Citation: 2009TCC93
Date: 20090211
Docket: 2008-1872(IT)I
BETWEEN:
MARCIA WILLIAMS,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
REASONS FOR JUDGMENT
Webb, J.
[1]
The issue in this appeal is
whether the Appellant is entitled to deduct, in whole or in part, certain
amounts that she spent on various items in 2004 and 2005 in determining the
income from her business for these years for the purposes of the Income Tax
Act (the “Act”).
[2]
In filing her tax returns for 2004
and 2005, the Appellant claimed exactly the same amount of revenue from her business
for each year. She claimed that her revenue for 2004 was $15,000 and that her revenue
for 2005 was $15,000. As unlikely as it may be that her revenue would be
exactly the same amount in each year and in each case a multiple of $1,000, the
amount of her revenue was not changed as part of her reassessment. The
Appellant was only reassessed to deny a deduction for the amounts claimed as
expenses.
[3]
Counsel for the Respondent in
questioning the Appellant seemed to be suggesting that the Appellant may have
had additional revenue in each of these years. However the issue before me is
whether the amounts claimed as expenses were deductible in whole or in part by
the Appellant. That was the basis of the reassessment. The Appellant was not
reassessed to include additional amounts in her gross income. If the Respondent
wanted to question or challenge the amount of gross income that the Appellant
was reporting that would have to be the matter of a separate reassessment as
the Minister cannot appeal his own assessment.
[4]
Justice Hamlyn in Valdis
v. The Queen, [2001] 1 C.T.C. 2827, stated the following in paragraph 21:
21
In Millette c. R.,
Judge Lamarre Proulx reaffirmed that this Court cannot entertain an appeal that
contemplates increasing an Appellant's tax liability. She stated at paragraph
72:
It
is accepted in the case law that this Court cannot increase the amount of
the Minister's assessment because that would be tantamount to the Minister
appealing the assessment, which he cannot do. The Minister cannot appeal his
own assessment: Harris v. M.N.R., 64 DTC 5332, at p. 5337; Shiewitz v.
M.N.R., 79 DTC 340, at p. 342; and Abed v. The Queen, 82 DTC 6099, at p.
6103. (emphasis added by Hamlyn J.)
[5]
Since the only issue raised in the
Reply filed by the Respondent was the denial of a deduction for the expenses
claimed by the Appellant, this is the only issue that will be addressed.
[6]
In the Reply, the Respondent
stated that one of the issues was whether the amounts claimed had actually been
incurred by the Appellant. The Appellant was represented by her agent, who is
also her accountant. He had brought to the hearing either the original receipts
or copies of the receipts for the amounts incurred, but he had not disclosed these
to counsel for the Respondent prior to the commencement of the hearing. The
hearing was adjourned for a brief period of time to allow counsel for the Respondent
and the agent for the Appellant to review these receipts to determine if the
parties could reach an agreement on the amount that was actually spent by the
Appellant. The parties were able to reach an agreement that the following amounts
had been expended:
|
Item
|
2004
|
2005
|
|
Advertising:
|
$897
|
$3,583
|
|
Professional Fees:
|
|
$150
|
|
Motor Vehicle Expenses
|
$3,572
|
|
|
Telephone:
|
$1,880
|
$2,520
|
|
Re: Business use of home:
|
|
Heat:
|
|
$1,365
|
|
Electricity:
|
|
$1,683
|
|
Mortgage Interest:
|
|
$8,554
|
|
Property taxes:
|
|
$2,665
|
|
Total of the amounts related to the home:
|
|
$14,267
|
[7]
The Appellant had also claimed an
amount for subcontractor fees of $6,000 in each year. The parties did not agree
that the Appellant had spent $6,000 in each year for subcontractors.
[8]
The Appellant operated a business
of providing child care services. Either the Appellant herself or a subcontract
worker would go to the home where the child was (or the children were) living
and look after the child (or children) for the parents.
