Coupland v. The Queen, [1988] 1 CTC 414, 88 DTC 6252 (FCTD)

Reed, J.: —The issue in this case is whether certain expenses incurred by the plaintiff during the 1980 and 1981 taxation years are business expenses. The business to which they are alleged to relate is the operation of a campground as well as the rental of a cottage and other properties. If the expenses are business expenses they, of course, are deductible for tax purposes.

The issue to be determined is purely one of the fact: did the plaintiff during the years in question incur the expenses for the purpose of producing income from a business, that is, was he engaged in an activity with a reasonable expectation of making a profit therefrom. The plaintiff, in 1959, purchased 200 acres of property in the Calabogie area of Lanark, as a holiday property for himself and his family. In 1961 it became their principal residence. He worked in Ottawa, both at that time and in the subsequent years; initially he commuted between the Lanark property and his Ottawa job on a daily basis. In the early 1970s he began living in Ottawa during the week and commuting home to the property only on weekends. When the property was first purchased, there was an old brick house on it which was not suitable as a residence for the family. A new house (referred to in the evidence as the D.V.A. house) was built; the family moved into it. It is clear that the family’s life style was such as to enjoy the rural location.

In 1974 the plaintiff decided to turn part of the property into a campground: 8 serviced campsites and approximately 12 unserviced sites were created for this purpose. There was as well, room for at least 10 other unserviced campsites more or less immediately available and potential for expansion to a much larger number (e.g. 100). Outhouses were built; a trout pond constructed; and, the requisite service roads installed. The tax treatment of the expenses incurred with respect to this construction is not part of the dispute in this case.

After these initiatives had been taken, sometime towards the end of 1975 or the beginning of 1976, the plaintiff sought the advice of a consultant with the Ontario Ministry of Tourism, a Mr. Bingham. The advice sought was with respect to the possibility of developing the campground and obtaining a business loan for this purpose. The plaintiff had applied prior to that time for a loan from the Federal Business Development Bank and had been turned down. The Federal Business Development Bank does not loan money to consolidate existing debts; it apparently advances money only for new projects. The Federal Business Development Bank application had been made in early 1975 and was turned down in September of that year.

The plaintiff's consultations with Mr. Bingham in the latter half of 1975 and beginning of 1976 led to suggestions for the development of the campsite through the construction of additional facilities: additional serviced sites; proper toilets; laundry facilities; a store on the property; a swimming pool; an activities building which might be used by the campers in bad weather. The plaintiff's accountant, Mr. McCoy, in early 1976 prepared projections as to the proposed profitability of the venture if the proposed development took place. These projections showed losses in the first year (1976-77) but a profit thereafter. The projections were based on information given to Mr. McCoy by the plaintiff and they envisaged the obtaining of a $280,000 loan. The plaintiff applied to the Eastern Ontario Development Corporation, in 1979, for a loan ($45,000, not $280,000). Mr. Bingham was asked to evaluate the loan application from the Department of Tourism's point of view. He was asked to consider: whether the plaintiff had the management capability to effect and operate the proposed development; whether there would be any negative effects on competitors in the area if the development took place; whether the plaintiff's marketing plans looked reasonable. Mr. Bingham's evaluation did not involve any financial analysis of the application. Mr. Bingham recommended that the loan application go forward for the next step, evaluation by the Eastern Ontario Development Corporation. Despite Mr. Bingham's positive recommendation, the plaintiff was unable to obtain an Eastern Ontario Development Corporation loan because that body was similarly constrained as the Federal Business Development Bank had been; the Eastern Ontario Development Corporation cannot make loans to discharge existing debts. Its funds are new money for new projects. (The determination that both development agencies are limited as set out above is based on the statements of the plaintiff given in evidence and not on any independent review of the legislative requirements.)

The events which occurred next are the subject of conflicting interpretations. The plaintiff purchased a "pre-fab" house for $40,000 which was constructed across the road from the D.V.A. house. The family moved into that house in January of 1980. The plaintiff contends that he had decided to proceed with the plans for the development of the campsite by turning the D.V.A. house into the general activities building envisaged in the projected development. He states that he planned to add laundry facilities, toilets, etc., thereto. The defendant contends that the plaintiff had no such intention but by that time, had decided to sell the property. The plaintiff's answers on the examination for discovery, with respect to the source of the advertising expenses ($28) shown on his tax forms for 1979, bears out this second interpretation. During 1980, the plaintiff rented the D.V.A. house to his daughter for $100 per month. This was not sufficient to cover the mortgage costs of the property. In May of 1980 the plaintiff had a massive heart attack. He was incapacitated until at least September of that year. The plans from then on became even less focussed. The plaintiff continued to charge the mortgage expenses of the property as a business expense, until the house and property were eventually sold, quite recently.

