Citation: 2011 TCC 562
Date: 20111209
Docket: 2011-96(GST)I
BETWEEN:
LARRY AND SUSAN EIRIKSON,
Appellants,
and
HER MAJESTY THE QUEEN,
Respondent.
REASONS FOR JUDGMENT
Margeson J.
[1]
This is an appeal from
an assessment of the Minister of National Revenue (the “Minister”) under the Excise
Tax Act (the “Act”) for the period from March 7, 2008 to December
31, 2008, notice of which is numbered 09104001012320032 and dated August 24,
2009. By that assessment, the Minister assessed the Appellants in respect of a
Goods and Services Tax (“GST”) return for the reporting period referred to
above, in the amount of $6,866.67, as well as interest in the amount of $100.92
and disallowed input tax credits claimed by the Appellants.
Evidence
[2]
Larry Eirikson
testified that he registered for GST in the year 2008 and received a GST
number. He referred to the Reply to the Notice of Appeal, paragraph 7, and
agreed with all of the presumptions with the exception of subparagraphs h), j),
k) and l) as well as the presumptions in paragraphs 8 and 9.
[3]
He agreed that the
amount in issue is $6,866.67.
[4]
At issue in this appeal
is the claim for an input tax credit related to the purchase of a yacht used by
the Appellants in a charter enterprise during the relevant period of time.
[5]
He said that there was
no personal use of the yacht in question since 2008. The boat was anchored over
eight hours away from his residence. The Appellants signed a contract for its
use and if they are going to use it personally, they must advise the management
company, Canadian Yacht Charters (“CYC”) of their intention and must pay for
its use.
[6]
The way that they
entered into this charter business was standard in the industry. They have been
chartering with the same company since the year 2000.
[7]
He identified Tab 1 of
Exhibit R-1 as the agreement that he and his wife signed with CYC. By the terms
of this agreement, he pays 50% of the fees earned to CYC.
[8]
Between 2000 and 2008,
the Appellants have owned two different yachts. Both were financed and they
made monthly payments on them and sometimes paid a lump sum at the end of the
year against the interest.
[9]
On the present boat,
they paid $13,795 interest in the 2009 taxation year.
[10]
They financed
$206,019.48 for the second boat at 3.25% interest. They have been unable to
reduce the interest payments below $13,000 per year.
[11]
The rental season runs
from May 1 to October 21 but the prime season is during the summer holidays
with occasional rentals in May, September and October. The yacht has a furnace
and full enclosure.
[12]
The witness identified
Exhibit R-2 which was the statements of income and expenses for the yacht.
[13]
The history of rentals
for the yacht in question showed only one rental in May and none in October. It
was never booked for all of September. Occasionally it was booked for two weeks
in September but normally only for one week.
[14]
Between the years 2000
and 2010, there has never been a profit on the operations.
[15]
He indicated that the
most accurate information was contained in the income tax returns. Some of the
expenses were not covered by the charter company and were paid for by the
Appellants.
[16]
He testified as to the
projections that he made for the business in the year 2009 as set out in Tab 5
of Exhibit R-1. Interest was not included in the projections.
[17]
He agreed that to meet
the projected income of $42,800, as found in Exhibit R-1 at Tab 5, for the
year 2011, the boats would have to be fully booked for July and August and for
two weeks in September and October. Even with the new boat, they were never
fully booked in July and August and they never had the additional two weeks in
June and September. He agreed that the interest payments were prohibiting them
from making a profit. If they were able to pay down the principal, they could
make a profit. He agreed that the first boat lost 34% of its value in ten years
and that yachts never appreciate in value over time. The net worth of the new
boat was between $150,000 to $160,000. This must be considered.
[18]
In re-direct, he said
that his projections were based on the economy at the time they were made.
[19]
They considered paying
down the debt and making a profit but they did not get around to doing it.
[20]
The Respondent called Jina
Choi who was a litigation officer for Canada Revenue Agency (“CRA”). She
had a personal knowledge of this case. She identified the internet filings
of the Appellants and the T1 taxation returns were accepted into evidence. The
figures shown in Tab 3 of Exhibit R-1 were extracted from the financial data
report and they are current.
[21]
She identified Tab 13
of Exhibit R-1 which was a graph showing the income trends of the Appellants
over ten years.
[22]
In cross-examination,
she said that she worked on this file since May of 2011. She had no experience
with the charter business.
[23]
She indicated that Tab
8 of Exhibit R-1 contained no data since there was a paper filing which was
accepted as filed. Only the GST return was audited. She did not know why.
