Date: 20010718
Docket: 1999-1366-IT-G
BETWEEN:
BRIAN RIKLEY,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
Reasons for Judgment
Bowman, A.C.J.
[1]
These appeals are from assessments for the 1990, 1991, 1992 and
1993 taxation years. The issue is whether the appellant is
entitled to deduct losses incurred in chartering a
C & C 51 yacht (called "Spice II") in the
British Virgin Islands ("BVI"). In the evidence and
argument the issue was stated to be whether the appellant had a
"reasonable expectation of profit". The fundamental
question that must be answered in cases of this sort is "Is
there or is there not a business?"
[2]
The appellant bought Spice II in 1990 and operated it during
and after the years under appeal as a full service crew sailing
yacht. It claimed substantial losses in those years:
1990
1991
1992
1993
$188,071.93
$232,787.89
$243,401.40
$129,798.87
Although the revenues and most of the expenses were in US
dollars these figures are in Canadian dollars.
[3]
Of these amounts, the following represented capital cost
allowance ("CCA"):
1990
1991
1992
1993
$Cdn
$86,653.22
$145,826.00
$145,826.00
$76,026.73
[4]
The CCA claimed was the result of accelerated CCA allowed in
respect of Canadian vessels under
paragraph 1100(1)(v) of the Income Tax
Regulations. Yet it is that very accelerated depreciation
given as an incentive to encourage the building of vessels in
Canada that in part gives rise to the losses which the Minister
of National Revenue uses to justify the assertion that the
appellant had no reasonable expectation of profit. This is a
striking example of the difficulties to which the statement of
Dickson J. in Moldowan v. The Queen, [1978]
1 S.C.R. 480, leads that one has no reasonable
expectation of profit unless one can show a profit after
deducting capital cost allowance. I shall not repeat what I
said about that statement in Roopchan v. The Queen,
96 DTC 1338, beyond observing that the existence or
non-existence of a REOP should not depend on the rates of CCA
allowed or the amount of CCA claimed.
[5]
The appellant was an experienced and successful businessman with
a substantial income. From 1985 to 1989 he operated a bareboat
charter of a yacht called Marathon Rummer in the BVI. The
Minister erroneously assumed that it was called Spice I.
Nothing turns on this error. Marathon Rummer was operated at a
loss. The bareboat operation was an arrangement with Nova Scotia
Yacht Charters under which the appellant received 60% of the
revenues and Nova Scotia Yacht Charters received 40%. The
operation was not a success and was abandoned in 1989. Marathon
Rummer was sold in 1991.
[6]
In addition to this venture the appellant had been involved in
other ventures involving the manufacture and sale of boats and
sails and was experienced with boats, having grown up on the
Great Lakes and having been involved extensively in owning,
sailing and racing yachts in North America.
[7]
In 1990 the appellant bought Spice II, a fast sailing sloop
with two cockpits and two staterooms. From the pictures in the
advertisements it appears to have been upscale and luxurious. It
had a retractable centreboard rather than a keel which enabled it
to go into shallower waters than it could if it had had a keel.
It sleeps six. The appellant was able to negotiate a favourable
purchase price of $335,000, a reduction of over $100,000 US
from the original asking price, possibly because the
manufacturer, C & C Industries, was in bankruptcy.
[8]
The purchase was financed in part by a marine mortgage of
$279,000 US for which further security was given on the
appellant's home in Hudson, Quebec. The $279,000 mortgage was
subsequently reduced to $269,000 US.
[9]
With Spice II the appellant decided that arrangements of the
type he had with Marathon Rummer were not suitable and that he
would run the business himself as a full service crew sailing
yacht. The crew of Spice II consisted of a captain and a
cook, who acted as hosts, operated the yacht, and provided
entertainment and meals to clients.
[10] Cruises
were arranged through brokers who charged a commission of 15% of
the cruise fee.
[11] A great
deal of advertising was done throughout the period in question,
particularly through a publication, Yacht Connections, which
published "The Leading Charter Yachts of the World" in
several languages. This publication advertises and illustrates
some very fancy yachts indeed, including Spice II.
[12] On
November 4, 1991 the appellant wrote to the Government of
the BVI and applied for a trade licence to operate in the BVI.