I would note that the event which gave rise to the department's reassessment of the plaintiff's tax indebtedness in this case occurred when the plaintiff moved across the road, out of the D.V.A. house. After that time, the plaintiff reported the mortgage interest on that D.V.A. house as a business expense incurred with respect to the campground operation. He had not reported the mortgage expenses in this fashion earlier. At the earlier time, the family was living in the house and thus the expenses were clearly felt to be of a personal nature.

The department reassessed the plaintiff for the 1977-1981 taxation years, taking the position that the expenses which the plaintiff had claimed during those years were not expenses incurred for the purpose of gaining or producing income from a business. The department subsequently dropped its claim for the 1977-1979 taxation years. This I understand to have been done because the department has adopted a policy of allowing all alleged businesses a three-year period before assessing whether or not they constitute genuine business enterprises. In any event, only the 1980 and 1981 taxation years are in issue in this case.

There is a vast body of case law concerning what constitutes the operation of a business and whether or not a taxpayer can be said to have had a reasonable expectation of profit. The leading case is Moldowan v. The Queen, [1977] C.T.C. 310; 77 D.T.C 5213 (S.C.C.) particularly at 313-14 (D.T.C. 485-86):

Although originally disputed, it is now accepted that in order to have a “source of income” the taxpayer must have a profit or a reasonable expectation of profit. Source of income, thus, is an equivalent term to business: Dorfman v. MNR, [1972] C.T.C. 151; 72 D.T.C. 6131. See also paragraph 139(1)(ae) of the Income Tax Act which includes as "personal and living expenses" and therefore not deductible for tax purposes, the expenses of properties maintained by the taxpayer for his own use and benefit, and not maintained in connection with a business carried on for profit or with a reasonable expectation of profit. If the taxpayer in operating his farm is merely indulging in a hobby, with no reasonable expectation of profit, he is disentitled to claim any deduction at all in respect of expenses incurred.

There is a vast case literature on what reasonable expectation of profit means and it is by no means entirely consistent. In my view, whether a taxpayer has a reasonable expectation of profit is an objective determination to be made from all of the facts. The following criteria should be considered: the profit and loss experience in past years, the taxpayer's training, the taxpayer's intended course of action, the capability of the venture as capitalized to show a profit after charging capital cost allowance. The list is not intended to be exhaustive. The factors will differ with the nature and extent of the undertaking: The Queen v. Matthews, [1974] C.T.C. 230; 74 D.T.C. 6193. One would not expect a farmer who purchased a productive going operation to suffer the same start-up losses as the man who begins a tree farm on raw land.

Counsel for the plaintiff argues that the Moldowan case is a farming case and that particular and more stringent rules apply with respect to farming businesses than is the case with other businesses. It is also argued that if Revenue Canada is correct, in this case, it means that a taxpayer whose business fails, is never going to be able to claim his expenses; if the business is a success, Revenue Canada takes its share.

In my view, the Moldowan case sets out rules which are applicable in all cases, regardless of whether the business under review is farming or of some other type. Also, I do not accept that there is unfair treatment because a taxpayer must demonstrate that he is engaged in a genuine business enterprise before being allowed to deduct, for tax purposes, the expenses related thereto. This rule is designed to prevent taxpayers writing off personal expenses under the guise of business expenses. It is designed to promote equity as between taxpayers.

Counsel for the plaintiff made reference to Interpretation Bulletin IT-487 dated April 26, 1982. In that Interpretation Bulletin, the Department refers to the relevant wording of the Income Tax Act, S.C. 1970-71-72, c.63, stating that it is not necessary to show that net income actually resulted from an enterprise in order for an expense to be considered a business expense. The Bulletin indicates that it is sufficient if the outlay or expense is part of an income earning process. The Interpretation Bulletin continues:

The word income refers to income after deductions as computed under Division B of the Income Tax Act. An expense would not be disallowed simplv because the income earning process produced a loss as long as the intention in making the expenditure was to produce income. Outlays or expenses made or incurred to maintain income or to reduce other expenses are also deductible as their purpose would be to increase income, whether or not such an increase resulted."

[Emphasis added]

That is of course an accurate exposition of the law. But to have an income earning process, the taxpayer must be engaged in a genuine business and not merely playing at such activity, not merely running a hobby against which to write off what otherwise would be for tax purposes, personal expenses. Thus, the test articulated by the Supreme Court in the Moldowan case is the relevant test.

