[OFFICIAL ENGLISH TRANSLATION]
Date: 20020409
Docket: 2000-3767(IT)I
2000-3769(IT)I
BETWEEN:
RICHARD TURCOTTE,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
REASONS FOR JUDGMENT
P.R. Dussault, J.T.C.C.
[1] These are appeals from assessments
made under the Income Tax Act
("the Act") for the 1997 and 1998 taxation
years. By those assessments, the Minister of National Revenue
("the Minister") disallowed the appellant's
deduction of $24,524 and of $23,238 in business losses for each
of those years, respectively, on the ground that the appellant
had no reasonable expectation of profit from his activities
during the years at issue.
[2] In making the assessment for 1997,
the Minister assumed the facts set out in
subparagraphs 12(a) to (r), except subparagraph (k), of
the Reply to the Notice of Appeal in file
No. 2000-3767(IT)I. Those subparagraphs read as
follows:
[TRANSLATION]
(a) at all relevant
times, the appellant was retired and his income basically came
from pension benefits and his retirement pension;
(b) at all relevant
times, the appellant carried on a horticultural activity under
the name "R.F.T. Enterprises International"
(hereinafter "the business");
(c) at all relevant
times, the appellant resided at 4911 Boul.
de Maisonneuve Ouest in Montréal and operated
the business at the same address;
(d) the business was
registered on September 24, 1992;
(e) the business had
been operating since 1992 under the name "Happy
Plants/Les plantes Heureuses" (hereinafter "the
enterprise"), which specialized in growing and selling
hydroponic plants;
(f) the
hydroponic plants were grown in the basement of the
appellant's home;
(g) the appellant
has reported the following gross income and net losses since
1992:
|
YEAR
|
GROSS INCOME
|
(NET
LOSS)
|
|
|
|
|
|
1992
|
$0
|
($9,569)
|
|
1993
|
$4,886
|
($17,351)
|
|
1994
|
$1,228
|
($28,259)
|
|
1995
|
$1,384
|
($26,044)
|
|
1996
|
$1,587
|
($23,480)
|
|
1997
|
$433
|
($24,524)
|
(h) according to the
appellant, the hydroponic plant enterprise ceased operating
during the 1997 taxation year;
(i) on August
24, 1999, the auditor sent the appellant a questionnaire to
determine whether he had a reasonable expectation of profit from
his activities;
(j) the
following information was provided by the appellant:
•
he had no occupational training or practical experience when he
began his plant enterprise;
•
there had been no increase in gross income since the start of the
business, and the appellant did not expect any in the future
because he planned to cease the activity in 1997;
•
about 200 plants were grown in the basement of the
appellant's home;
•
since retiring, the appellant had devoted about 30 to 40
hours a week to his horticultural activity;
•
the appellant prepared various advertising brochures and tried to
find customers at hardware stores and florists;
•
the appellant has no plan to make his enterprise profitable and
no expansion plans;
•
the lack of financing, the limited funds available for
advertising, the Canadian dollar exchange rate and the high cost
of production and imported products were significant factors in
the failure of this pilot project;
. . .
(l) the
appellant did not include any financial statements in his tax
return for the 1997 taxation year;
(m) to his notice of
objection of April 11, 2000, the appellant attached financial
statements showing the following distribution of his income and
expenses:
|
Description
|
Total
|
Happy Plants
|
Consulting
|
|
|
|
|
|
|
Gross income
|
$433
|
$433
|
$0
|
|
minus:
|
|
|
|
|
Expenses
|
$23,679
|
$6,531
|
$16,788
|
|
Depreciation
|
$1,278
|
$271
|
$1,007
|
|
Total expenses
|
$24,957
|
$6,802
|
$17,795
|
|
|
|
|
|
|
Net loss
|
($24,524)
|
($6,369)
|
($17,795)
|
(n) although the
appellant said that he had ceased his horticultural activity in
1997, he claimed a net loss of $23,238 from that activity in his
tax return for the 1998 taxation year, a loss that included
$23,238 in expenses, and did not report any income from that
source;
(o) as in the
previous years, the main expense claimed for 1997 was the salary
of $15,908 paid to his wife;
(p) the appellant
ceased his consulting activities during the 1999 taxation
year;
(q) the appellant
has not shown that the expenses claimed for the year at issue in
connection with the horticultural activity he carried on in the
basement of his home were incurred to make a profit therefrom or
with a reasonable expectation of earning income therefrom;
(r) the appellant
has not shown that the expenses claimed for the year at issue in
connection with his consulting activity were incurred to make a
profit therefrom or with a reasonable expectation of earning
income therefrom.
[3] Only subparagraphs (c), (d), (i),
(o) and (p) were admitted. The other subparagraphs were denied in
their entirety, aside from subparagraph (j), the fifth and
seventh points of which were admitted.
