Citation: 2007TCC557
Date: 20070920
Docket: 2006-853(IT)I
BETWEEN:
JOHN G. BROOKS,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
REASONS FOR JUDGMENT
Webb J.
[1] The issue in this case is whether the
Appellant had a source of income from which to deduct certain expenses in 2002,
2003 and 2004. The Appellant, in his Notice of Appeal, had indicated that there
was a separate issue related to certain rental expenses that had been claimed.
However at the commencement of the hearing, it was confirmed that the Appellant
was not pursuing his appeal in relation to the rental expenses. The only items
before the Court related to the business losses that had been claimed in 2002,
2003 and 2004.
[2] The Appellant had
some previous business experience in the early 1990s when he drove for an auto
parts dealer. This was not the business that was the subject of this appeal but
it does illustrate the Appellant’s prior business experience.
[3] The activities for
which the Appellant is claiming the expenses that are the subject of this
appeal started in 1999. The Appellant determined that he would be able to make
money by buying Beanie Babies on e‑bay and then later selling them for a
profit. It was the Appellant’s understanding that the company that was making
Beanie Babies was going to stop production and hence that this could increase
the demand for the Beanie Babies. Instead, the company chose to produce a
separate line of Beanie Babies which effectively flooded the market and caused
the price to drop. While the Appellant was carrying on this activity he
acquired as many as 2,500 Beanie Babies. The Appellant’s brother lived with the
Appellant and assisted him significantly in carrying out these activities and
the activities that are described below.
[4] The Appellant also
acquired other items on e-bay that he believed he could sell for a profit
including soccer memorabilia from a team that the Appellant supported, Royal
Navy memorabilia related to the aircraft carrier on which the Appellant’s
brother served in the navy, VHS tapes of different shows, a model airplane, and
other items that he believed would be collectors’ items and that he could sell
for a profit. Also included in the list of purchases were items such as a
satellite dish, compact discs, DVD RAM drive, and video cards that were not
items that were intended to be resold. Although the activities commenced in
1999, the Appellant has not, to the date of the hearing, sold a single item.
Because the items were occupying a large part of his house, he decided to put
them in storage. As the Appellant has not paid the storage fee, the items are
still in storage and the Appellant cannot retrieve the items without paying the
past due storage fees.
[5] The business losses
that were claimed in each of the taxation years under appeal are summarized in
Schedule A to the Reply as follows:
|
Expense
|
2002
|
2003
|
2004
|
|
Opening inventory
|
0
|
0
|
$9,269
|
|
Purchases
|
$8,356
|
$9,269
|
$9,302
|
|
Delivery and Freight
|
0
|
$644
|
$1,525
|
|
Tax, Licence, fees, Dues
|
0
|
$261
|
0
|
|
Utility Expenses
|
0
|
$1,050
|
$5,022
|
|
Office Expenses
|
$632
|
0
|
0
|
|
Capital Costs Allowance
|
$919
|
$643
|
$450
|
|
Advertising Expenses
|
$888
|
$2,337
|
$5,960
|
|
Management and Administration Expense
|
0
|
0
|
$206
|
|
Other Business Expenses
|
0
|
0
|
$799
|
|
Totals
|
$10,795
|
$14,204
|
$32,533
|
[6] The most striking
element of the expenses that were claimed relates to the purchases/inventory.
Although not a single item was sold by the Appellant, the entire amount spent
on purchases was deducted in 2002 and 2003 and in 2004 not only was the entire
amount spent on purchases made in 2004 deducted but also the amount spent on
purchases made in 2003 was again deducted in 2004. There was no recognition in
any of these years for the closing inventory. No valuation of the closing
inventory was completed as the Appellant stated that it would have taken too
long to value the inventory at any particular point in time. Assuming that any
goods were sold, the costs of goods sold would be determined by the following
formula: opening inventory + purchases - closing inventory = costs
of goods sold.
[7] By not making any
deduction for the closing inventory, the Appellant has clearly overstated the
expenses and in 2004 by showing $9,269 as an opening inventory (the cost of
which had been fully deducted in 2003), the Appellant has claimed this amount
twice.
[8] The evidence in
relation to the activities shows that the Appellant was initially trying to
capitalize on the Beanie Baby craze of the late 1990s. There is very little
evidence of any market research that the Appellant had completed and his
attempts to sell any of the items in inventory were minimal. He indicated that
he had tried to sell some on e‑bay but he lost his account with e‑bay.