Applying that test, I could not conclude on the basis of the evidence in this case, that the expenses in question were incurred by the taxpayer for the purpose of producing income from a business. I do not conclude that the activities in which the plaintiff was engaged were carried on with a reasonable expectation of a profit. (I accept that the test of what constitutes a reasonable expectation of profit is one to be determined by reference to all the facts of the case.)

My conclusion, that the plaintiff's activities were not carried on with a reasonable expectation of profit, is based on the reasons which follow. The profit and loss record of the plaintiff's business never showed a profit from the first year of its operation, in 1975 to 1985. The plaintiff has consistently reported losses: $7,985.54; $8,676.84; $8,383.37; $14,491.57; $24,414.44; $14,350.77, and $14,508.35 for the 1977-1983 years respectively. The gross income for the campground itself for the years 1977 to 1980 was $86; $134; $258; and $520 respectively. After 1980, the campground income was reported in a combined fashion with that received from the cottage and farmhouse property; therefore, it cannot be separately identified. The evidence is sketchy with respect to the renting of the cottage, the farmhouse and the D.V.A. house. That which exists does not show a vigorous and concerted effort to run a business. The D.V.A. house, as well as being rented to the plaintiff's daughter for $100 per month in 1980, was rented during a few of the winter months in 1981-82 to some loggers and for approximately six months in 1984 to some miners who were prospecting in the area.

With respect to the taxpayer's training, I have no doubt that the plaintiff had adequate managerial and the other abilities to develop the campground and run the operation had he chosen to do so as a serious business venture, and, had he had the capital to do so. His past experience in various managerial functions, albeit not in the private sector, and his obvious ability to deal well with people would have made him an ideal candidate to operate such a business. And, in any event, the running of a campsite is not a high skill occupation.

While I have no doubt that the plaintiff had the experience and ability to run a campground operation as a business, he was not in fact doing so. He was not on the property much of the time. He had a full-time job in Ottawa during the whole period and only returned to the Lanark property on weekends. There is no evidence of a concerted effort to try to ensure a full occupancy rate of even the limited number of campsites which were in existence. (By full occupancy I mean what would constitute average occupancy in the industry.)

There is no evidence of any concerted advertising of the campground. The plaintiff stated that he had done such advertising but the only concrete evidence on the record is the fact that Camp Coupland was listed in a Government of Ontario camping brochure published for the 1981 season and the plaintiff had had some calling cards made with Camp Coupland, the address, a map and rates listed thereon. No expenses for advertising of the Camp were included in his 1975-1985 tax returns.

The plaintiff gave evidence that he was creating the campground as a retirement business. That may be so, but there was obviously no concerted attempt being made to treat the operation as a business during or preceding the relevant taxation years. It is clear that the enterprise, from the start, was undercapitalized. Indeed, it would appear that the attempts to acquire capital in 1978-1980 for the purpose of expanding the campsite facility may have been precipitated as an attempt to bail the plaintiff out of financial difficulties which, as of that time, had fallen upon him. No capital cost allowance was ever claimed with respect to the alleged business.

Counsel for the plaintiff argues that the taxpayer was engaged in a business from which there was a reasonable expectation of profit but that all that was needed was time to develop the property. He argues that if the taxpayer had not had a heart attack, he would have developed the property by virtue of “sweat equity”. He argues that the plaintiff was engaged in a viable business operation and all that was required was further time, effort and moneys to bring it to fruition. I do not so conclude from the evidence. As noted above, I do not conclude that the move out of the D.V.A. house was to enable it to be converted into a general activities building. If this had been the purpose, there would have been no reason to move in January rather than at a later date, closer to the summer months. The January move is quite consonant with a decision to sell the property. There is no evidence of any definite or specific plans for conversion of the house - merely the plaintiff's vague statement that this was intended. Counsel referred to the fact that some cases have held that taxpayers might be expected to incur up to ten years of start up losses before it is reasonable to expect them to turn a profit. These cases relate to the establishment of dairy herds and breeding cattle stock, which activity, by its very nature, requires a long period of development. The establishment of a campground is not of this nature. It is a business where a long start up time is not required.

Counsel for the defendant argues that the conclusion that there was a reasonable expectation of profit arising out of this business appears from the evidence of Mr. Bingham, an independent, disinterested observer. Mr. Bingham's evidence was that the business was marginally viable in 1976 and that with the expansion of the facilities, the business could become truly viable. Counsel argues that unlike most evidence of reasonable expectation of profit, this evidence is not of a self-serving nature. I have no doubt that the operation of a campground in the area might be a viable enterprise especially had the suggested improvements been made. But, the issue is whether the business as the plaintiff was operating it, was one which was being run with a reasonable expectation of profit. I do not think it was.

For the reasons given, the plaintiff's action will be dismissed. The defendant is entitled to recover its costs of the action.

Action dismissed.