[4] In making the assessment for 1998,
the Minister assumed the facts set out in
subparagraphs 13(a) to (m), except subparagraph (h), of
the Reply to the Notice of Appeal in file
No. 2000-3769(IT)I. Those subparagraphs read as
follows:
[TRANSLATION]
(a) at all relevant
times, the appellant was retired and his income basically came
from pension benefits and his retirement pension;
(b) at all relevant
times, the appellant carried on various activities under the name
"R.F.T. Enterprises International" (hereinafter
"the business");
(c) at all relevant
times, the appellant resided at 4911 Boul.
de Maisonneuve Ouest in Montréal and operated
the business at the same address;
(d) the business was
registered on September 24, 1992, and its main activity was
growing and selling hydroponic plants;
(e) the appellant
has reported the following business income and losses since
1992:
|
YEAR
|
GROSS INCOME
|
(NET
LOSS)
|
|
|
|
|
|
1992
|
$0
|
($9,569)
|
|
1993
|
$4,886
|
($17,351)
|
|
1994
|
$1,228
|
($28,259)
|
|
1995
|
$1,384
|
($26,044)
|
|
1996
|
$1,587
|
($23,480)
|
|
1997
|
$433
|
($24,524)
|
|
1998
|
$5,439
|
($23,239)
|
(f) according
to the appellant, the hydroponic plant enterprise ceased
operating during the 1997 taxation year;
(g) on August 24,
1999, the auditor sent the appellant a questionnaire to determine
whether he had a reasonable expectation of profit from his
activities;
. . .
(i) according
to the financial statements filed with the appellant's tax
return for the 1998 taxation year, the income, expenses and
losses from the appellant's activities were distributed as
follows:
|
Description
|
Total
|
Happy Plants
|
Consulting
|
|
|
|
|
|
|
Gross income
|
$3,371
|
$1,140
|
$2,231
|
|
minus:
|
|
|
|
|
Expenses
|
$23,559
|
$23,559
|
$0
|
|
Depreciation
|
$820
|
$820
|
$0
|
|
Total expenses
|
$24,378
|
$24,378
|
$0
|
|
minus:
|
|
|
|
|
Home expenses
|
$2,231
|
$0
|
$2,231
|
|
Net loss
|
($23,238)
|
($23,238)
|
$0
|
(j) to his
notice of objection of April 11, 2000, the appellant attached
revised financial statements showing the following distribution
of his income and expenses:
|
Description
|
Total
|
Happy Plants
|
Consulting
|
|
|
|
|
|
|
Gross income
|
$3,371
|
$1,140
|
$2,231
|
|
minus:
|
|
|
|
|
Expenses
|
$23,559
|
$0
|
$23,011
|
|
Depreciation
|
$820
|
$0
|
$820
|
|
Total expenses
|
$24,378
|
$0
|
$23,830
|
|
minus:
|
|
|
|
|
Home expenses
|
$1,140
|
$1,140
|
$0
|
|
Net loss
|
($22,147)
|
$0
|
($21,599)
|
(k) as in the
previous years, the main expense claimed by the appellant for
1998 was the salary of $15,908 paid to his wife;
(l) the
appellant ceased his consulting activities during the 1999
taxation year;
(m) the appellant has not
shown that the expenses claimed for the year at issue in
connection with his horticultural and consulting activities were
incurred to make a profit therefrom or with a reasonable
expectation of earning income therefrom;
[5] Subparagraphs (b), (c), (g), (i),
(k) and (l) were admitted. The other subparagraphs were
denied.
[6] The appellant is a retired federal
employee. He made his career as a commercial attaché at
various Canadian embassies abroad. He retired from the federal
government in 1991. In 1992, he worked for the Ministère
des Relations internationales of Quebec. He retired in early
1993.
[7] In September 1992, the appellant
registered a sole proprietorship by the name of "RFT
Enterprises International Reg./Les Entreprises RFT International
Enr." ("RFTI") in order, he said, to structure his
hydroponics and consulting activities. The name "Happy
Plants/Les Plantes heureuses" was used to designate the
hydroponics side of the business.
[8] According to the appellant, his
interest in hydroponics resulted from the fact that it was a type
of cultivation that was very popular in Europe, especially in
Germany, Austria and the Scandinavian countries, where 50 percent
of indoor ornamental plants were grown in that way, whereas the
technique was not used in Canada.
[9] The technique involves growing a
plant without potting soil in a special pot with an inner tray
containing pellets of expanded clay to replace the soil. The pot
contains a special nutrient solution. A water-level
indicator placed in each pot ensures proper watering.