He indicated that he lost his account on e‑bay because various
individuals had submitted complaints concerning his payment record.
[9] The Appellant also
testified that he had set up websites to try to sell his inventory. He
indicated that he had as many as four different websites. However, none of the
websites had any hits. The amounts that the Appellant had claimed as
advertising related mostly to work related to the websites that were prepared
for him by his brother-in-law. He also spent some money for flyers that were
distributed.
[10] The Supreme Court of
Canada in Stewart v. The
Queen, [2002] 2 S.C.R. 645 dealt with the issue of
whether the reasonable expectation of profit test is an acceptable test to
determine a source of income. Justices Iacobucci
and Bastarache stated the following:
5 It
is undisputed that the concept of a “source of income” is fundamental to the
Canadian tax system; however, any test which assesses the existence of a source
must be firmly based on the words and scheme of the Act. As such, in order to
determine whether a particular activity constitutes a source of income, the
taxpayer must show that he or she intends to carry on that activity in pursuit
of profit and support that intention with evidence. The purpose of this test is
to distinguish between commercial and personal activities, and where there is
no personal or hobby element to a venture undertaken with a view to a profit,
the activity is commercial, and the taxpayer's pursuit of profit is
established. However, where there is a suspicion that the taxpayer's
activity is a hobby or personal endeavour rather than a business, the
taxpayer's so-called reasonable expectation of profit is a factor, among
others, which can be examined to ascertain whether the taxpayer has a
commercial intent.
.
. .
50 It is clear that in order to apply s. 9, the
taxpayer must first determine whether he or she has a source of either business
or property income. As has been pointed out, a commercial activity which falls
short of being a business, may nevertheless be a source of property
income. As well, it is clear that some taxpayer endeavours are
neither businesses, nor sources of property income, but are mere personal
activities. As such, the following two-stage approach with
respect to the source question can be employed:
(i) Is the activity of
the taxpayer undertaken in pursuit of profit, or is it a personal endeavour?
(ii) If it is not a personal
endeavour, is the source of the income a business or property?
The first stage of the test assesses the general
question of whether or not a source of income exists; the second stage categorizes the source as either
business or property.
51 Equating “source of income” with an activity
undertaken “in pursuit of profit” accords with the traditional common law definition
of “business,” i.e., “anything which occupies the time and attention and labour
of a man for the purpose of profit”: Smith, supra, at p. 258, Terminal Dock,
supra. As well, business income is generally distinguished from property income
on the basis that a business requires an additional level of taxpayer activity:
see Krishna, supra, at p. 240. As such, it is logical to
conclude that an activity undertaken in pursuit of profit, regardless of the
level of taxpayer activity, will be either a business or property source of
income.
52 The purpose of this first stage of the
test is simply to distinguish between commercial and personal activities,
and, as discussed above, it has been pointed out that this may well have been
the original intention of Dickson J.'s reference to “reasonable expectation of
profit” in Moldowan. Viewed in this light, the criteria listed by Dickson
J. are an attempt to provide an objective list of factors for determining
whether the activity in question is of a commercial or personal nature.
These factors are what Bowman J.T.C.C. has referred to as “indicia of
commerciality” or “badges of trade”: Nichol, supra, at p. 1218. Thus,
where the nature of a taxpayer's venture contains elements which suggest that
it could be considered a hobby or other personal pursuit, but the venture is
undertaken in a sufficiently commercial manner, the venture will be considered
a source of income for the purposes of the Act.
53 We
emphasize that this “pursuit of profit” source test will only require analysis
in situations where there is some personal or hobby element to the activity in
question. With respect, in our view, courts have erred in the past in
applying the REOP test to activities, such as law practices and restaurants,
where there exists no such personal element: see, for example, Landry, supra,
Sirois, supra, Engler v. R. (1994), 94 D.T.C. 6280 (Fed. T.D.). Where the
nature of an activity is clearly commercial, there is no need to analyze the
taxpayer's business decisions. Such endeavours necessarily involve
the pursuit of profit. As such, a source of income by definition
exists, and there is no need to take the inquiry any further.
54 It should also be noted that the source of
income assessment is not a purely subjective inquiry. Although
in order for an activity to be classified as commercial in nature, the taxpayer
must have the subjective intention to profit, in addition, as stated in Moldowan,
this determination should be made by looking at a variety of objective factors.