[9]
The Appellant operated her
business from her home. The Respondent did not question the fact that the
Appellant was carrying on a business and in paragraph 8 a) of the Reply (which
sets out the assumptions made by the Minister) stated as follows:
a) at all
material times, the Appellant operated a sole proprietorship under the business
name of “Marcia Cares” (the “Business”);
[10]
The main argument of the Respondent
is that the expenses claimed by the Appellant were not reasonable since her reported
revenue for each year was only $15,000. The Respondent was relying on section
67 of the Act. This section provides as follows:
67. In
computing income, no deduction shall be made in respect of an outlay or expense
in respect of which any amount is otherwise deductible under this Act, except
to the extent that the outlay or expense was reasonable in the circumstances.
[11]
The Supreme Court of Canada in Stewart v. The Queen, [2002] 2 S.C.R. 645, in obiter, made the following comments with respect
to section 67:
57 It
is clear from these provisions that the deductibility of expenses presupposes
the existence of a source of income, and thus should not be confused with the
preliminary source inquiry. If the deductibility of a particular expense is in
question, then it is not the existence of a source of income which ought to be
questioned, but the relationship between that expense and the source to which
it is purported to relate. The fact that an expense is found to be a personal
or living expense does not affect the characterization of the source of income
to which the taxpayer attempts to allocate the expense, it simply means that
the expense cannot be attributed to the source of income in question. As
well, if, in the circumstances, the expense is unreasonable in relation to the
source of income, then s. 67 of the Act provides a mechanism to reduce or
eliminate the amount of the expense. Again, however, excessive or
unreasonable expenses have no bearing on the characterization of a particular
activity as a source of income.
(emphasis
added)
[12]
The Federal Court of Appeal in Hammill
v. The Queen, 2005 FCA 252, [2005] 4 C.T.C. 29, 2005 DTC 5397 stated,
also in obiter, as follows:
48 Although
it is not necessary to deal with the alternative ground on which the Tax Court
Judge rejected the appeal, I believe it useful to say a few words about the
scope of section 67 and its application in this case.
49 The
appellant points out that this provision contemplates an outlay or expense that
has been incurred for the purpose of earning income within the meaning of
paragraph 18(1)(a), and allows the Minister to disallow that part of the
expenditure which can be shown to be unreasonable. In other words, the
provision does not allow for a qualitative review of the expenditure since the
expenditure must have been made to earn income to begin with. What is
contemplated is a quantitative review of the expenditure.
50 Indeed,
the judicial pronouncements on section 67 to date have treated the issue
arising under that provision as one of magnitude or quantum (see Mohamad,
supra; Gabco Ltd. v. Minister of National Revenue (1968), 68 D.T.C.
5210 (Can. Ex. Ct.)). The appellant submits that the following passage from
Vern Krishna, The Fundamentals of Canadian Income Tax, 3[rd] edition,
properly illustrates the scope and purpose of section 67 (page 312):
The word “reasonable” [in section
67] would appear to relate primarily to the size or the amount of the deductions
claimed or quantified and not to the type of the expense. “The purpose of the
rule is to prevent taxpayers from artificially reducing income by deducting
inordinately high expenses”,...
51 I
agree that this statement accurately reflects how section 67 has been applied
by the courts to date. However, the Supreme Court in Stewart, supra,
commented on the application of section 67 and signalled that it could have a
broader application. It will be recalled that in Stewart, the Supreme
Court dealt away with the “reasonable expectation of profit” test as a means of
ascertaining the existence of a source of income. The Court recognized that
this test had been devised to counter abuses, but held that it had no statutory
foundation and created more problems than it resolved.
52 In
devising the “recommended approach”, the Supreme Court identified section 67 as
the statutory means of controlling excessive or unwarranted expenditures once a
source of income is found to exist. It said at paragraph 57:
...If the deductibility of a
particular expense is in question, then it is not the existence of a source of
income which ought to be questioned, but the relationship between that expense
and the source to which it is purported to relate. The fact that an expense is
found to be a personal or living expense does not affect the characterization
of the source of income to which the taxpayer attempts to allocate the expense,
it simply means that the expense cannot be attributed to the source of income
in question. As well, if, in the circumstances, the expense is unreasonable in
relation to the source of income, then s.67 of the Act provides a mechanism to reduce
or eliminate the amount of the expense. Again, however, excessive or
unreasonable expenses have no bearing on the characterization of a particular
activity as a source of income. [emphasis added]
53 The
choice of words (reduce or eliminate) is not accidental. The
Supreme Court was setting-up section 67 as the proper means of testing the
reasonableness of an expense once a business has been found to exist.
