26 March 2015 Internal T.I. 2013-0503031I7 F - Existence d’une source de revenu -- translation

Principal Issues:

1) Do the taxpayer's activities qualify as a source of income?

2) If the taxpayer is carrying on a business, are the allowable deductible expenses limited to the business income?

3) If there is a business, are all vehicle expenses deductible?

4) Are the travel expenses regarded as personal expenses?

5) If the activity qualifies as a hobby:

a) How should we proceed with the T4 slips issued by the payer?
b) How should we notify the taxpayer regarding the filing of future income tax returns?
c) How should tax returns selected for the audit be modified?

Position:

1) No, based on the given facts and the jurisprudence, we consider the activities to be a hobby.

2) Since there is no business or source of income, the expenditures are not deductible in computing business income.

3) and 4) General comments provided.

5) a) No changes to be made.
b) It is a question of fact based on the information currently available to us. If the facts change in the future, the conclusion could be different .
c) There is no amending of tax returns under audit.

Reasons: 1) Question of fact. 2) 18(1)(a), 18(1)(h), 67 ITA. 3) and 4) 18(1)(h), Interpretation Bulletin IT-521R

March 26, 2015

Laval Tax Services Office

HEADQUARTERS

Small and Medium Businesses

Income Tax Ruling Directorate

Attention Mario Caron Sophie Lambert, CPA, CMA,
DESS. FISC

2013-050303

Existence of a source of income

This memo is in response to your email of August 29, 2013 concerning the above-mentioned subject.

Please note that unless otherwise stated, all statutory references herein are references to the provisions of the Income Tax Act (the "Act").

In an attachment to your request, you described the following situation:

• The taxpayer is XXXXXXXXXX;
• XXXXXXXXXX;
• He makes approximately XXXXXXXXXX per year and receives $ XXXXXXXXXX each time;
• More than XXXXXXXXXX% XXXXXXXXXX are provided to XXXXXXXXXX, XXXXXXXXXX% in the second, and the others are provided in XXXXXXXXXX;
• XXXXXXXXXX produces the T4As
• The taxpayer affirms that it is a hobby and is not seeking to turn a profit;
• He does not seek to increase the number of XXXXXXXXXX offered in a year;
• While making XXXXXXXXXX a day, he brings home between XXXXXXXXXX;
• The taxpayer's annual revenues total approximately $XXXXXXXXXX and current net income before auditing expenses was $XXXXXXXXXX;
• An application for Canada Pension Plan and Employment Insurance has been made and the decision was given to the effect that the taxpayer was self-employed;
• If the decision of the Canada Revenue Agency ( "CRA") is to the effect that the taxpayer carries on a business, he would like to claim a capital cost allowance for his vehicle;
• Deductions for depreciation would generate business losses for the taxpayer being, for the three years audited, XXXXXXXXXX, XXXXXXXXXX and XXXXXXXXXX, and a significant terminal loss (nearly $ XXXXXXXXXX) in XXXXXXXXXX when he sold his vehicle (being a class of depreciable property).

In light of the scenario described above, you wish to know the following:

1. Does the income of the taxpayer from his XXXXXXXXXX activity income qualify as a source of income under section 3?
2. If a business was carried on, are the deductible expenses limited to the income generated by the taxpayer's business?
3. If a business was carried on, are all vehicle expenses deductible considering that:
   • travel expenses (including CCA) are as high as the XXXXXXXXXX income given the distance between his residence and the XXXXXXXXXX;
   • while making XXXXXXXXXX in a day, he makes XXXXXXXXXX roundtrips.
4. Are the travel expenses of the taxpayer between his residence and XXXXXXXXXX where the activity occurs considered personal?
5. If the taxpayer's activity is considered a hobby:

   a. How should the T4A slips issued by XXXXXXXXXX be dealt with?
   b. How should we notify the taxpayer regarding the filing of future income tax returns?
   c. How should tax returns currently under audit be treated?