With his letter he projected revenues and expenses in the first
five years as follows: (US$)
1
2
3
4
5
Revenues
$127,000 $140,000 $159,000 $228,000 $240,000
Expenses
$126,000 $128,000 $140,300 $194,100 $205,100
(no depreciation)
[13] The
actual figures in the first years (1991-1995) as reported by the
appellant, were: (US$)
1991
1992
1993
1994 1995
Revenues
$55,813 $70,904 $120,965 $134,467
$133,763
[14] In 1990
there were gross revenues of $6,000 and expenses of $194,071.93
for a loss of $188,071. This included CCA of $86,653 Cdn.
[15] The
expenses on the statements of profit and loss are a little
confusing. In 1991 a gross figure for expenses is shown of
$158,684.19 US without CCA, to arrive at a loss of $102,870.46 US
when the figure is converted to Canadian currency and CCA of
$145,836 Cdn and office expenses of $373.20 Cdn are claimed we
have a loss of $264,057.89 Cdn.
[16] In 1992
we have two groups of expenses, $84,253 US plus $193,607 US, to
arrive at a loss of $206,955 US. If we remove the CCA of $126,201
US we arrive at a loss of $80,754 US.
[17] In 1993
we have two groups of expenses, $95,100 US and $133,075 US,
resulting in a loss of $107,209 US. If we exclude the CCA of
$65,795 US we have a loss of $41,414 US.
[18] For 1994
we have again two groups of expenses, $79,827 US and $52,954 US
to arrive at a net income of $1,685 US.
[19] For 1995
a similar calculation (without CCA) yields a net profit of
$479.77 US.
[20] The
projections given to the Government of BVI were more sanguine
than the actual results. Nonetheless, if we ignore CCA a profit
was realized in 1994 and 1995. By 1994 CCA had run out on the
yacht because of the accelerated straight line CCA treatment
accorded to Canadian vessels. Therefore, if we follow strictly
the statement of Dickson J. in Moldowan, the lack of
CCA should have no bearing on the question of REOP in 1994
because CCA was fully deducted in prior years and therefore there
was nothing to deduct. If, on the other hand, we read
"accounting depreciation" for CCA in the obiter
dictum of Dickson J., there is no evidence upon which I
could decide what an appropriate rate of depreciation should be.
Mr. Dubois, the assessor called as a witness for the
respondent, prepared "theoretical" profit and loss
statements in which he used two alternative straight line
depreciation rates, one based on a life of eight years, the other
on a 20 year life. Before I review his report I shall deal
with several preliminary points.
(a)
The losses claimed in 1985 to 1989 from the operation of the
bareboat chartering business of the Marathon Rummer were as
follows: (Cdn$)
1987
$47,680
1988
$60,040
1989
$27,180
The respondent contends that I should consider the losses from
that business in deciding whether the operation of Spice II
had a REOP. It is true that the prior history of losses in a
business may be a factor but it is important to emphasize that
while they may be of historical interest in the context of a
prospective determination of an expectation of profit, the real
question is whether there is a business.
I do not think that the bareboat charter of Marathon Rummer sheds
much light on whether the chartering of Spice II is a
business. It was a fundamentally different venture in association
with someone else involving a different form of charter. The two
operations are not comparable. The bareboat business did not work
out and the appellant terminated it after several years and moved
on to the Spice II operation.
(b)
The respondent assumed on assessing that the appellant used
Spice II for personal vacations. This was a fundamental
assumption and the evidence is unequivocal and unchallenged that
he did not. If he sailed or raced on vacation he chartered other
sailing craft or used other persons' boats.
(c)
The Crown makes some point of the fact that Spice II was put
in the appellant's name personally for tax reasons on the
advice of his tax accountant. This is unquestionably true. The
appellant had a high income and to put Spice II into a
corporation so as not to take advantage of the high CCA on
Canadian built vessels to reduce his personal income would have
made no sense. In fact, when he moved to the BVI in 1996 he
rolled Spice II into a Canadian corporation under
section 85. I see nothing sinister in taking advantage of
the incentives the government provides. Doing so hardly proves
there is no REOP or no business.
(d)
The Crown suggests that the bank, in lending the appellant the
money to buy Spice II, took additional security on his house
in Hudson, Quebec, and that this shows that the bank, at least,
thought the venture had no REOP. In my view, it proves no such
thing. Banks take security on whatever they can get their hands
on and security on a house in Canada is vastly preferable to
security on a yacht that is sailing around the Caribbean. It
proves nothing about what the bank might have thought of the
prospects of the business, even if the bank's opinion were
relevant, which it is not.
[21] I come
now to the analysis made by Mr. Dubois. His conclusion was
that even in 1994 when the appellant reported a profit there was
no profit. He bases this conclusion on a number of
considerations. Essentially the implication in his report is that
the appellant artificially inflated the income from Spice II
in that year either by exaggerating the revenues or understating
the expenses.
[22]
Mr. Dubois has concluded that a cruise for which the Maura
family contracted did not take place, or, at all events a deposit
of $2,400 US was counted twice in the appellant's 1994
revenues. In the result, he contends, the 1994 revenues are
overstated by either $2,400 US (the amount of the deposit) or
$8,950 US (the full amount of cruise fee). The evidence does not
support the contention. Mr. Rickley's testimony was
unchallenged. The Maura cruise took place toward the end of 1994
after two cancellations, the second of which resulted in a
forfeiture of the deposit.
[23]
Mr. Dubois' second concern was with the Campbell
charter. It appears that no salaries were paid in September,
October and November of 1994, and there were problems with the
crew, Ian and Suzanne, about their salaries.
[24]
Mr. Rickley explained that, during the period when he was
having a dispute with the crew and their departure to work on
another ship, the Thalassi, was delayed, they agreed to work on
the Spice II without a salary but they were allowed to keep
all tips. I do not find this arrangement unbelievable. They left
on good terms and may well have already been paid by the
Thalassi.
[25] The new
crew, which started in December, was paid in January of the
following year. Mr. Dubois concluded that the absence of
salaries indicated that the Campbell cruise did not take place
and even suggested that some of the moneys credited to the
Campbell cruise may have been deposited there by the appellant
himself. I would need cogent evidence to accept such an
improbable hypothesis.
[26] I am
satisfied with the explanations given by Mr. Rickley. I am
also satisfied that the Campbell cruise took place.
[27]
Mr. Dubois also doubts that the Burguess and Watts charters
took place because on his analysis there was insufficient food
purchased for them. One point of contention was a freezer that
Mr. Rickley bought for Spice II. Mr. Dubois did
not believe that it could be made to work. The fact is it did
work and it explains why food could be purchased and stored in
advance of a cruise.
[28] The Yurch
charter was another one to which Mr. Dubois took exception.
It took place in 1995 but Mr. Dubois objected to the fact
that the income was included in 1994, which he sees as another
distortion of the 1994 income. The short answer is that the money
was received in 1994 and under paragraph 12(1)(a) of
the Income Tax Act had to be included in income in that
year even though the services were to be performed in the
following year. Paragraph 20(1)(m) permits but does
not require a reserve to be taken.
[29] The
overall conclusion of Mr. Dubois was that revenues were
overstated and expenses understated in an attempt to inflate the
1994 income so as to establish that by 1994 Spice II was
showing a profit.
[30]
Mr. Dubois attempted to show that Spice II did not have
a profit in 1994 and, depending on whether the four charters
mentioned above took place, it had a loss of either $60,979 or
$21,300 Cdn. If they did not take place the respondent contends
that the loss should be $60,979. If they did the respondent says
there was still a loss of $21,300.
[31] I will
not deal with the hypothesis that these charters did not take
place. I find that they did.
[32] To arrive
at the loss of $21,300 Cdn under the second hypothesis, one has
to deduct from the declared profit of $2,302 the following.
(a)
The deposit of $2,400 US which Mr. Dubois says was double
counted. I find it was not. It was forfeited after the second
cancellation.
(b)
The $4,130 US for the Yurch charter which took place in 1995.
This fee had to be included in the year in which it was received,
1994, by reason of paragraph 12(1)(a).
(c)
The salary of $8,250 US that should have been paid for September
to November. I have accepted the appellant's explanation of
this.
[33] While I
commend Mr. Dubois' tenacity and thoroughness his
conclusions are based in large measure on conjecture and
erroneous assumptions of fact.
[34] Indeed,
even if I accepted that a loss of $21,300 was sustained in 1994
it would not have affected my conclusion that Mr. Rickley
was carrying on a business.
[35] I am
satisfied that from the inception of the business in 1990 the
revenues increased during the ensuing five years, as did the
number of charters. Mr. Rickley made great efforts to
increase revenues and reduce expenses. I do not accept that
Mr. Rickley artificially inflated the 1994 income. Indeed,
Spice II is still operating although it is run by the
appellant's son.