It was doing so after having explained that at the first level of inquiry (i.e.
the existence of a source of income and the relationship between an expense and
that source) courts ought not to second guess the business judgment of the
taxpayer (Stewart, supra, paragraphs 55, 56 and 57). Section 67 was
identified as the statutory authority pursuant to which an inquiry could be
made as to the reasonableness of an expense. In my view, the Supreme Court in Stewart
acknowledged that there is no inherent limit to the application of section 67,
and that in the appropriate circumstances, it can be used to deny the
whole of an expense, if it is shown to be unreasonable.
(emphasis
added)
[13]
In Raghavan v. The Queen,
2007 FCA 27, [2007] 2 C.T.C. 232, 2007 DTC 5214, the Federal Court of Appeal
stated that:
9 Second,
having found a source of income, a court must determine if the expenses claimed
by the taxpayer may be deducted pursuant to subsection 18(1) from the income
earned from the business. If they can, the expenses will be allowed, but only
to the extent that they are "reasonable" under section 67: at para.
57. The Court emphasized (at para. 60):
Whether or
not a business exists is a separate question from the deductibility of
expenses.
See also Hammill
v. Canada, [2005] F.C.J. No. 1197, 2005 FCA 252 paras. 51-53, on the
approach to be taken to the application of section 67 in light of the decision
in Stewart.
[14]
Justice Woods in Ankrah v. The
Queen [2003] 4 C.T.C. 2851 stated as follows:
32 The Crown submits
that it was unreasonable for Mr. Ankrah to incur large expenditures after the
business had incurred losses for several years. It was suggested that instead
of spending large sums of money on recruits, the same result could have been
achieved by personal training.
33 The difficulty with
the Crown's position is that supplants the business judgment of the taxpayer.
Mr. Justice Rothstein commented on this in another Amway case, Keeping
v. R., [2001] 3 C.T.C. 120 (F.C.A.), at paragraph 5:
With respect,
I am of the opinion that the analysis conducted by the Tax Court Judge, [1999]
T.C.J. No. 277, amounted to second-guessing the business acumen of the
appellant which is not the place of the Courts. As stated in Mastri v. R.
(1997), [1998] 1 F.C. 66 (Fed. C.A.), at paragraph 12:
In summary,
the decision of this Court in Tonn does not purport to alter the law as
stated in Moldowan. Tonn simply affirms the
common-sense understanding that it is not the place of the courts to
second-guess the business acumen of a taxpayer whose commercial venture turns
out to be less profitable than anticipated.
In basing his
decision on profit margins, potential market opportunities and costs, as well
as the appellant's approach to operating his distributorship, the Tax Court
Judge was second-guessing the business acumen of the appellant. In doing so,
the Tax Court Judge erred in law.
This comment was made in the
context of the REOP doctrine but I see no reason why it should not also apply
in the context of section 67.
34 The phrase in
section 67 "reasonable in the circumstances" is broad but I do not
believe that it should apply to reduce expenses based on poor business judgment.
Section 67 is commonly applied to reduce the quantum of expenses in cases where
the taxpayer is motivated partly by something other than business reasons, such
as a payment of salaries to family members. This was described by Mr. Justice
Cattanach in the case of Gabco Limited v. M.N.R., 68 D.T.C. 5210
(Ex. Ct.) at page 5216 as follows:
It is not a
question of the Minister or this Court substituting its judgment for what is a
reasonable amount to pay, but rather a case of the Minister or the Court
coming to the conclusion that no reasonable business man would have contracted
to pay such an amount having only the business consideration of the appellant
in mind.
(emphasis
added)
[15]
As noted by Justice Cattanach in Gabco
Limited, if the court reaches a “conclusion that no reasonable business man
would have contracted to pay such an amount having only the business
consideration of the appellant in mind” then the provisions of section 67 of
the Act would apply. It seems to me that this is consistent with the
statement of the Supreme Court of Canada in Stewart that section 67 will
apply “if, in the circumstances, the expense is unreasonable in relation to the
source of income”. If an expense is unreasonable in relation to the source of
income then “no reasonable business man would have contracted to pay such an
amount having only the business consideration of the appellant in mind”.
