under the Act. This is not a case where the Court must have regard to the taxpayer's state of mind, or the extent of a personal element in order to determine whether a certain activity gives rise to a source of income under the Act (Stewart, supra, Tonn v. The Queen, 96 DTC 6001 etc.). Nor is this a defalcation case of the type described in Parkland Operations, supra; Cassidy's Limited, supra; Agnew, supra; and IT-185R, where a business is defrauded by an employee or a third party, and the issue becomes whether the resulting loss is reasonably incidental to the income-earning activities.

[28]            A fraudulent scheme from beginning to end or a sting operation, if that be the case, cannot give rise to a source of income from the victim's point of view and hence cannot be considered as a business under any definition. However, the appellant contends that the Tax Court Judge could not hold that the claimed expenses were not deductible on that basis given the Minister's concession that he was engaged in an adventure in the nature of a trade (paragraph 16 of the Agreed Statement of Facts).

[29]            Specifically, the appellant argues that the Tax Court Judge was bound by the facts as admitted, even if contrary evidence was adduced at trial. Sopinka, The Law of Evidence in Canada, 2^nd ed, Butterworths, 2004 at page 1051; Urquhart v. Butterfield (1887), 37 Ch.D. 357, at 369 and 374; Copp v. Clancy (1957), 16 D.L.R. (2d) 415, at 425, are relied upon in this regard.

[30]            In my view, these authorities which derive from private party civil proceedings are of no assistance to the appellant in the context of this appeal. While the admission reflected in the Agreed Statement of Facts was favourable to the appellant, he was not satisfied to have his appeal disposed of on that basis. The appellant chose to place extensive evidence before the Court, over and beyond what had been agreed to, about the nature and extent of the scam.

[31]            In an appeal against an assessment under the Act, the outcome does not belong to the parties. Public funds are involved and the Tax Court is given, in the first instance, the statutory mandate to confirm or vary the assessment based on the facts, proven or admitted. In this respect, while the Court will not generally look behind a formal admission, the parties cannot by agreement dictate the outcome of a tax appeal. The Tax Court is not bound by an admission which is shown, through properly tendered evidence, to be contrary to the facts.

[32]            In this case, the relevant evidence was tendered by the appellant himself, and the Tax Court Judge concluded from this evidence that he had been the subject of a fraud from beginning to end, a conclusion which precludes the existence of a business. In my view, the Tax Court Judge could not pronounce on the validity of the reassessments while turning a blind eye on the evidence placed before him.

[33]            Moreover, there is no basis for the appellant's contention (made during the hearing of the appeal) that this finding was not open to the Tax Court Judge because the statutory period for reassessing had expired when it was made (Pedwell v. The Queen, 2000 DTC 6405 (F.C.A.)). The decision of the Tax Court Judge on this point confirms the reassessments on the primary basis on which they were issued (paragraph 18(1)(a)) and results in no taxes being payable beyond those originally assessed (compare The Queen v. Anchor Pointe Energy Ltd., 2003 DTC 5512 (F.C.A.) at paragraphs 39 and 40).

[34]            The evidence produced by the appellant with regard to the nature and extent of the fraud was very elaborate. The appellant called Constable Laurence, the RCMP Constable who investigated the fraud. He was qualified as an expert. Constable Laurence explained that the entire scheme had been a fraud from start to finish.

[35]            The gems were originally purchased from York Union where Bill Hawkins was the appellant's main contact. The appellant testified that Bill Hawkins sold him most of his gems (Reasons, paragraph 74). In 1990, Bill Hawkins moved to H & H Rarities, the entity from which the appellant continued to purchase gems. Sometime in 1993, after the appellant expressed to Bill Hawkins his desire to sell his gems, he was contacted by Peter Manning who acted for a company by the name of Premier Group Investments (Premier). He later met Harold Schnap, its president and Andrew Martin who became his principal contact (Agreed Statement of Facts, paragraphs 4 and 5).

[36]            According to the expert testimony of Constable Laurence, Andrew Martin was at the centre of the scam. Peter Manning was also one of the perpetrators. Bill Hawkins who sold the appellant most of his gems (Reasons, paragraph 40) and who referred the appellant to Peter Manning was suspected of being part of the scam as was Mr. Schnap, the president of Premier (Reasons, paragraphs 85 and 88; Transcript, Vol. II, pages 232 to 235).