[10] The appellant said that he learned the
technique himself in Europe and that, with his wife's help,
he began that type of cultivation in Quebec. The appellant's
wife had a great deal of experience with Japanese flower
arrangement ("Ikebana") and had won several
prizes at shows in both Europe and Canada. The appellant said
that, although he found a few pots here that could be suitable
for hydroponics, he actually had to import the necessary
equipment from Germany, which necessarily increased costs,
especially because of the drop in the Canadian dollar exchange
rate.
[11] The experiment therefore started
slowly, more as a hobby for the appellant's wife, who grew
the plants in the basement of their home with the intention of
eventually renting space elsewhere. The appellant said that his
wife did not devote all her time to this since she also had to do
the secretarial work for the consulting side of his activities,
to which I will return a little later.
[12] As regards the market for the
hydroponic plants, it was in 1994 that the appellant himself made
more extensive efforts to find appropriate retailers. He said
that the market was limited and was confined to florists because
the plants were a "clean product" that could not be
sold in garden centres or hardware stores. The appellant said
that, the same year, he identified a network of 12 florists
operating under the name "Jardins Directs" who agreed
to put his plants on display in five or six of their stores. He
said that he also made displays for his products himself. The
arrangement with the stores was that the plants would be sold on
a commission basis. The appellant also referred to another store
in Place Alexis Nihon where his attempts to place his plants were
met with little success. The appellant having failed to develop
the market for this new product sufficiently, the experiment
proved to be unsuccessful overall. Between 200 and 300 plants a
year were sold, whereas he said that he would have had to sell
5,000 to cover his overhead. The appellant also referred to the
economic problems that florists were generally having at the
time, which could explain his lack of success.
[13] On cross-examination, the appellant
admitted that he had applied for a grant in 1994 from RESO
(Regroupement pour la relance économique et sociale du
sud-ouest) so he could pursue his hydroponics project
elsewhere than in his basement and that he had been told that his
activity was too small-scale. According to the appellant,
his activity needed to be at a more developed stage to receive a
grant.
[14] The appellant said that, in 1996, he
concluded that the experiment was not going very well and he
started to turn to another market, that is, artistic
arrangements, including fountains and plants for the offices of
senior corporate executives.
[15] In June 1996, the appellant contacted a
company called Alpha ("Alpha"), one of the largest
providers of office plants. According to the appellant, Alpha
expressed an interest in hydroponics, especially because of the
high cost of the watering service for which it had to pay. Since
hydroponics requires much less frequent watering, Alpha saw it as
a way to reduce its costs, provided that the technique proved to
be efficient for the large plants in which it specialized. Until
then, the appellant had concentrated on growing small plants. A
pilot project therefore began in the summer of 1996. Alpha lent
the premises and imported the plants. The appellant invested his
time but did not incur any expenses. Despite results that the
appellant described as positive in terms of technical
feasibility, the experiment, which he was already seeing as a
good source of income for him- about $15,000 a year for work that
would have required a quarter of his time- came to nothing.
According to the appellant, Alpha's owner refused to commit
himself because he was too busy and because the company had just
taken over two competitors. Thus, despite two positive progress
reports-the first in September 1996 and the last in
December 1996, in which the appellant made a proposal for a
co-operative agreement, without including any figures-no
agreement or remuneration was negotiated with Alpha. Under
pressure from the appellant, Alpha's owner finally decided in
May 1997 not to commit himself.
[16] The appellant said that the $15,000 in
earnings he could have expected was not the only benefit that
could have resulted from an agreement since he also thought that
he might be able to sell new products to Alpha's clients,
especially plant arrangements with fountains for the offices of
senior executives.
[17] The project with Alpha therefore ended
in mid-May 1997 without the appellant being paid for
anything. The appellant said that, at the end of June 1997,
he also put an end to the hydroponics project as such. The
remaining inventory was apparently liquidated in 1998. However,
no expenses relating to the project were allegedly incurred in
1998. Exhibit A-1 filed in evidence also establishes
that the hydroponics project ended on June 30, 1997.
However, it should be noted that, in another
document-Exhibit A-2, Tab 2, at page 2 of the
questionnaire-the appellant stated that he had given up the
hydroponics project for indoor ornamental plants at the end of
1998.
[18] In 1997, gross plant sales amounted to
$992.52 and the gross profit was $433.27. In 1998, sales amounted
to $3,207.93 and the gross profit was $1,139.51. For the same
year, $2,231.25 reported as consulting fees or income must be
added. The business loss claimed was $24,524 in 1997 and $23,238
in 1998.
[19] According to the appellant, while his
wife was the one who primarily took care of hydroponics in 1992
and 1993, he devoted himself to consulting in various fields. He
referred to an aerospace project with Russia in 1992 that never
came to fruition. In 1993, he was retained by the
Conseil d'affaires tchèques du Québec,
which had obtained a grant from the Quebec government. The
appellant said that he was paid $2,000 a month to organize and
manage certain activities and that he received a total of $15,000
before the Quebec government terminated the grant because the
Conseil had set up its offices in Prague. The appellant argued
that Revenue Canada had failed to take that income into account
to establish his business income for 1994. However, he admitted
on cross-examination that he himself had reported
$12,314.99 in gross income and $4,987 in net income from that
activity separately as professional income and not as part of his
income from RFTI.
[20] From May 1997 to May 1998, the
appellant was in contact with the CPI Media group, which
publishes the LUX lighting journal in France, about doing a
feasibility study concerning a Franco-Canadian exchange
trip to bring people involved in urban lighting and in the
illumination of cities and monuments into contact with one
another. The appellant said that his rate basis was $60,000 to
$65,000 a year and that he could have earned a great deal from
the project since he could have organized the mission,
participated in the publishing and perhaps represented companies
in the Canadian market. However, in spite of the efforts made and
the expectations, the project fell through and did not generate
any income.
[21] In the fall of 1997, the appellant,
through his brother, was approached by E.E.S. Financial
Services Ltd. ("E.E.S."), a company that provided
senior corporate executives with the services of financial
planning experts. E.E.S. wanted to market a new interactive,
computerized financial planning service for employees of
companies other than executives. It was looking for associates to
whom it could pay a fee to sell its services to employers and
break into the Quebec market. In February 1998, the
appellant signed a contract with E.E.S. According to him, it
could have earned him some $25,000 for about 10 contracts with
companies. Despite the many efforts he made with large companies,
the companies showed little interest, and the appellant had to
content himself with $2,231.35 in fees for a single contract with
C.P. Rail.
[22] In 1998, the appellant also took an
interest in the preparation of tax returns. On
November 14, 1998, he obtained a certificate of
competency from H & R Block at the end of a study
program.
[23] The appellant said that he put an end
to all of his activities in 1999 and admitted that he did not
file a tax return for that year.
[24] The appellant submitted extensive
documentation concerning his various projects relating to both
hydroponics and his so-called consulting activities
(Exhibits A-2, A-6, A-7 and A-8).
Several times, he also underscored his wife's participation
both in the hydroponics project and as an assistant responsible
for secretarial work and logistics for the other projects in
which he took an interest over the years.
[25] As indicated in subparagraph 12(g)
of the Reply to the Notice of Appeal for 1997 (file
No. 2000-3767(IT)I) and in subparagraph 13(e) of
the Reply to the Notice of Appeal for 1998 (file
No. 2000-3769(IT)I), the appellant has claimed
substantial losses of more than $152,000 since 1992. The greatest
expense contributing to those losses was the annual salary of
about $15,000 paid to his wife over the years. It must be
recalled that the consulting activities in fact generated only a
total of $2,231 in income in 1998 for the period of 1992 to 1998.
It is true that the appellant reported gross income of $12,314.99
and net income of $4,987 in 1994 in connection with his
activities for the Conseil d'affaires tchèques du
Québec. However, as mentioned above, that amount was
reported as professional income and not as income from RFTI.
Moreover, separate expenses were claimed against the amount
received.
[26] The hydroponics project generated only
a total of $12,726 in gross income over eight years. The project
was abandoned in mid-1997, as was the related Alpha
project. The appellant's wife allegedly stopped working on
the project at that time. The appellant himself said that in 1998
he merely liquidated the remaining inventory. When he filed his
1997 tax return, he allocated all of the expenses claimed to the
hydroponics activity even though he had given it up
mid-year. When he objected to the assessment, the
distribution was changed: 25 percent of the expenses were
allocated to hydroponics and 75 percent to consulting. For
1998, 100 percent of the claimed expenses, except the
use-of-home expenses, were initially allocated to the
hydroponics activity. In addition, use-of-home
expenses amounting to $2,231 were initially claimed against the
same amount of consulting income. At the objection stage,
100 percent of the expenses, except the
use-of-home expenses, were allocated to the
consulting activity. Reduced use-of-home expenses of
$1,140 were claimed against the same amount of hydroponics
income. The changes made can be traced in Exhibit A-4.
What the appellant describes as accounting errors can only make
one wonder. The way he initially presented things allowed him to
deduct higher use-of-home expenses of $2,231,
against the same amount of consulting income, since no other
expenses were claimed against that income. As
Exhibit A-4 also shows, the substantial losses claimed
by the appellant do not include an additional amount-either of
$12,416.52 or of $11,131.45-that was accumulated until 1998 as
business-use-of-home expenses and that was
reported as an available carryback. We know that the deduction of
such expenses is prohibited by paragraph 18(12)(b) of
the Act where the taxpayer otherwise incurs losses but
that paragraph 18(12)(c) allows them to be carried
forward to any year in which the taxpayer has income.
[27] While cross-examining the
appellant, counsel for the respondent also noted other
inconsistencies in the way the appellant had presented certain
items in his financial statements. Thus, in the balance sheet
submitted for 1997 (Exhibit I-1), the appellant
included a bank loan of $65,490 in his liabilities. The appellant
explained that this was a software error, that his line of credit
at the bank was only for $25,000 and that the amount in question
was actually what he had himself invested in the business.
However, in the 1998 balance sheet (Exhibit I-2), the
same items are used and a bank loan of $77,665 is reported.
[28] It may also be added that both
documents (Exhibits I-1 and I-2) indicate an
amount of $0 at the end of both 1997 and 1998 for the item
"Total Inventory for Resale" in the assets. However,
Exhibit A-4 states that the year-end inventory
for 1997 was $11,000. For 1998, the figure shown for the
year-end inventory is $9,125. Yet the appellant testified
that he sold his remaining inventory in 1998.
[29] The issue of whether the Minister was
justified in disallowing the appellant's deduction of a
business loss of $24,524 in 1997 and of $23,238 in 1998 on the
ground that the appellant had no reasonable expectation of profit
from his hydroponics and consulting activities for 1997 and from
his consulting activities for 1998 must be examined in this
context.
[30] Counsel for the appellant argued that
the appellant had a reasonable expectation of profit from both
the hydroponics project and his consulting activities in 1997.
With regard to 1998, she pointed out that the only issue, as set
out in paragraph 14 of the Reply to the Notice of Appeal for
that year, is whether the appellant had a reasonable expectation
of profit from his consulting activity.
[31] She noted that the hydroponics project
was not a hobby and that the appellant considered it a promising
business given the untapped market. She submitted that the
appellant had the know-how and technical expertise and that
he was supported in the project by his wife, who was very
competent in the area. When he realized that the retail sales
were not profitable, the appellant tried to break into the retail
market and then redirected his efforts by working with Alpha, a
very large supplier of office plants. According to her, the fact
that the new direction was abandoned in 1997 after Alpha refused
to commit itself further was beyond the appellant's
control.
[32] Counsel for the appellant argued that
the reasonable expectation of profit test is basically designed
to prevent the deduction of personal expenses and that, where
there is no personal aspect, it must be accepted that a taxpayer
might have made a poor business decision. According to her, the
appellant changed direction when he realized that sales were not
increasing, and he became involved in a serious project with
Alpha, which, moreover, paid most of the expenses. She submitted
that a taxpayer must also be given a reasonable period of time
before it can be determined that the taxpayer has no reasonable
expectation of profit.
[33] Counsel for the appellant based her
arguments on the Federal Court of Appeal's decision in
Tonn v. Canada, [1996] 2 F.C. 73. She also referred to the
same Court's decision in Kuhlmann et al. v. The Queen,
98 DTC 6652, in arguing that the burden is on the Minister to
establish that the expectation of profit is irrational, absurd or
ridiculous in the circumstances.
[34] Counsel for the appellant also referred
to the Federal Court of Appeal's decision in Keeping v.
The Queen, 2001 DTC 5358, in arguing that it is not for the
courts to second-guess a taxpayer's business decisions and
that the taxpayer must be given the time needed to make his or
her activity profitable. In the circumstances of that case, a
period of five or six years was considered necessary.
[35] In support of her arguments, counsel
for the appellant also referred to the decisions in
Bélec v. The Queen, 95 DTC 121, and Rikley v.
The Queen, 2001 DTC 756.
[36] With regard to the consulting
activities, counsel for the appellant emphasized the seriousness
of each project and the fact that the appellant contacted
appropriate persons. According to her, the projects had no
personal element and had a good profit potential. If they did not
go as planned, it was simply because the appellant was unlucky.
Here again, she argued that the Minister bears the burden of
proving that the appellant did not have a reasonable expectation
of profit. She submitted that the expenses claimed are genuine
business expenses and that the Court therefore cannot substitute
its judgment for the appellant's, even if he made some poor
business decisions.
[37] With regard specifically to the salary
the appellant paid his wife, counsel for the appellant argued
that, even where an expense is substantial, it must still be
asked whether there is a reasonable expectation of profit in
light of all the tests adopted by the courts and the specific
circumstances of the case. She submitted that, inasmuch as a
person was hired, it was obviously for the purpose of making a
profit and that the appellant cannot be criticized for hiring his
wife because, if he had not had any employees, he would then have
been criticized for failing to make all the necessary efforts. On
this point, counsel for the appellant referred to the decisions
in Nichol v. the Queen, 93 DTC 1216; Kuhlmann v. The
Queen, supra; and Mohammad v. Canada, [1998] 1
F.C. 165 (F.C.A.).
[38] Counsel for the respondent argued that
it is not for the Minister to prove that the appellant had no
reasonable expectation of profit and that it is rather the
appellant who must prove objectively that he had such an
expectation.
[39] For the years at issue, he noted that
the appellant initially allocated all of his expenses to the
hydroponics activity and then allocated them in a completely
different manner at the objection stage. He also pointed out the
different way the appellant did his accounting for 1994, when the
consulting income and the related expenses were recorded
completely separately from the hydroponics activity and the net
amount was reported as professional income.
[40] Counsel for the respondent submitted
that the hydroponics activity was a hobby. He stressed that it
began as a hobby and that it was confined to the basement of the
home, which made it possible to deduct a $15,000 salary paid to
the appellant's wife as well as certain home-related
expenses. According to him, those are personal elements that must
be taken into account. He submitted that the appellant's
expectation of profit was unreasonable. Even though the appellant
had some knowledge, he had no experience with this new product,
which had to be imported and for which he had to find a market.
He argued that the high costs and the low sales volume, that is
200 to 300 plants a year compared with the 5,000 needed for the
appellant to cover his costs, as well as the lack of grants are
additional factors to be considered. Counsel for the respondent
also noted that the appellant had no business plan and was given
all the time he needed to adapt (from 1992 to 1996), which he did
not do, since the salary paid to his wife, the greatest expense,
was never changed.
[41] With regard to the appellant's
other projects, counsel for the respondent took the view that
they were merely attempts to find business opportunities that
yielded almost nothing concrete and that certainly do not make it
possible to assert that the appellant had a reasonable
expectation of profit in view, inter alia, of the expense
of $15,000 for the salary paid to his wife year after year.
[42] Counsel for the respondent noted that a
taxpayer's time, effort and reputation are not sufficient to
establish that the taxpayer had a reasonable expectation of
profit.
Analysis
[43] To begin with, it is important to note
that it is wrong to claim that the burden is on the Minister, or
rather the respondent, to prove that the appellant did not have a
reasonable expectation of profit. Contrary to what counsel for
the appellant argued, the Federal Court of Appeal's decision
in Kuhlmann, supra, can certainly not be cited as
an authority on that point. In that case, the burden of proof was
reversed basically because of a late change in the basis of the
assessments made by the Minister. Décary J.A.
explained this situation as follows at paragraph 2 of the
reasons for judgment:
2 A
novelty in the two appeals before us is that as a result of a
last-minute change in the basis of the assessments made by the
Minister, it is the Minister who has the burden of proving that
the partnership formed by the appellants ('Southern Cross
Stables' or 'SCS') did not have a reasonable
expectation of profit in the four taxation years under appeal,
i.e. 1986, 1987, 1988 and 1989. The Minister had originally
relied on section 31 of the Income Tax Act (loss from
farming) which implies that there is a business and a reasonable
expectation of profit.
[44] In Tonn, supra, Linden
J.A. of the Federal Court of Appeal, after looking at the
relevant case law, stressed the need to distinguish various
situations for the purposes of applying the test taken from the
Supreme Court of Canada's judgment in Moldowan v. The
Queen, [1978] 1 S.C.R. 480. Thus, at paragraph 39
of the reasons for judgment, he stated:
. . . I otherwise agree that the Moldowan test should
be applied sparingly where a taxpayer's "business
judgment" is involved, where no personal element is in
evidence, and where the extent of the deductions claimed are not
on their face questionable. However, where circumstances suggest
that a personal or other-than-business motivation
existed, or where the expectation of profit was so unreasonable
as to raise a suspicion, the taxpayer will be called upon to
justify objectively that the operation was in fact a business.
Suspicious circumstances, therefore, will more often lead to
closer scrutiny than those that are in no way suspect.
[45] At paragraph 40, Linden J.A. then began
his analysis by setting out the tests used by the courts as
follows:
. . . A variety of factors have been proposed over the years
by which objective reasonability might be demonstrated in given
circumstances. In the original Moldowan decision, these
factors were enumerated as follows:
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.56
Another listing of the factors to be assessed was set out in
Sipley (P.D.) v. Canada:
The objective test includes an examination of profit and loss
experience over past years, also an examination of the
operational plan and the background to the implementation of the
operational plan including a planned course of action. The test
further includes an examination of the time spent in the activity
as well as the background of the taxpayer and the education and
experience of the taxpayer.57
Finally, Landry (C.) v. Canada suggests the following
items to consider:
Apart from the tests set out by Mr. Justice Dickson, the tests
that have been applied in the case law to date in order to
determine whether there was a reasonable expectation of profit
include the following: the time required to make an activity of
this nature profitable, the presence of the necessary ingredients
for profits ultimately to be earned, the profit and loss
situation for the years subsequent to the years in issue, the
number of consecutive years during which losses were incurred,
the increase in expenses and decrease in expenses in the course
of the relevant periods, the persistence of the factors causing
the losses, the absence of planning, and failure to adjust.