[16]
It is also important to note that
the determination of whether the amount would have been paid by a reasonable
business person should also be made as of the time the expenditure was made and
not with the benefit of hindsight. When expenditures are being incurred by a
business person, that person does not know what the future will hold. Expenses
should not be denied simply because a person, with the benefit of hindsight,
made a poor business decision. As stated by Justice Rothstein (as he then was)
in Keeping v. R., supra, in quoting from the decision of that
Court in Tonn, “it is not the place of the courts to second-guess the
business acumen of a taxpayer whose commercial venture turns out to be less profitable
than anticipated”.
[17]
It is also not appropriate in my
opinion to simply deny expenses on the basis that they exceed revenue. This
could lead to a conclusion that a person could never incur a loss for tax
purposes. Simply the fact that the expenditures exceed revenue is not, in and of
itself, sufficient to deny a deduction for such expenditures.
[18]
In this particular case, the
expenditures that were claimed were for subcontractors, advertising,
professional fees, motor vehicle expenses, and telephone.
Subcontractor Fees
[19]
The Appellant claimed an amount of
$6,000 in each year for subcontractor fees. The Respondent did not agree that
these fees had been incurred. The Appellant stated that these were amounts that
she paid to other individuals to provide the services to her clients. The
Appellant stated that at least $6,000 had been incurred in each year but she
could not confirm how the amount of $6,000 was determined. I accept her
testimony and I find that, on a balance of probabilities, she incurred
expenditures of at least $6,000 in each year for subcontractors.
[20]
The Respondent submitted that it
would not be reasonable for a person in her position to hire subcontractors since
the reported revenue was only $15,000 per year. The Appellant indicated that
she retained the subcontractors to fill in for her. The Respondent did not
question that the subcontractors did not provide the services for which they
were paid, but only that it was not reasonable for the Appellant to hire them
in the first place.
[21]
As noted by the Federal Court of
Appeal in Hammill, “section 67… in the appropriate circumstances … can
be used to deny the whole of an expense, if it is shown to be unreasonable”. If
the Appellant determined that she had to hire subcontractors to do the work,
without anything to suggest that this was unreasonable (other than the argument
based on the amount of revenue that was claimed), the provisions of section 67
of the Act will not apply to these payments as they would not be shown
to be unreasonable in this case. The amounts claimed for subcontractors ($6,000
in each year) do not seem to me to be amounts that “no reasonable business man
would have contracted to pay”. If the Appellant was unable to provide the
services that were being requested by a client, it seems reasonable to hire a
subcontractor to provide such services rather than lose the business. As a
result I find that the Appellant is entitled to deduct these amounts in
determining her income from her business.
Advertising
[22]
The amount that the parties agree
was spent on advertising in each year was $897 in 2004 and $3,583 in 2005. The
advertising consisted of advertisements in the Yellow Pages, brochures, pens,
books, magnets and a webpage. The Respondent, since all expenses that were
claimed were denied, is asking this Court to determine that the Appellant should
not have spent any amount on advertising in 2004 or 2005. The Respondent did
not dispute that the Appellant received advertising goods and services that
were worth $897 in 2004 and $3,583 in 2005, only that the Appellant should not
have spent this money on advertising.
[23]
The business was slumping and the
Appellant noted that she was having a bad year. This was why she decided to spend
the additional amounts on advertising in 2005. It also seems reasonable to me
that the Appellant would advertise her business and when her business was
suffering from a loss of revenues, that additional amounts would be spent on
advertising to try to increase the revenue. As a result the amounts spent for
advertising for these two years will be deductible.
Professional Fees
[24]
There was no evidence of any
amount that was incurred for professional fees in 2004. Professional fees of $150
were incurred in 2005. These related to the preparation of the financial
statements for the business and the tax returns for the Appellant. The
Respondent did not question that the amount was not reasonable for the services
that were provided, only that the amount should not have been incurred at all.
It seems to me that a reasonable business person would have financial
statements prepared. There was no evidence with respect to what part, if any,
of the $150 was paid for any services of preparing those parts of the
Appellant’s tax return that were not related to the business. It seems likely
that any amount that would be allocated to this would be insignificant since
only two sources of income were identified for each year (RRSP income and the
business) and therefore the amount of $150 will be allowed as a deduction in
computing the Appellant’s income from her business in 2005.