[24]
In completing the graph
at Tab 13 of Exhibit R-1, she did not take into account capital cost allowance
(“CCA”). In the year 2007 without a consideration of CCA, there would have been
a profit.
Argument on behalf of the Respondent
[25]
In written and oral
argument, counsel for the Respondent admits that the Appellants had some
experience with boats and yachts but even if you remove CCA from the equation,
this enterprise would be in a loss position except for a small profit of $715
in 2005.
[26]
The Appellants have
been operating the same business since 2000 except for the purchase of the new
yacht. As in the case of Canadian Dredge and Dock Company Limited v. The
Minister of National Revenue, 81 DTC 154, we should look at the profit and
loss positions since its inception. By looking at the graph, you can see that
interest is constantly knocking out the profit. The business is “too highly
leveraged” to be able to reasonably return a profit. In spite of nearly ten
years of consecutive losses, there has been no change instituted that could
turn it around. There is no reasonable expectation of profit here. Therefore,
it cannot constitute a commercial activity and therefore under section 169 of
the Act, the Appellant would not be entitled to claim an input tax
credit on the purchase of the yacht.
[27]
When the Appellants
purchased the second boat they had all of the information about income,
expenses and particularly the interest factor. The Appellants should have
known that the business could not have been carried on with a “reasonable
expectation of profit” (R.E.O.P.), and therefore it could not constitute a
commercial activity.
[28]
The projections that
the Appellants made were unrealistic mathematically and there was no R.E.O.P.
according to the financial data. The Appellants’ share of the revenue was not
enough to cover the operational expenses. The situation here is akin to that
described in Stacey v. Canada, [1997] 2 C.T.C. 2703 and Dinnall v. R.,
[1996] 3 C.T.C. 2647.
[29]
Counsel argued that in
a GST case the Moldowan
test may be used to determine R.E.O.P. because as indicated in Bowden v. Canada, 2011 FCA 218, the Court indicated that “. . . the
entitlement of a taxpayer to input tax credits does not depend upon whether the
taxpayer has paid GST in relation to a “business”. Rather, it depends upon
whether the taxpayer has paid GST in relation to a “commercial activity”.
[30]
Here the taxpayer has
moved beyond the reasonable start-up period and there was no R.E.O.P.
[31]
With respect to the
taxpayers’ intention here, it is necessary to show an objective intention to
pay down the debt in order to have a R.E.O.P. and this was not done. There was
no realistic plan to reduce the debt shortly after the purchase to allow a
profit. Here there was no meeting of the burden by the taxpayer (see Klotzin
v. Canada., [2000] 3 C.T.C. 2074).
[32]
The kind of seasons
that were enjoyed by the taxpayers did not allow enough income to make a
profit. Only operational expenses could be paid even when the yacht was fully
booked during July and August. The profit projections did not include the
payment of interest and were related to principal only.
[33]
At some point, the
taxpayer must take depreciation into account.
[34]
The appeals should be
dismissed.
Argument on behalf of the Appellants
[35]
The Appellants argued
that there was no personal use of the yacht and therefore there could be no
disallowance on that basis.
[36]
There was a business
and a source of income. The Appellants hired a management company to promote
the business and invest funds into it to ensure its long-term viability. The
Respondent’s counsel has admitted that there was a business and if it were a
business then R.E.O.P. does not apply because it is not a personal endeavour.
There is no personal factor.
[37]
As can be seen at Tab
12 of Exhibit R-1, there was a profit in 2005 if you take out CCA. In 2008, if
a new vessel had not been purchased there would have been a profit.
[38]
Based upon near profit
levels in 2008 and upon advice received from consultants, it was a good idea to
have a new boat.
[39]
CCA is an accounting
entry and not cash. In 2005 and 2007, there was a profit or near profit
situations without considering CCA. They paid down the principal by $16,000.
[40]
The first boat reached
profitability in 2005. The age of the boat and maintenance costs caused them to
change boats.
[41]
In 2008, they had to put
$4,000 of new equipment on the boat due to regulations. In 2010, they had an unusual
expense in replacing a lost dinghy and repairs that were not covered by the
seller due to a bankruptcy.
[42]
In 2008 and 2009, all
expenses incurred were standard items that were required for the charter
season. The expenses made in 2009 were more typical expenses than those made in
2008 when the boat was purchased.
[43]
The prediction made
should have been achieved in five years and were not due to changes in the
business. This is a risk of the business.
[44]
The business was the
same between 2000 and 2008 but they made changes to increase the income stream
by changing the rate from $2,500 per week to $3,700 per week.