Moreover, it is apparent from these decisions that the
taxpayer's good faith and reputation, the quality of the
results obtained and the time and energy devoted are not in
themselves sufficient to turn the activity carried on into a
business.58
These quotations suggest that the list of relevant factors is
growing and that it may continue to grow. What this indicates is
that a detailed look at the business in the context of its
operations is what is required, and that reasonableness is to be
assessed on the basis of all the relevant factors, both the
already listed ones and any new ones that may be helpful.
[Notes omitted.]
[46] In the case at bar, there is no doubt
that a number of personal elements are present. First, the losses
claimed by the appellant had the effect of considerably reducing
his pension income and generating a tax refund for each of the
years at issue. The expenses claimed, apart from the
use-of-home expenses, include telephone expenses,
motor vehicle expenses, the capital cost allowance related
thereto, vehicle leasing costs and expenses for travel and
business trips. By nature, all of those expenses may have a
personal element. Next, there are the use-of-home
expenses, which were recorded so that they could possibly be
carried over. As mentioned earlier, the appellant had initially
deducted part of those expenses from his consulting income of
$2,231 in 1998. Subsequently, he claimed a reduced amount against
the hydroponics income. Finally, there is the salary of about
$15,000 that the appellant paid his wife every year. Although
that salary was reported by the appellant's wife, the fact
remains that it was likely to confer a personal tax benefit on
him because of income splitting while keeping the amount for the
couple's benefit. It is obvious that a situation such as that
cannot be compared to the payment of a salary to an unrelated
person.
[47] As counsel for the respondent pointed
out, the context in which those expenses were claimed and the way
they were initially claimed by the appellant for 1997 and 1998,
as well as the change made at the objection stage, must also be
noted. Moreover, it must be recalled that the gross hydroponics
income for 1997 was only $433, while the net loss claimed was
$24,524. No consulting income was reported in 1997. In 1998, the
appellant reported a total gross income of $3,371, of which
$1,140 was from hydroponics and $2,231 was from consulting. The
net loss initially claimed for that year for the hydroponics was
$23,238, which was disallowed, in addition to the amount of
$2,231 claimed as use-of-home expenses against the
consulting income. The changes made by the appellant at the
objection stage have been indicated above. I simply do not
believe that the initial allocation of the expenses between the
hydroponics activity and the consulting activity for the years at
issue was the result of an error that was simply corrected at the
objection stage.
[48] According to the appellant, the
hydroponics project that began in 1992 ended in June 1997,
and his wife stopped looking after it at that time. He said that
he himself had subsequently sold the remaining inventory, which
he finished doing in 1998. However, Exhibit A-4
indicates that there was a significant inventory at the end of
1998. Since the appellant did not file a return for 1999, we do
not know what became of it. Moreover, Exhibit A-2
contains documents indicating that the hydroponics activity did
not end in June 1997 but continued at least for a good part
of 1998. This should normally have resulted in certain expenses.
In any event, the fact that more sales were made in 1998 than in
1997 should normally have led to a minimum amount of expenses.
Yet the appellant, after initially allocating all of the
year's expenses (aside from the use-of-home
expenses) to hydroponics, allocated all of them to the consulting
activity at the objection stage. In his testimony, the appellant
also said that no expenses had been incurred in liquidating the
inventory in 1998. It is quite difficult to understand and accept
that statement.
[49] The changes made to the allocation of
expenses for 1997 also raise questions. Initially, all of the
expenses were allocated to hydroponics. Subsequently, at the
objections stage, 25 percent of the expenses were apportioned to
hydroponics and 75 percent to consulting.
[50] The way the appellant reported his
consulting income and claimed separate expenses against that
income in 1994 is also questionable. The fact that he presented
his various activities sometimes as separate activities and
sometimes as different aspects of RFTI most certainly contributes
to maintaining some confusion.
[51] As mentioned earlier, in the financial
statements submitted (Exhibits I-1 and I-2), the
appellant included in his liabilities an amount that he actually
considers to have been his investment in the business and
indicated it as a bank loan. The explanation he gave is that this
resulted from a software error. As in explaining the changes made
to the allocation of expenses for 1997 and 1998, the appellant
resorted to the overly facile explanation that there had been a
software or accounting error. It is difficult to accept this kind
of explanation when the same errors recur from one year to the
next with respect to several items. This state of affairs leads
more to the conclusion that there was, to say the least, an
obvious lack of transparency that cannot help but affect
credibility.
[52] The very nature of the appellant's
activities also calls for several comments.
[53] The appellant started the hydroponics
activity as a hobby. As a result of some knowledge he had
acquired and his wife's experience, he began that form of
cultivation, which is popular in Europe, here. Having no real
business plan or actual knowledge of the potential demand for
plants grown in that way, he took on the local market, which,
quite obviously, did not meet his aspirations. The strictly
commercial activity was never on as large a scale as he wanted.