[37]            Constable Laurence added that in the course of the investigation, he took possession of documents identified as "call sheets". These "call sheets" reflected lists of potential victims purchased from other gem sellers (Reasons, paragraphs 98, subparagraph 36). Constable Laurence suggested that the appellant's name had been "sold" to Premier (Reasons, paragraph 98, subparagraph 12). He testified that the scam was operated from the office of an entity called Summit International in Toronto where files on the appellant and other victims were found by the RCMP (Reasons, paragraph 83).

[38]            Constable Laurence indicated that the victim is initially contacted by phone as was the case in this instance. He explained that there is no secondary market for precious gems. The appellant's initial purchases from York Union may have been at the early stages of the scam. As the victim has no venue for selling his gems, he must turn to the seller. Typically, he is then promised large profits against further payments (Reasons, paragraph 98, subparagraph 41). This is precisely what took place in this instance.

[39]            In my view, it was open to the Tax Court Judge to hold, on the basis of this evidence, that the appellant was the victim of a fraud from beginning to end. This finding, which the appellant has not confronted, precludes the existence of a business under the Act, regardless of any other consideration. The Tax Court Judge needed to go no further to support his conclusion that the claimed expenses were not incurred to earn income from a business pursuant to paragraph 18(1)(a).

[40]            The appellant places reliance on two sales which, according to his testimony, were made to arm's length purchasers in May and November of 1995 for proceeds of $127,700 and $30,200 respectively and which would fall outside the scope of the scam as he testified that he made a 25% profit on each sale.

[41]            There are issues surrounding these sales. Although the appellant testified that they took place in 1995, they were not reported until the next year, that is after the appellant had devised his tax strategy for claiming the $1,651,766 "selling" expenses and the $529,926 "inventory costs" which he had lost as a result of the scam.

[42]            The sales were reported by the appellant in his tax return for the 1996 taxation year (filed in April of 1997) in which he discloses for the first time that he is engaged in the gem "business" under the trade name "WHH Ventures". He claims in that return the full loss resulting from the scam ($2,276,253) and applies against this loss the proceeds of these two sales ($157,900) which, if they took place, should have been reported in the prior year (1996 tax return, Appeal Book, Vol. I, page 217).

[43]            No invoice or receipt reflects these sales, nor is there any documentary support for the 25% profit which would have been generated. While the Agreed Statement of Facts explains that the fraud artists did not generally provide receipts or invoices (Agreed Statement of Facts, paragraph 18), this would not extend to bona fide purchasers. The appellant did point to bank deposit slips which would reflect the proceeds from one of these sales (Transcript, Vol. I, page 28; Vol. II, page 114). However the numbers (in U.S. dollars) do not match and no reference is made to the gems (Appeal Book, Vol. II, page 348). The absence of documentation is particularly puzzling given the magnitude of these sales and the appellant's testimony that he intended to report them all along (Reasons, paragraph 41).

[44]            There is also no indication as to where the inventory of gems underlying these two sales would have come from. A reading of the Agreed Statement of Facts suggests that the total inventory cost amounted to $529,926, and it is there indicated (paragraph 12) that Mr. Martin absconded with all the gems. As well, the Notice of Appeal filed by the appellant indicates that this figure of $529,926 reflects the acquisitions which he made between 1987 and 1994 in the course of his "adventure in the nature of a trade" (Notice of Appeal, paragraphs 6 and 7, Appeal Book, Vol. I, page 80).

[45]            The testimony adduced at trial reinforces this impression. The appellant testified that the purchase and sale agreement dated August 30, 1993, (Appeal Book, Vol. II, page 298) was for all of his inventory (Reasons, paragraph 9; Transcript. Vol. I, page 34). This inventory had been purchased between 1987 and 1993 (Reasons, paragraph 40). The only additional purchase alluded to by the appellant is the one made on February 16, 1994, through Andrew Martin when three emeralds were added to his portfolio to make it "more saleable" (Reasons, paragraph 16). These additional gems were also lost since their cost ($175,280.96 U.S. or $237,137 Cdn.) forms part of the inventory loss claimed by the appellant.

[46]            Another troubling feature is that at the time when these two sales would have taken place (May and November of 1995), the appellant was still under the spell of Andrew Martin and his cohorts and convinced that he could obtain enormous gains (ten times his cost) from the sale of his gems. Why then would he have agreed to sell a significant part of his inventory for a 25% profit? Finally, these two sales seem to be at odds with the expert testimony of Constable Laurence who indicated that there was no secondary market for the gems which the appellant purchased.