[45]
The Appellants dispute
the Respondent’s argument that it was unreasonable for them to go into the
charter business because many others are in it and it brings in a lot of money.
[46]
In re-direct, counsel
for the Respondent pointed out that the requirements are not the same as under
the Income Tax Act. R.E.O.P. is still a requirement under the GST
legislation.
[47]
You cannot have a
business for GST purposes without considering R.E.O.P. Counsel did not concede
that he referred to the operation as a “business”. One must consider the
definition in the statute.
[48]
The Appellants said
that they reduced debt by $16,000 over two years but they obviously did not
reduce it enough to get a R.E.O.P. within a few years of acquiring the
property. The spreadsheets should have been based upon the real expenses and
not just the receipts.
[49]
It is not enough just
to take into account the interest expense alone. One must consider all of the
operating expenses.
Analysis and Decision
[50]
It was clear from the
evidence and argument of the Appellants that because of an article he had read
he believed that R.E.O.P. had no place in the consideration as to whether he
was entitled to claim the input tax credit which he seeks. From that article,
he concluded that since there was no personal use of the yachts and since the
Minister’s solicitor had accepted that he was “running a business”, then one
had only to consider whether he operated it in a businesslike way.
[51]
The Court is not
satisfied that when counsel for the Respondent discussed the Appellants’
“business” that he meant anything more than an “enterprise” or “undertaking” or
activity.
[52]
In any event, the Court
is satisfied that the Moldowan principle is still good law and that
R.E.O.P. as discussed in that case is a proper consideration when considering
the right of the Appellants here to an input tax credit under the provisions of
the Excise Tax Act.
[53]
In this case, as in Bowden,
the Stewart
and Walls
limitation does not assist the Appellants. That case clearly indicates that “.
. . the entitlement of the taxpayer to input tax credits does not depend upon
whether the taxpayer has paid GST in relation to a “business”. Rather, it
depends upon whether the taxpayer has paid GST in relation to a “commercial
activity”.
[54]
In this context, the
phrase “commercial activity” does not bear its ordinary meaning. It is
specifically defined for GST purposes to mean a business that is carried on
with a reasonable expectation of profit (see the definition in the Act).
This definition implicitly recognizes that a business may exist without a reasonable
expectation of profit but it states that a business without a reasonable
expectation of profit is not a “commercial activity”.
[55]
The Court is satisfied
that under the circumstances of this case, the operation was too highly leveraged
to be able to reasonably return a profit.
[56]
As argued by counsel
for the Respondent, this operation was carried on with over ten years of
consecutive losses. During that period of time, the Appellants did very little
to turn things around except that they purchased a new yacht with greater capabilities
and changed their fee structure to earn more income. However, neither of these
changes resulted in any significant change in the bottom line.
[57]
By looking at the
spreadsheet and the graph located at Tab 13 of Exhibit R-1 introduced into
evidence, it is clear that the business has suffered continuous losses since
2000. When the CCA charge is removed, there is still a loss situation except in
2005 when there would have been a small profit of $715.
[58]
It is clear from the
graph that the Appellants have not been realizing a profit because of the
interest charges. Without some substantial reduction in the interest charges,
there is no R.E.O.P. There was no evidence that the Appellants had any plans to
bring about this substantial reduction in the interest charges. The only move
was to pay down the principal by $16,000 but this did not enable the Appellants
to turn around the rather dismal financial practices that had persisted from
the beginning.
[59]
They also increased the
rental charges for the yacht, but again this did not have any real effect on
the bottom line.
[60]
The Appellants did have
several unexpected expenses but these were no more than reasonable business
persons could have expected. The Appellants failed to meet their own
predictions and on the basis of all of the evidence, the Court must conclude
that these predictions were not reasonable. It is obvious from the evidence
that the only way that the Appellants could have reached the stage where there
was a R.E.O.P. were if they earned substantially more income than they did and
if they significantly reduced the interest payments. This they did not do.
[61]
It was not feasible for
them to reduce operating expenses significantly because these charges were
fairly constant.
[62]
As argued by counsel
for the Respondent “the taxpayers have not shown an intent to retire a meaningful
portion of the debt . . . to show that they had a realistic plan to reduce the
principal amount borrowed within a few years of the yacht’s acquisition, to
allow for profitability.”
[63]
There is no doubt that
the taxpayers have been allowed a reasonable start-up period to bring about
profitability and this has not been achieved.
[64]
The appeal is dismissed
and the Minister’s assessment is confirmed.
Signed at Ottawa, Canada, this 9th day of December 2011.
“T.E. Margeson”
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