If 5,000 plants must be sold every year to cover one's
costs and one is able to sell only 200 to 300 plants, and if this
goes on for several years, it is quite clear that it is difficult
to argue that one still has a reasonable expectation of
profit.
[54] Thus, in 1996, after several years of
efforts, the appellant himself concluded that the retail sale of
ornamental hydroponic plants was not making progress. On this
point, it will be recalled that the gross income was $1,228 for
1994, $1,384 for 1995 and $1,587 for 1996. The appellant carried
on all the same, and in the summer of 1996 he tried to join
forces with Alpha, a company that specialized in supplying office
plants. Although the appellant said that he had demonstrated the
feasibility of using the hydroponics technique to grow large
office plants by means of a pilot project that ended in
December 1996, Alpha refused to embark upon a business
partnership with him and informed him of its decision in
May 1997. Thus, despite his hopes of taking hydroponics in
another direction and earning substantial income as a result, the
appellant received absolutely no income from that experiment with
Alpha and apparently put a complete end to his hydroponics
project at the end of June 1997. It must be noted that,
despite the abandonment of the project and the fact that the
appellant's wife stopped devoting at least part of her time
to it, the expenses and therefore the losses claimed by the
appellant for the year are just as high as for the previous
years.
[55] Given the number of previous years of
losses, the acknowledgement of failure in 1996, the uncertainty
of a business partnership with Alpha and the scrapping of the
entire hydroponics project in June 1997, it is my view that
in 1997 the appellant did not have a reasonable expectation of
profit from the activities relating to that project.
[56] What about the appellant's various
other activities, which he has grouped together as
"consulting" activities? First of all, they were very
diverse activities, some of which had little to do with actual
consulting or with the appellant's previous professional
activities. While the first activities referred to by the
appellant for the period of 1992 to 1994 had a fairly direct
connection with his former duties, personal financial planning
for employees of companies and the preparation of tax returns had
no such connection. Despite numerous steps taken in various
directions for a variety of projects, it must be acknowledged
that, on the whole, few concrete results were obtained.
[57] In 1997 and 1998 specifically, the
project with the French company CPI (LUX journal) never came to
anything, and the appellant got nothing out of it. The
appellant's mere assertion that such a project could have
generated so many thousands of dollars of income for him is not
enough to say that there was a reasonable expectation of profit,
since the steps taken remained at the preliminary stage, before
the financial terms were negotiated and accepted or even
discussed. This comment also applies to the project with Alpha
discussed previously.
[58] As for the project with E.E.S., it
represented a new direction for the appellant, who in fact had to
test a new service in an unknown market. Despite his efforts, the
financial planning service offered to companies for their
employees found only one taker, and the appellant earned a modest
income of $2,231 therefrom. The appellant, who said that he could
have made a substantial profit of $25,000 or so by entering into
about 10 contracts with large companies, did not show in any way
that that was a realistic expectation based on a serious study of
the potential market. In short, it was another activity that led
nowhere, and the appellant once again turned in another
direction. He registered for courses with H & R Block and
in November 1998 obtained a certificate of competency to
prepare tax returns. We do not know whether that activity led to
anything since he did not file a tax return for 1999. In any
event, he said that he ceased all his activities at the end of
1999, and RFTI's registration was struck off on
April 28, 2000 (Exhibit A-5).
[59] It cannot be concluded from all of this
that the failures were merely the result of bad luck. The
appellant's lack of experience and lack of knowledge of the
market must be emphasized, as must the lack of control over
expenses that led to losses that were totally disproportionate to
the reported income.
[60] During every year from 1992 to 1998,
the appellant, regardless of the activity in which he was
engaged, claimed substantial losses that often amounted to more
than $20,000 and sometimes to more than $25,000 a year. For 1997
and 1998, irrespective of which activity the expenses were
allocated to, it can be seen that they are basically the same
expenses, which he assigned sometimes to one activity and
sometimes to the other. A number of the expenses claimed,
including his wife's salary, have an undeniable personal
element. The appellant was allowed all of his losses from 1992 to
1996. The deduction of the losses claimed for 1997 and 1998 was
disallowed. There comes a time when a taxpayer must show that the
continuation of his or her activities is justified by a strictly
business motivation and supported by a realistic business plan
allowing for a reasonable expectation of profit and is not
designed to conceal the deduction of certain expenses that may,
moreover, have a personal element. In my view, the appellant has
not shown this with the required degree of proof, that is, the
balance of probabilities.
[61] As a result of the foregoing, the
appeals are dismissed.
Signed at Ottawa, Canada, this 9th day of April 2002.
J.T.C.C.
Translation certified true
on this 29th day of July 2003.
Sophie Debbané, Revisor
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