[47]            In my view, the Tax Court Judge properly ignored these transactions in concluding that the appellant was the subject of a scam from start to finish. This finding precludes the existence of a business and was sufficient to dispose of the appeal.

[48]            Although it is not necessary to deal with the alternative ground on which the Tax Court Judge rejected the appeal, I believe it useful to say a few words about the scope of section 67 and its application in this case.

[49]            The appellant points out that this provision contemplates an outlay or expense that has been incurred for the purpose of earning income within the meaning of paragraph 18(1)(a), and allows the Minister to disallow that part of the expenditure which can be shown to be unreasonable. In other words, the provision does not allow for a qualitative review of the expenditure since the expenditure must have been made to earn income to begin with. What is contemplated is a quantitative review of the expenditure.

[50]            Indeed, the judicial pronouncements on section 67 to date have treated the issue arising under that provision as one of magnitude or quantum (see Mohamad, supra; Garbco Ltd. v. M.N.R., 68 DTC 5210). The appellant submits that the following passage from Vern Krishna, The Fundamentals of Canadian Income Tax, 3^rd edition, properly illustrates the scope and purpose of section 67 (page 312):

The word "reasonable" [in section 67] would appear to relate primarily to the size or the amount of the deductions claimed or quantified and not to the type of the expense. "The purpose of the rule is to prevent taxpayers from artificially reducing income by deducting inordinately high expenses", ...

[51]            I agree that this statement accurately reflects how section 67 has been applied by the courts to date. However, the Supreme Court in Stewart, supra, commented on the application of section 67 and signalled that it could have a broader application. It will be recalled that in Stewart, the Supreme Court dealt away with the "reasonable expectation of profit" test as a means of ascertaining the existence of a source of income. The Court recognized that this test had been devised to counter abuses, but held that it had no statutory foundation and created more problems than it resolved.

[52]            In devising the "recommended approach", the Supreme Court identified section 67 as the statutory means of controlling excessive or unwarranted expenditures once a source of income is found to exist. It said at paragraph 57:

... If the deductibility of a particular expense is in question, then it is not the existence of a source of income which ought to be questioned, but the relationship between that expense and the source to which it is purported to relate. The fact that an expense is found to be a personal or living expense does not affect the characterization of the source of income to which the taxpayer attempts to allocate the expense, it simply means that the expense cannot be attributed to the source of income in question. As well, if, in the circumstances, the expense is unreasonable in relation to the source of income, then s.67 of the Act provides a mechanism to reduce or eliminate the amount of the expense. Again, however, excessive or unreasonable expenses have no bearing on the characterization of a particular activity as a source of income. [emphasis added]

[53]            The choice of words (reduce or eliminate) is not accidental. The Supreme Court was setting-up section 67 as the proper means of testing the reasonableness of an expense once a business has been found to exist. It was doing so after having explained that at the first level of inquiry (i.e. the existence of a source of income and the relationship between an expense and that source) courts ought not to second guess the business judgment of the taxpayer (Stewart, supra, paragraphs 55, 56 and 57). Section 67 was identified as the statutory authority pursuant to which an inquiry could be made as to the reasonableness of an expense. In my view, the Supreme Court in Stewart acknowledged that there is no inherent limit to the application of section 67, and that in the appropriate circumstances, it can be used to deny the whole of an expense, if it is shown to be unreasonable.

[54]            In this case, the Tax Court Judge attempted to identify what part of the "selling" expenses could be viewed as reasonable in the circumstances. He noted that neither counsel could indicate any cut off point. He went on the hold that the actions of the appellant were the same throughout and concluded that the expenditures were unreasonable from beginning to end. In my view, this is a conclusion that was open to him why regard is had to the evidence.

[55]            I would dismiss the appeal with costs.

                    "Marc Noël"                        

J.A.

"I agree.

Gilles Létourneau J.A."

"I agree.

M. Nadon J.A."

                          FEDERAL COURT OF APPEAL

    NAMES OF COUNSEL AND SOLICITORS OF RECORD

DOCKET:                                                       A-507-04

Appeal from a decision of the Tax Court of Canada dated September 13, 2004.

STYLE OF CAUSE: WILLIAM HAMMILL

v.

HER MAJESTY THE QUEEN

PLACE OF HEARING:                                             Ottawa, Ontario

DATE OF HEARING:                                               June 28, 2005

REASONS FOR JUDGMENT:                                Noël J.A.

CONCURRED IN BY:                                              Létourneau J.A.

Nadon J.A.

DATED:                                                          July 7, 2005

APPEARANCES:

SOLICITORS OF RECORD: