Citation: 2010 TCC 39
Date: 20100202
Docket: 2007-3992(IT)I,
2008-2611(GST)I.
BETWEEN:
MARK SCHARFE,
Appellant,
and
HER MAJESTY THE QUEEN
Respondent.
____________________________________________________________________
|
Agent for the Appellant:
|
K.E.
Koshy
|
|
Counsel for the Respondent:
|
Suzanie Chua
|
____________________________________________________________________
REASONS FOR JUDGMENT
(Delivered
orally by conference call on
September 25, 2009, at Ottawa, Ontario)
[1] The Appellant, Mark Scharfe, has filed two
appeals. In the first appeal, the Appellant has appealed income tax assessments
in respect of his 2002, 2003 and 2004 taxation years. In the second appeal, the
Appellant appealed GST assessments in respect of his GST reporting periods that
began on January 1, 2002 and ended on December 31, 2004.
[2] The two appeals were heard together on common evidence.
[3] I will first provide my decision with
respect to the income tax appeal.
[4] The parties agreed at the commencement of
the hearing that the following three issues were before the Court:
- Whether the Appellant was entitled to the
business expenses disallowed by the Minister in the amount of $35,856, $17,519
and $9,771 for the 2002, 2003 and 2004 taxation years respectively;
- Whether the Appellant was entitled to the
farming expenses disallowed by the Minister in the amount of $2,416 and $5,479
for the 2002 and 2003 taxation years respectively;
- Whether the Minister was correct in
restricting the farm loss claimed by the Appellant for the 2004 taxation year.
[5] Two witnesses testified at the hearing. Mr. Scharfe
provided evidence in support of his case and Mr. Michael Kocher, a CRA auditor,
testified for the Respondent.
[6] Counsel for the Respondent questioned the credibility of the
Appellant and suggested that his testimony should not be relied upon by the Court.
[7] I strongly disagree with the Respondent's counsel. I found
Mr. Scharfe to be honest. He answered all of the questions to the best of his
knowledge. It is not surprising that he cannot provide specific answers to all
of the questions considering the time that has lapsed and the fact that during
the relevant period, he was trying to maintain his farming operations during a
crisis, plus start three new businesses and tried to do all of this while
maintaining his job as a police officer.
[8] Mr. Scharfe was a credible witness and I accept his
testimony as reliable.
[9] The agent for the Appellant appeared to question the methods
employed by Mr. Kocher, the employee of the CRA who audited the Appellant. I
disagree with any suggestion that Mr. Kocher's work was deficient. It was clear
from the evidence provided by both the Appellant and Mr. Kocher that the
maintenance of books and records was not one of the Appellant's strengths.
[10] Mr. Kocher did the best job he could with the information
available to him. Mr. Kocher was also a credible witness and I accept his
testimony as reliable.
[11] It should be noted that the Appellant was not the only party
who was not able to produce information that would have been helpful to the Court.
Counsel for the Respondent informed the Court that all of the CRA's records
with respect to the Appellant's 2002 taxation year had been destroyed.
[12] In addition, counsel for the Respondent informed the Court
that the CRA was not able to calculate the amount of taxes at issue for any of
the three taxation years under appeal.
[13] The inability of the CRA to calculate the amount of tax at
issue presented a problem for the Court. During the closing argument of the
agent for the Appellant, I became aware of the fact that the amounts at issue
for at least two of the taxation years under appeal may exceed the $12,000
limitation for proceedings under the Court's informal procedure, or
alternatively may exceed the $24,000 limitation for losses.
[14] I then directed counsel for the Respondent to determine the
amounts at issue for each taxation year. After discussing the issue with her
client, counsel reiterated that the CRA was unable to calculate the amounts at
issue.
[15] Fortunately, the agent for the Appellant informed me that the Appellant
elected to limit the appeal to the statutory limits set out in subsection 18(1)
of the Tax Court of Canada Act; amounts in issue equal or less than
$12,000 or losses determined under subsection 152(1.1) of the Income Tax Act
equal to or less than $24,000.
[16] As a result of the Appellant's election, the appeal proceeded
under the informal procedure rules pursuant to Section 18.13 of the Tax
Court of Canada Act.