[36] It is not
necessary for me to reproduce in detail the very thorough
analysis of the business made by the appellant's tax advisor,
Ms. Danielle Lacasse, in Exhibit A-46, described as a
"Memorandum of Representations". It, as well as the
evidence of Ms. Lacasse and Mr. Rickley, whom I found
to be credible and impressive witnesses, demonstrate a tightly
controlled and well run business that in a relatively short
period of time became profitable. I have concluded that this was
a genuine business and the losses are deductible.
[37] It is
sufficient to summarize my reasons briefly.
(a)
If it was not a business what was it? It was no hobby. There was
no personal element. The REOP principle should be applied with
great caution in such circumstances. (Tonn et al. v. The
Queen, 96 DTC 6001; Keeping v. The Queen,
2001 F.C.A. 182; Bélec v. The Queen,
95 DTC 121; and Walls v. The Queen,
2000 DTC 6025 (under appeal to S.C.C.).)
(b)
The Minister should not second guess the appellant's business
judgement. That is precisely what the Minister has tried to do
here. (Keeping; Tonn; Nichol v. The Queen,
93 DTC 1216; Kuhlmann et al. v. The Queen,
98 DTC 6652; Bélec; and Smith v. The
Queen, 96 DTC 1886.)
(c)
By any objective standard the operation looks like a business and
is operated in a businesslike way on recognized business
principles. As was said in Kaye v. The Queen,
98 DTC 1659, at p. 1660:
[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 as 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.
(d)
The Minister applied the REOP test in the first year of the
business. The taxpayer is entitled to a reasonable period to get
the business established (Keeping). At least five years is
not unreasonable in a business of this type where the charter
operation has to build up its reputation, clientele, and goodwill
over a period of years.
(e)
The appellant took advantage of certain favourable tax provisions
relating to accelerated CCA on Canadian built vessels. This
cannot be used to enhance the Minister's REOP argument.
(f)
There is nothing irrational, absurd or ridiculous in the
appellant's expectation of profit (Kuhlmann).
[38] In short
this strikes me as an ordinary commercial operation and,
notwithstanding the consummate skill with which
Me Labbé, counsel for the respondent, presented the
Crown's case, I can see no justification for applying the
REOP principle in this case.
[39] The
appeals are allowed with costs and the assessments for the 1990,
1991, 1992 and 1993 taxation years are referred back to the
Minister of National Revenue for reconsideration and reassessment
to allow the deduction of the losses claimed from the business of
chartering Spice II.
Signed at Toronto, Canada, this 18th day of July 2001.
"D.G.H. Bowman"
A.C.J.
COURT FILE
NO.:
1999-1366(IT)G
STYLE OF
CAUSE:
Between Brian Rikley and
Her Majesty The Queen
PLACE OF
HEARING:
Montréal, Quebec
DATE OF
HEARING:
June 18, 19 and 20, 2001
REASONS FOR JUDGMENT BY: The
Honourable D.G.H. Bowman
Associate Chief Judge
DATE OF
JUDGMENT:
July 18, 2001
APPEARANCES:
Counsel for the Appellant: André P. Gauthier, Esq.
Josée Vigeant
Counsel for the
Respondent:
Nathalie Labbé
COUNSEL OF RECORD:
For the
Appellant:
Name:
André P. Gauthier, Esq.
Firm:
Heenan Blaikie
Montréal, Quebec
For the
Respondent:
Morris Rosenberg
Deputy Attorney General of Canada
Ottawa, Canada
1999-1366(IT)G
BETWEEN:
BRIAN RIKLEY,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
Appeals heard on June 18, 19 and 20, 2001
at Montréal, Quebec, by
The Honourable D.G.H. Bowman
Associate Chief Judge
Appearances
Counsel for the
Appellant:
André P. Gauthier, Esq.
Josée Vigeant
Counsel for the Respondent: Nathalie
Labbé
JUDGMENT
It is
ordered that the appeals from assessments made under the
Income Tax Act for the 1990, 1991, 1992 and 1993 taxation
years be allowed and the assessments be referred back to the
Minister of National Revenue for reconsideration and reassessment
to allow the deduction of the losses claimed from the business of
chartering Spice II.
Signed at Toronto, Canada, this 18th day of July 2001.
A.C.J.
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