Our Comments

Question 1)

In determining whether the taxpayer's activities result in income from carrying on a business, it is necessary to find the existence of a source of income that is not income from an office or employment. Based on the facts provided, the revenues of the taxpayer are not employment income.

As the context of this analysis, the decision in Stewart v. The Queen, 2002 DTC 6983 of the Supreme Court of Canada suggests a two-stage approach. The first stage is to determine if the activity carried on by the taxpayer is undertaken in the pursuit of profit, or is a personal endeavour. In the second stage, if the activity is not a personal endeavour, it is necessary to determine if the source of income is a business or property.

It is only when the activity has a personal aspect that the first stage is relevant. Indeed, where the activity of the taxpayer is not a personal endeavour, a source of income exists under the Act.

Since the activity of the taxpayer has a personal aspect, it is essential to consider all the facts surrounding the activity to determine if it is carried on in a sufficiently commercial manner. For an activity to be classified as commercial in nature, the taxpayer must have the subjective and predominant intention to profit and the activity must be carried out in accordance with standards of businesslike behaviour. There must be evidence to support that intention. According to the facts provided, the taxpayer wishes to earn extra income to use for personal purposes, such as XXXXXXXXXX. We therefore believe that he intended to make a minimum income by participating in this activity.

Next, one must examine whether the activity is carried on in a sufficiently commercial manner in the light of a combination of factors, such as a reasonable expectation of profit and the following four criteria suggested by the Supreme Court of Canada in Moldowan v. The Queen, [1978] 1 S.C.R. 480 ("Moldowan"):

(1) the profit and loss experience in past years;
(2) the taxpayer's training;
(3) the taxpayer's intended course of action; and
(4) the capability of the venture as capitalized to show a profit.

In this case, we are of the view that the taxpayer's activity is a hobby or, at the very least, it has a personal aspect. Thus, before concluding as to the existence of a source of income, it is necessary to determine if the taxpayer carries on his XXXXXXXXXX activity in a sufficiently commercial manner.

We considered your analysis of the four criteria in Moldowan and would like to add some refinements.

On the taxpayer's intended course of action, the taxpayer has affirmed to not be seeking to increase the number of XXXXXXXXXX per year. Certainly there is no evidence of the taxpayer seeking to scale back, but we are of the view that the objectives of a reasonable business person are to grow the business and, in turn, the earnings. In this case, the taxpayer's activity only seems dedicated to generating funds for recreational activities (in particular, XXXXXXXXXX) and the taxpayer does not seem motivated by a desire to maximize earnings.

In addition, some indicators have arisen from the case law to determine whether or not there is reasonable expectation of making a profit, namely, the time required to produce a return from the activity, the presence of the necessary ingredients to achieve a profit, the profit and loss experience for the years subsequent to those at issue, the number of consecutive years of loss, growth in expenses and declines in revenues, the persistence of the factors causing the loss, lack of planning, and failure to adjust.

According to the facts presented as well as your analysis, the taxpayer makes XXXXXXXXXX per year, which represents an average of XXXXXXXXXX week and he invests time at home to prepare his XXXXXXXXXX for the XXXXXXXXXX. The taxpayer tabulates his results monthly. On the one hand, these factors seem to point to a certain level of organization and commerciality. Indeed, the taxpayer has the intention all the same to make some profit in order to receive generate additional funds for personal purposes.

On the other hand, the following factors seem to support the position that the taxpayer's activity does not represent the carrying on of a business on the grounds that it is not carried on in a sufficiently commercial manner:

• subject to any verification that you might undertake in respect of the taxpayer, the activity of the latter seems to generate losses repeatedly or, at any rate, not to generate profit;
• the taxpayer does not seek to increase the number of XXXXXXXXXX that he offers in a given year;
• we question whether the rate charged by the taxpayer for XXXXXXXXXX reflects the market rate. At first glance, XXXXXXXXXX seems insufficient;
• Taxpayer education: Does he have a background in XXXXXXXXXX? Has he acquired more on-the-job experience?

The question you have asked is one of fact which is difficult to determine in a situation such as you described. However, it seems that the activity of the taxpayer has a personal aspect since it seems to represent for the taxpayer a hobby allowing him to raise money for XXXXXXXXXX. Moreover, we do not believe that the conduct of the taxpayer is akin to that of a reasonable and prudent business person whose primary objective is to grow the business and maximize profits.

We wish to reiterate that the taxpayer's situation represents a particular case on its facts and the tests to be applied are, for the most part, questions of fact which you are better equipped to address. Nevertheless, on the facts you have provided to us, and without prejudice to any other facts that have not have been brought to our attention, we are of the view that the activities of the taxpayer are not a source of income.

Question 2)

Given our conclusion stated above, the taxpayer may not deduct any expenses incurred in the course of the activity of XXXXXXXXXX. However, in the event that you reach a conclusion contrary to ours, we would state the following general principles.

Where a taxpayer carries on a business, it can generally deduct any expense incurred for the purpose of earning income from the business. However, the expense must be incurred to earn income under section 9, its deductibility must not be limited by paragraphs 18(1)(a) and 18(1)(h) and in accordance with section 67 it must be reasonable in the circumstances . Generally, where expenses satisfy these tests for deductibility, they are generally not limited to the business revenue.

Question 3 and 4)

Again, we are of the view that it is not necessary to answer this question. However, here are the principles governing deductibility of travel expenses for a self-employed traveller.

Paragraph 18(1)(a) denies the deduction of an expense, except to the extent where it was made or incurred by the taxpayer for the purpose of gaining or producing income from a business or property. In addition, paragraph 18(1)(h) explicitly precludes the deduction of personal or living expenses of a taxpayer in computing the taxpayer's business income with the exception of travel expenses incurred by the taxpayer in the course of carrying on a business while the taxpayer was away from home.

As noted in paragraph 24 of Interpretation Bulletin IT-521R, Motor Vehicle Expenses Claimed by Self-Employed Individuals, the use of a car for personal purposes generally includes travelling between the individual's home and place of business unless it is established that the home is the principal place of business.

What is the principal place of business of an individual or business is a question of mixed law and fact. There are some indicators or facts which are quite useful in determining the location of the principal place of business. According to case law, the principal place of business of a taxpayer represents where the activities necessary for the carrying on of the business take place, including calling customers and suppliers, issuing invoices, maintaining payroll and other books and records, communicating with the authorities to obtain permits, preparing tax returns, collecting receivables, handling complaints, developing business plans, preparing the financial statements and engaging with accountants and lawyers.

Question 5)

As previously discussed, we believe there is no source of income for the years covered by the audit. Thus, the amounts that are included in T4A prepared by payers will not have to be included in computing the taxpayer's income. However, it should be noted that this interpretation is based on the information you have submitted to us and does not cover future taxation years. In fact, if the taxpayer changed the way in which he carried on his activities, it is possible that the returns derived by him would become income from a source for the purposes of the Act. With respect to tax returns which are subject to the current audit, the returns derived by the taxpayer from his activities XXXXXXXXXX should not be included in computing his income.

Access to Information

For your information, unless exempted, a copy of this memorandum will be severed using the Access to Information Act criteria and placed in the Canada Revenue Agency’s electronic library. After a 90-day waiting period, a severed copy will also be distributed to the commercial tax publishers for inclusion in their databases.The severing process removes all content that is not subject to disclosure, including information that could reveal the identity of the taxpayer. The taxpayer may ask for a version that has been severed using the Privacy Act criteria, which does not remove taxpayer identity. You can request this by e-mailing us at: ITRACCESSG@cra-arc.gc.ca. A copy will be sent to you for delivery to the taxpayer.

We hope that these comments will be of assistance.

Michel Lambert, CPA, CA, M. Fisc.
Manager
Business and Employment Income Division
Income Tax Rulings Directorate
Legislative Policy
and Regulatory Affairs Branch