[17] I will now turn to the facts before the Court. I will begin by
discussing the farm operations.
[18] It is clear from the evidence that Mr. Scharfe and his family
are very hard-working individuals who take great pride in their farm operation
and have worked extremely hard over the last few years to ensure that the farm
operation survived the mad cow scare.
[19] The Appellant has either lived or worked on the farm in
question for most of his life. The Appellant grew up on the farm, which was
originally owned by the Appellant's father. In fact, the farm has been owned by
the Appellant's family since 1911.
[20] The Appellant attended agricultural college and then worked on
a government-operated experimental farm for between one and a half and two
years.
[21] In 1981 the Appellant joined the Ottawa Police Force.
[22] In 1985 the Appellant purchased cattle and farming equipment
from his father and agreed to rent 49 acres of farmland from his father.
[23] In 1998 the Appellant purchased the 49 acres of farmland from
his father.
[24] One acre of this land was used by the Appellant for his home.
The remaining 48 acres were used for the farm. In addition, the Appellant
testified that during the periods at issue he was renting an additional one hundred
acres of adjacent land for his farming business.
[25] It is clear from the testimony of the Appellant that the
farming operation was substantial. There were a number of structures on the
farm, including two buildings used for the cattle and hay storage, a 40-by-80
structure that was built some time ago, referred to as the old barn, and a
42-by-110-foot structure that was built in 2002, referred to as the new barn.
[26] In addition, the Appellant purchased farming equipment from
his father, which he was constantly updating, including tractors, hay equipment
and cattle-handling equipment.
[27] The Appellant testified that he divided his time between his
work as a police officer and the operation of the farm. He worked 40 hours per
week as a police officer and at least 40 hours per week on the farm.
[28] The running of the farm is a family operation. The Appellant's
spouse was raised on a beef cattle farm. She supervises the operation of the
farm when the Appellant is at work, watches the cattle, directs trucks and
deals with any phone calls.
[29] The evidence before the Court was that the Appellant's three
children also help with the operation of the farm. During the period at issue,
the Appellant testified that his three sons devoted most of their time to the
operation of the start-up businesses that will be discussed shortly.
[30] The Appellant testified that it was his intention to grow the
farming business so that it could support his family after he retired from the
police force.
[31] During the years under appeal, the Canadian cattle business
was hit by the mad cow scare. The Appellant noted that the price for cattle
collapsed as a result of the border to the U.S. being closed for Canadian
cattle. During this period, the Appellant decided that he needed to find other
sources of revenue if he was to save the farm. As a result he started three
ancillary businesses: a cold storage business, a business of selling police
duty belt suspenders over the Internet, and a home security business.
[32] It was the evidence before the Court that the old barn and the
new barn were used for the cold storage business. This required the cattle and
hay to remain in the fields. The farming equipment was removed from the barn
and tarped.
[33] The police duty suspender business was conducted from the Appellant's
home. The Appellant designed a suspender that police officers could wear to
distribute the weight of their equipment. It was designed to reduce the weight
on police officers’ backs. The Appellant outsourced the manufacturing of the
belts to companies in Ontario.
[34] The home security business involved the sale of monitoring
systems to homeowners. The Appellant contracted with a third party to provide
the monitoring services.
[35] The Appellant testified that he visited the Canada Revenue
Agency’s local office once a year to discuss the reporting of his taxes. He
followed the suggestion of the CRA officials and reported the income from
all three businesses as one business.
[36] I will now turn to the issues before the Court.
[37] I will first consider the deduction of the business expenses
disallowed by the Minister.
[38] These expenses relate to the three ancillary businesses
discussed above. The Respondent has not questioned whether the operation of the
businesses constituted sources of income. In fact, the CRA has allowed the
deduction of numerous expenses.
[39] The only issue before me is the deduction of certain
expenses incurred by the Appellant. I will consider each of the expense
categories noted in the reply statement.
[40] The first category was referred to as wages. The Minister
denied the amount of $7,300 deducted by the Appellant in his 2002 taxation
year. The Respondent did not appear to deny any amounts deducted by the Appellant
for wages in his 2003 and 2004 taxation years.
[41] The Appellant testified that all three of his children helped
with the ancillary businesses. His oldest son, who was 14 in 2002, helped with
the operation of the website for the police suspender business. His other two
sons, who were 10 and 12 in 2002, performed numerous tasks. For example, they
helped prepare the belts for shipment, helped maintain the storage buildings,
removed snow, cut the grass, and helped clean up the storage facilities once a
tenant left.
[42] The Appellant paid each of his children $10 per day for the
work they performed. He felt that the $10 was a reasonable sum to reflect the
average hours they worked throughout the year.
[43] The CRA allowed the deduction for the Appellant's oldest son,
but denied the amounts deducted in respect of the Appellant's youngest two
sons. The CRA did not feel that the amounts were reasonable in light of the age
of the children.
[44] I cannot agree with the CRA's position. Ten dollars per day
appears to be a reasonable amount to pay the children for the work performed.
It is clear from the evidence that this was an extremely difficult financial
period for the Appellant and all the family members were required to work in
the ancillary businesses.
[45] In addition, the Appellant testified that his two youngest
sons were paid wages in 2003 and 2004. However, the CRA did not disallow the
deduction of these wages. If the CRA felt that the amounts paid were reasonable
in 2003 and 2004, they were certainly also reasonable in 2002.
[46] As a result, I find the Appellant was entitled to deduct
$7,300 as a business expense in his 2002 taxation year.
[47] The second category of business expenses was referred to as
meals and entertainment. The CRA denied the amounts deducted in each of the
relevant years; $1,375, $2,433 and $2,079 for each of the 2002, 2003 and 2004
taxation years respectively.
[48] The evidence filed by the Respondent indicated that the above
amounts equalled 50 per cent of the actual expenses incurred. The Appellant
testified that he incurred the meals and entertainment expenses in the course
of marketing the cold storage business. His target market was small business
operators who required storage space at a low cost.
[49] He described his target customer as “hard-working people who
were responsible”. He felt that these potential customers would eat at local
restaurants that served good food at a reasonable price. He felt that by
meeting them in their community, he could sell them on the benefits of using a
local person for their storage needs.
[50] The Appellant submitted approximately 250 invoices in support
of his deductions. In other words, he visited a lot of restaurants. The CRA
denied all amounts claimed on the basis they were personal expenditures.
[51] The onus is on the Appellant to produce evidence to rebut the
assumption made by the CRA that the expenses were not incurred to earn income
from a business. I find that the evidence of the Appellant successfully rebuts
this assumption.
[52] However, the witness for the Respondent also provided evidence
to support the CRA's position. In particular, the witness referred to nine
receipts that had been provided to the CRA by the Appellant. I have reviewed the
nine receipts. Seven totalling $386.03 appear to be for food delivered to the Appellant's
home. The remaining two receipts support the evidence provided by the Appellant.
Further, the Appellant filed another 241 receipts that were only referred to in
general terms by the witness for the Respondent.
[53] While the Respondent has filed evidence to show that $386.03
of the expenses were personal expenditures, I find that the evidence provided
by the Appellant supports his position that the remaining $11,387.97 of
expenses were incurred to earn income from a business. One-half of these
amounts, or $5,693.98, are to be deducted as follows: $1,375 in the 2002
taxation year, $2,331.87 in the 2003 taxation year, and $1,987.11 in the 2004
taxation year.
[54] The third category of expenses was referred to as repair and
maintenance. The Minister disallowed the amounts of $27,181 deducted in the
2002 taxation year and $8,764 in the 2003 taxation year on the basis that such
amounts were incurred on account of capital and not income.
[55] The Appellant argued that such expenses were incurred on
account of income. He noted that the expenses were incurred to bring the barns,
particularly the old barn, to a state where they could be rented as cold
storage.
[56] In support of the Appellant's position, the Appellant's agent
referred the Court to numerous invoices filed by the Respondent (Exhibit
R-1, Pages 21, 22, 23 and 28).
[57] It appears to me that all of the invoices referred to by the Appellant's
agent relate to capital expenditures. The expenditures noted in the invoices
exceed normal repair and were more in the nature of improvements to the barns.
[58] As a result, I find that the Appellant has not filed any
evidence to rebut the Minister's assumption that the expenses were capital in
nature.
[59] The fourth category of business expenses was referred to as
purchases. The Minister disallowed $3,326 that the Appellant deducted in his
2003 taxation year. The Appellant provided evidence (Exhibit A-3, Page 1) that
the amount in question was paid to Les Footwear to purchase 74 sets of
police duty suspenders. It was the evidence of the Respondent's witness that
the amount was deducted twice when calculating the Appellant's income from the
business.
[60] The Appellant noted on cross-examination that the $3,326 was
deducted twice. However, he stated that each deduction represented a separate
purchase of 74 sets of police duty suspenders.
[61] I accept the evidence of the Appellant. It is reasonable that
a business would purchase supplies in standard quantities. As a result the
$3,326 is to be deducted when determining the Appellant's income from a
business for his 2003 taxation year.
[62] The next category of business expenses was referred to as
management and administration fees. The Minister disallowed $2,996 and $7,538
that the Appellant deducted in the 2003 and 2004 taxation years
respectively under this heading.
[63] The Appellant did not provide the Court with a complete list
of expenses that supported the amounts deducted. The agent for the Appellant
referred the Court to the working papers of the auditor (Exhibit A-1,
pages 1 to 4) in the hope that they would provide details with respect to
the amounts deducted.
[64] Unfortunately for the Appellant, the working papers provided
very few details. Most of the entries are followed by a note that states “No
documentation was provided to show that this expense was incurred”. The only
reference to actual expenses in the 2003 working papers were amounts paid
to Global Payments, Magma, Rogers and Minister of Finance. However, the working papers
show that the CRA allowed the Appellant to deduct the amounts paid to Global
Payments and Magma.
[65] The Appellant noted that the primary service purchased from Rogers was the
Internet connection required to operate the website. The Appellant explained
that when he contacted Rogers to purchase the Internet connection, he was
informed that it would be cheaper if the Appellant purchased a so-called bundle
that included cable TV.
[66] In short, the payments to Rogers contained both a personal and
a business element. The witness testified that approximately 80 per cent of the
expenses were for business. Based on my calculation, this translates into a
deductible amount of $355.98 in the 2003 taxation year and $799.48 in the 2004
taxation year.
[67] The auditor's working papers for the 2004 taxation year also
note two additional payees, Ontario Hydro and the Receiver General, in
respect of which the Appellant was not allowed deductions.
[68] With respect to the payment to Ontario Hydro for $2,801.66, the
Appellant referred the Court to the receipt filed by the Appellant (Exhibit
A-1, page 1) and noted that the payment related to services rendered by Ontario
Hydro to run hydro to one of the small buildings being rented to a third party.
This building was adjacent to one of the barns.
[69] With respect to the $500 payment to the Receiver General, the Appellant
noted that the expenditure related to the registration of patents and
trademarks in respect of the police suspenders.
[70] I accept the evidence of the Appellant and find that the
amounts paid to Ontario Hydro and the Receiver General were incurred to
earn income from a business and are deductible.
[71] In summary, in respect of the management and administration
fee category, the Appellant is entitled to additional deductions of $355.98 in
the 2003 taxation year and $4,101.14 in the 2004 taxation year.
[72] I will now turn to the second issue before the Court; whether
the Appellant is entitled to the farming expenses disallowed by the
Minister in the amount of $2,416 and $5,479 for the 2002 and 2003
taxation years.
[73] The first amount, $2,416, related to amounts deducted in the
2002 taxation year by the Appellant in respect of property taxes. An amount of
$3,777 was deducted in the 2003 taxation year.
[74] The Appellant provided the CRA with a tax invoice from the
City of Ottawa for $2,416 (Exhibit
R-1, page 34). However, this invoice related to the family home, not to
the farm property. A tax bill was presented for the farm property for the 2003
taxation year (Exhibit R-1, page 36). However, it was for the amount of
$217.57, not the $3,777 claimed by the Appellant.
[75] The Appellant appeared to acknowledge his error during
cross-examination, noting that the property tax bill filed related to his home
and the ancillary businesses, not the farming business.
[76] As a result, an additional amount of $217.57 is to be deducted
when determining the Appellant's income from farming for his 2003 taxation
year. Further, an additional amount of $206 is to be deducted for the Appellant's
2002 taxation years. This is a reasonable estimate of the taxes that he would
have paid in 2002 being 95 per cent of the taxes he paid in 2003.
[77] The remaining amount in dispute related to property insurance.
The CRA denied the $1,702 deduction claimed by the Appellant for insurance when
calculating his farming income for the 2003 taxation year. The Appellant
testified that general liability insurance was purchased for the farm. This was
required as the cattle, together with the tractors and other farm
vehicles, were occasionally on the road. The Appellant was not able to produce
any receipts to support his deduction. He did produce receipts for an
insurance policy. However, the policy related to the family home, not the
farming property.
[78] I accept the Appellant's testimony that he purchased liability
insurance for the farm. However, the $1,000 premium suggested by the Appellant
appears to be high. I will allow $235 as a deduction for the 2003 taxation
year, which is one half of the insurance paid on his home.
[79] I will now address the third issue, the farm losses. Although
not raised in the reply statement, the Respondent argued in her closing
address that this Court does not have the jurisdiction to review the
determination by the Minister under subsection 31(2) of the Income Tax Act,
that the Appellant's chief source of income for the 2004 taxation year was
neither farming or a combination of farming and some other source of
income.
[80] I do not believe that the Respondent’s argument has any legal
merit. Subsection 12(1) of the Tax Court of Canada Act provides this Court
with exclusive jurisdiction to hear and determine references and appeals to the
Court on matters arising under the Income Tax Act.
[81] Subsection 169(1) of the Income Tax Act gives the
taxpayer the right to appeal an assessment to the Tax Court of Canada.
There are limitations to this right listed in subsection 169(2), but none of
these relate to the Minister's decision under subsection 31(2) relating to the Appellant's
chief source of income.
[82] Pursuant to these provisions, the Court clearly has the
exclusive jurisdiction to hear appeals from assessments under the Income Tax
Act, including appeals in respect of section 31. Further, this Court has
heard numerous appeals in respect of section 31.
[83] The principles to be applied when considering whether a
taxpayer's chief source of income was either farming or a combination of
farming and some other source of income were established by the Supreme Court
of Canada in its decision in Moldowan v. Canada [1978] 1 S.C.R. 480 and have
been summarized by numerous decisions of the Federal Court of Appeal, including
Canada v. Donnelly, [1998] 1 F.C. 513; Taylor v. Canada, [2002] FCA
425; and Gunn v. The Queen, 2006 FCA 281.
[84] It is clear from these cases that the issue is one of fact and
that each case is to be decided on its own facts. However, the Court of Appeal
has summarized the factors that should be considered as follows: the capital
committed to the farm; the time spent by the taxpayer working the farm; and
the profitability of the farm.
[85] The Court of Appeal found in the Taylor case that “substantial”
income from farming was not required to satisfy the chief source of income
test. Further, the Court found that the taxpayer’s farming operations were
profitable when the operations generated profits before the deduction of
CCA.
[86] The Court of Appeal in Gunn provided guidance with
respect to the application of the factors when the taxpayer's chief
source of income is a combination of farming and another source of
income.
[87] In particular, the Court stated:
In
my view, the combination question should be interpreted to require only an
examination of the cumulative effect of the aggregate of the capital invested
in farming and a second source of income, the aggregate of the income derived
from farming and a second source of income, and the aggregate of the time spent
on farming and on the second source of income, considered in the light of the
taxpayer's ordinary mode of living, farming history, and future intentions and
expectations.
[88] The following facts support a finding that the Appellant's
chief source of income was a combination of farming and his income from
his employment as a police officer:
- The Appellant has lived and worked on the farm for
most of his life.
- The Appellant attended agricultural college.
- The Appellant has made substantial investments in the
farm. He purchased the 48 acres of farmland, the farm equipment and cattle
from his father. He has continuously invested money to update and upgrade the farm
equipment and also invested funds to build the new barn.
- He rented an additional 100 acres of adjacent land
for this farming business.
- He divided his time between working as a police
officer and operating the farm; working 40 hours a week as a police
officer, and at least 40 hours per week operating the farm.
- His family assisted with the running of the farm.
- Documents filed by the Respondent (Exhibit R-1, pages
2 to 4) evidence that, before the deduction of CCA, the operation of the farm
was profitable in 2003. It is important to note at the time this occurred the
selling price of the main product of the farm, cattle, had collapsed as a
result of the mad cow scare.
- Based upon pages 009 and 010 of R-1, it appears that
the large loss suffered in 2004 was mainly as a result of the continuing low
prices and a substantial claim for CCA.
- The Appellant intends to continue to grow the farming
business.
[89] In summary, based upon the evidence provided by the Appellant,
I find that the Appellant's chief source of income was a combination of farming
and his employment as a police officer. The Appellant has invested substantial
capital in the farm and has devoted substantial time to the operation of
the farm. Further, it is clear from the evidence that the farm is a profitable
enterprise, with the mad cow scare being the primary cause of the loss realized
in 2004.
[90] As a result the Appellant is entitled to deduct the full
farming loss of $25,379 when calculating his income for the 2004 taxation
year.
[91] In summary, the appeals with respect to income tax are
allowed, with costs, and the matter is referred back to the Minister of
National Revenue for reconsideration and reassessment on the following
basis:
- With respect to the 2002 taxation year, an additional
$8,675 is to be deducted when determining the Appellant's income from his
business other than his farming business. An additional $206 is to be deducted
when determining the Appellant's income from his farming business.
- With respect to the 2003 taxation year, an additional
$6,014 is to be deducted when determining the Appellant's income from his
business, other than his farming business. An additional $453 is to be
deducted when determining the Appellant's income from his farming business.
- With respect to the 2004 taxation year, an additional
$6,088 is to be deducted when determining the Appellant's income from his
business other than his farming business. The $25,379 loss realized by the Appellant
from his farming business is not subject to the restrictions contained in section
31 of the Income Tax Act.
[92] The second appeal relates to GST assessments in respect to the
Appellant's GST reporting periods that began on January 1st, 2002 and ended on December
31st, 2004.
[93] Two issues are before the Court. The first issue is the failure
by the Appellant to remit GST in respect of certain taxable supplies made by
his three ancillary businesses. The amounts at issue are $922, $405 and $1,404
for each of the 2002, 2003 and 2004 calendar years respectively.
[94] During his testimony, the Appellant acknowledged that he had
failed to remit the required amounts. He believed he was a small supplier
during these calendar years. Unfortunately for the Appellant, he was not a
small supplier since he had registered under the GST legislation. As a result,
the Appellant was properly assessed for failure to remit the GST in
respect of the taxable supplies.
[95] The second issue relates to the Minister's decision to deny
input tax credits in the amount of $3,399.16, $3,429.87 and $4,576.15 for each
of the 2002, 2003 and 2004 calendar years respectively.
[96] The input tax credits denied related to the GST paid by the Appellant
in respect of the expenditures that the Minister found were not incurred
for purposes of earning income from the ancillary businesses.
[97] The Appellant is entitled to the input tax credits to the
extent I have found that the related expenditures were incurred to earn income
from one of the businesses. This will not include amounts in respect of
which GST was not paid, such as the amount paid to the Receiver General as
registration fees.
[98] As a result the appeal with respect to GST is allowed without
costs and the matters is referred back to the Minister of National Revenue for
reconsideration and reassessment on the basis the Appellant is entitled to
claim input tax credits equal to 7 per cent of the following:
- With respect to the 2002 calendar year, the $1,375
allowed as a deduction for meals and entertainment.
- With respect to the 2003 calendar year, the $2,332
allowed as a deduction for meals and entertainment, the $3,326 allowed as a
deduction for purchases, and the $356 allowed as a deduction for management and
administration fees.
- With respect to the 2004 taxation year, the $1,987
allowed as a deduction for meals and entertainment and $3,601.14 of the amount
allowed as a deduction for management and administration fees.
“S. D’Arcy”
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