Motor Vehicle Expenses
[25]
Motor vehicle expenses were only
claimed in 2004. There was no evidence of any motor vehicle expenses for 2005. The
parties agree that $3,572 was spent in 2005 on the following:
Gas: $730
Maintenance: $50
Insurance: $2,792
Total: $3,572
[26]
The Appellant acknowledged during
the hearing that the motor vehicle was not entirely used in the business. The
evidence of the Appellant was that the business use of the vehicle was about
40%. The Appellant did not keep any mileage logs. During the cross-examination
of the Appellant, she provided an estimate of the total number of kilometres that
the vehicle was driven and the number of kilometres that the vehicle was driven
for business purposes which would suggest a greater percentage of business use
than 40%. However since the Appellant in her direct testimony had stated that
the business use of the motor vehicle was 40%, the lower percentage will be
allowed.
[27]
Again the argument of the
Respondent was that it was not reasonable for the Appellant to have incurred
any motor vehicle expenses. I do not accept this argument as it seems
reasonable to me that a business person who is required to travel to carry on
their business would incur motor vehicle expenses. Since the child care
services were provided at the homes of her clients, the Appellant would have
had to travel to carry on her business.
[28]
As noted above, the motor vehicle
expenses included amounts spent on gas, maintenance, and insurance. While the
amounts for maintenance and insurance were the total amounts spent on these
items in 2004, the amount for gas was approximately one-half of the total
amount spent on gas. Since the business use was 40%, the amount of $730 will be
multiplied by 0.8 to determine the amount that would be 40% of the total amount
spent on gas or 0.8 x $730 = $584,
[29]
As a result, the Appellant is
entitled to claim motor expenses of $584 plus 40% of $2,842 ($1,721 in total) in
2004.
Telephone
[30]
The parties agree that the Appellant
spent $1,880 on telephone charges in 2004 and $2,520 on telephone charges in
2005. The Appellant stated that she had one phone line for business, one for
personal use and a cell phone. She claimed that the cell phone was only used
for business purposes. The Appellant also stated that the amount claimed for the
telephone expense did not include the amount spent for the personal phone in
her home. The amounts that the Appellant claimed on her tax returns for
telephone expense were $942 for 2004 and $1,825 in 2005.
[31]
It seems to me that since the
Appellant stated that the amounts claimed on her tax returns did not include
the amount incurred in relation to her personal phone line and since the
amounts stated above were the amounts that the parties agreed had been spent
(not necessarily incurred for business purposes), that while the Appellant
spent $1,880 on her telephones in 2004, the amount that she spent on her
personal telephone line must have been $1,880 - $942 = $938. For 2005, it seems
to me that while the Appellant spent $2,520 on her telephones, the amount that
she spent on her personal telephone line must have been $2,520 - $1,825 = $695.
[32]
The Respondent submitted that a
reasonable business person would not have incurred these telephone expenditures
given her level of income. However, this would mean that the Respondent would
be suggesting that a reasonable business person would operate their business
without a telephone. Since the Appellant was placing ads in the Yellow Pages,
how could she operate her business without a telephone? It seems reasonable to
me that any business person would need a telephone and therefore the amount
that the Appellant had claimed in her tax return as the business related
expense of the telephones ($942 for 2004 and $1,825 for 2005) will be
deductible by the Appellant in computing her income from her business for the
purposes of the Act.
[33]
As a result, the following will be
the income of the Appellant from her business before taking into account any
amount that may be allowed in relation to the business use of her home:
|
Item
|
2004
|
2005
|
|
Revenue:
|
$15,000
|
$15,000
|
|
Subcontractors Fees:
|
($6,000)
|
($6,000)
|
|
Advertising:
|
($897)
|
($3,583)
|
|
Professional Fees:
|
|
($150)
|
|
Motor Vehicle Expenses:
|
($1,721)
|
|
|
Telephone:
|
($942)
|
($1,825)
|
|
|
$5,440
|
$3,442
|
[34]
The Appellant claimed business use
of the home expenses in 2005. No amount was claimed in relation to the business
use of the home in 2004, and there was no evidence of the amount incurred for
heat, electricity, mortgage interest, or property taxes in 2004. Subsection 18
(12) of the Act provides as follows:
(12) Notwithstanding any other
provision of this Act, in computing an individual's income from a business for
a taxation year,
(a) no amount shall be deducted
in respect of an otherwise deductible amount for any part (in this subsection
referred to as the “work space”) of a self-contained domestic establishment in
which the individual resides, except to the extent that the work space is
either
(i) the individual's principal place
of business, or
(ii) used exclusively for the
purpose of earning income from business and used on a regular and continuous
basis for meeting clients, customers or patients of the individual in respect
of the business;
(b) where the conditions set out
in subparagraph (a)(i) or (ii) are met, the amount for the work space that is
deductible in computing the individual's income for the year from the business
shall not exceed the individual's income for the year from the business,
computed without reference to the amount and sections 34.1 and 34.2; and
(c) any amount
not deductible by reason only of paragraph (b) in computing the individual's
income from the business for the immediately preceding taxation year shall be
deemed to be an amount otherwise deductible that, subject to paragraphs (a) and
(b), may be deducted for the year for the work space in respect of the business.
[35]
It seems clear to me that the
principal place of business of the Appellant was her home. Therefore, the
appropriate percentage of her expenses related to her home should be allowed in
determining her income from her business. During her testimony the Appellant
claimed that approximately one-third of her home was used for her business.
This percentage was not challenged by the Respondent (except the general
submission that all amounts claimed should be denied under section 67 of the Act)
and therefore this amount will be allowed. The basis for the application of
section 67 of the Act to these amounts is not at all clear. Is it
unreasonable for a business person to heat their premises or to have
electricity or to pay the interest on their mortgage or to pay their property
taxes?
[36]
As a result one third of the
amounts incurred in relation to the amounts incurred for heat, electricity,
mortgage interest, and property taxes, subject to the limitations in paragraph
18(12)(b) of the Act, will be allowed for 2005.
[37]
There is one additional matter
that should be addressed in this appeal. During the cross-examination of the
Appellant counsel for the Respondent asked the Appellant if the $15,000 for
each year was all of the income from this business. The response of the
Appellant was that the $15,000 represented her share after she paid the subcontractors
and expenses. Counsel for the Respondent did not ask any further questions in
relation to this. This raises concerns with respect to whether the amounts claimed
as expenses may already have been deducted in determining her gross income (determined
before any of the expenses described herein were deducted therefrom). However
no questions were asked and no evidence was adduced with respect to whether the
amounts paid to the subcontractors and the expenses to which the Appellant was referring
when answering the question about the $15,000 of income were the same subcontractor
fees and expenses that were claimed in her tax return.
[38]
There is nothing in the Reply to
indicate or suggest that the Respondent made any assumption that these expenses
had already been claimed in determining her gross income (before the expenses
in question were deducted to determine her net income). The only issue raised
in the Reply was whether these amounts were deductible. The position of the
Respondent, as stated in the Reply, is that the expenses were not deductible
because they were not incurred to earn income, they were personal expenses or
they were unreasonable. As well counsel for the Respondent did not make any
argument that the expenses should be denied on the basis that the expenses had
already been deducted. As a result, no adjustment will be made in relation to
this issue.
[39]
As a result, the appeals are
allowed, without costs, and the matter is referred back to the Minister of National
Revenue for reconsideration and reassessment on the basis that the Appellant's
income for 2004 and 2005 from her business for the purposes of the Act was
as follows:
|
Item
|
2004
|
2005
|
|
Gross Income:
|
$15,000
|
$15,000
|
|
Minus: Subcontractors Fees:
|
($6,000)
|
($6,000)
|
|
Advertising:
|
($897)
|
($3,583)
|
|
Professional Fees:
|
|
($150)
|
|
Motor Vehicle
Expenses:
|
($1,721)
|
|
|
Telephone:
|
($942)
|
($1,825)
|
|
Income before business use
of home expenses:
|
$5,440
|
$3,442
|
|
Minus: Business use of home
expenses (lesser of $3,442 and 1/3 of $14,267 = $4,756):
|
|
($3,442)
|
|
Net Income:
|
$5,440
|
0
|
Signed at Halifax, Nova Scotia, this 11th day of February 2009.
“Wyman W. Webb”
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