Thus, in expanded form, the first stage of the above test can be restated as
follows: "Does the taxpayer intend to carry on an activity for profit and
is there evidence to support that intention?" This requires the
taxpayer to establish that his or her predominant intention is to make a profit
from the activity and that the activity has been carried out in accordance with
objective standards of businesslike behaviour.
55 The
objective factors listed by Dickson J. in Moldowan, at p. 486, were: (1)
the profit and loss experience in past years; (2) the taxpayer's training; (3)
the taxpayer's intended course of action; and (4) the capability of the venture
to show a profit. As we conclude below, it is not necessary
for the purposes of this appeal to expand on this list of
factors. As such, we decline to do so; however, we would reiterate
Dickson J.'s caution that this list is not intended to be exhaustive, and that
the factors will differ with the nature and extent of the
undertaking. We would also emphasize that although the reasonable
expectation of profit is a factor to be considered at this stage, it is not the
only factor, nor is it conclusive. The overall assessment to be made
is whether or not the taxpayer is carrying on the activity in a commercial manner.
…
(emphasis
added)
[11] In Morris v. Her
Majesty the Queen, 2003 FCA 116, 2003 D.T.C. 5236, [2003] 3 C.T.C. 75, 301
N.R. 327, the Federal Court of Appeal stated as follows:
11 The
Judge's finding that Mr. Morris had a strong personal interest in fishing assumes
a particular importance because the Court stated in Stewart that, although a
reasonable expectation of profit is not a necessary requirement to establish a
source of income for the purpose of section 9 of the Act when the activity is
of a commercial nature, if there is a personal or hobby element in the
activity in question it is still relevant to determine if there is a reasonable
expectation of profit from the activity in order to decide whether the taxpayer
had a commercial intent. In these circumstances, the objective criteria
prescribed in Moldowan remain relevant, although the existence of a reasonable
expectation of profit from the activity is only one of the circumstances that
must be examined when ascertaining whether the taxpayer has a commercial
intent: Stewart at paras. 5 and 55..
12 According
to Stewart (at para. 50), in order to determine if a source of income exists a
court should first ask: “is the activity of the taxpayer undertaken in pursuit
of profit, or is it a personal endeavour?” The factors listed in Moldowan
provide objective criteria for answering this question. Thus, even though the
taxpayer has a personal interest in the activity, if “the venture is undertaken
in a sufficiently commercial manner, the venture will be considered a source of
income for the purposes of the Act”: Stewart at para 52. The Court went on to
say (at para. 54) that to establish an intention on the part of the taxpayer to
pursue an activity for profit, rather than personal interest, requires the taxpayer
to establish that his or her predominant intention is to make a profit and that
the activity has been carried on in accordance with objective standards of
businesslike behaviour.
(emphasis added)
[12] In this case the
activities of the Appellant could be a hobby or personal endeavour. Many
individuals collect memorabilia and other items. Some of the items that were
purchased had a personal connection to the Appellant or his brother. The items
that were purchased included soccer memorabilia from the soccer team that the
Appellant supported and items related to the aircraft carrier on which the
Appellant’s brother served in the navy. Many of the items were purchased in a
haphazard manner on e-bay. As a result, the activities may have been personal
or at least “there is a suspicion that
the taxpayer's activity is a hobby or personal endeavour”. In this situation, it
is necessary to determine whether the activities have been undertaken in a
sufficiently commercial manner to make the activities commercial in nature. Did
the Appellant carry out his activities “in accordance with objective standards
of businesslike behaviour”?
[13] The Supreme Court of
Canada noted four objective factors that are to be examined in determining
whether an activity should be classified as commercial in nature when making
the determination of whether the activity is personal or commercial. These are
as follows:
1. the profit and
loss experience in past years;
2. the taxpayer’s
training;
3. taxpayer’s
intended course of action; and
4. the capability
of the venture to show a profit.
[14] The alleged business
in this case commenced in 1999 and since no items were sold at all, there could
not have been a profit in either 1999 or 2000. Since no items were sold in
2002, 2003 or 2004, again there was obviously no profit in any of those years.
While the Appellant did attempt to take some training there was no evidence of
any prior experience or training in buying and selling fad items or memorabilia
or carrying on any retail operation. The previous business venture was driving
for an auto parts company.
[15] The Appellant’s
intended course of action in holding on to the items in the hopes that they
would appreciate in value does not suggest that this is a commercial activity.
During the years under appeal, there does not appear to be any plan of action
to liquidate the inventory. Rather the plan was to hold it and hope that it
would go up in value.
[16] In this particular
case, there is very little evidence of any advertising that was actually
completed. Although the amount spent on advertising was significant in
2003 and 2004, most of this was paid to the brother-in-law of the
Appellant for work related to the website design for a website which received
no hits.
[17] The final criteria
listed by the Supreme Court of Canada is the capability of the venture to show
a profit. Without selling a single item, it is difficult for the Appellant to
establish that the venture had any capability of showing a profit.
[18] In this particular
case there is also an issue in relation to the record keeping and the
determination of profit. In Kaye v. The Queen, 98 DTC 1659, [1998] 3 C.T.C.
2248, Bowman, J. (as he then was) dealt with a situation in which a person was
claiming various expenses for an alleged business. The alleged business in that
case was buying and selling antiques and collectibles. Although this case was
prior to the Supreme Court of Canada decision in Stewart, the test
applied by Bowman, J. still relates to the question of whether it was carried
on in a businesslike manner and this case was cited by the Supreme Court of
Canada in the Stewart case. As well, Bowman, A.C.J. (as he then was) also
cited this case in Martin v. Her Majesty the Queen 2003 TCC 155,
[2003] 3 C.T.C. 2416 which was after the Supreme Court of Canada
released its decision in the Stewart case. Of particular note in the Kaye
case are the comments of Bowman, J. (as he then was) in paragraphs 12, 13
and 14 where he stated as follows:
[12] After most of the evidence had been adduced
counsel agreed to abandon the claim for the additional $6,287 and limited it to
a claim for $5,523. This was probably on the basis that it was clear that many
of the expenses could not be substantiated. For example, some $3,000 was
claimed as an opening inventory although the appellant was unable to state just
what was in the opening inventory, some of which he agreed was purchased from
his father-in-law's wife. I should have thought that if there was $3,000 worth
of opening inventory and only $150 worth was sold the balance together with
purchases in the year, valued at the lower of lost [sic] or market or on
some other basis as may be appropriate, would have appeared in the closing
inventory. The statement of business activities shows, in computing as cost of
goods sold an opening inventory of $3,000, purchases of $4,300 for a total of
$7,300, less a closing inventory of $5,500 for a cost of goods sold of $1,800.
This means that the goods sold of $150 (two hockey cards) had a notional cost attributed
to them of $1,800.
[13] I cite this as one example of the somewhat
unrealistic way in which the computation of the income or loss was approached.
Many of the other expenses appear to have been ballpark guesstimates. The other
expenses claimed are round figures - such as salaries ($2,450) travel ($1,500)
motor vehicle expenses ($3,250) and so forth. There was no separate business
bank account and it was impossible to tell from the bank statement that was put
in evidence just what the money withdrawn from the account was spent on.
[14] Quite apart from the rather fundamental
question of what the loss, if any, was, this somewhat haphazard method of
record keeping is quite inconsistent with the assertion that a real business
was being carried on.
[19] In Kaye, the
fact that the taxpayer had claimed that the costs of goods sold was $1,800 in
relation to the sale of two hockey cards indicated a “somewhat unrealistic way
in which the computation of the income or loss was approached”. In this
particular case, no items were sold yet the entire amount of the purchases was
deducted in each year and the amount spent on purchases made in 2003 was
deducted twice, once in 2003 and again in 2004. In 2002, the amount deducted as
purchases represented 77% of all the expenses that were claimed. In 2003, the
amount deducted for purchases represented approximately 65% of all of the
expenses that were claimed. In 2004, the total amount claimed as a deduction
for the opening inventory and as a deduction for the purchases represented
approximately 57% of all of the expenses that were claimed. As in the Kaye
case, this is an unrealistic method of calculating income. As noted no
valuation of the inventory was completed and therefore it is impossible to
determine what, if any, write down of the inventory should be taken into
account for any of these years. This also confirms that the activities were not
carried on in a businesslike manner.
[20] As a result, I find
that the activities of the Appellant in 2002, 2003 and 2004 were personal and not
commercial in nature and hence the amounts claimed as business expenses were
not deductible by the Appellant as the Appellant had no source of income from
which to deduct these amounts.
[21] The appeals for the
2002, 2003 and 2004 taxation years are dismissed, without costs.
Signed at Halifax, Nova Scotia, this 20th day of September 2007.
“Wyman W. Webb”
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