Citation: 2008TCC175
Date: 20080331
Docket: 2007-3088(IT)I
BETWEEN:
LIANGHONG LI,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
REASONS FOR JUDGMENT
Webb J.
[1] The primary issue in this case is whether the
Appellant was carrying on a business in 2003 and 2004. The Appellant claimed
business expenses in each of these years and the Respondent has taken the
position that the Appellant had not commenced any business. If the Appellant
was carrying on a business, the expenses claimed will have to be examined to
determine the amounts thereof that are deductible in computing his income for
the purposes of the Income Tax Act (“Act”).
[2] The Appellant is well-educated. He received his M.D. from Chongqing Medical College
(now Chongqing University of Medical Sciences), Chongqing, Sichuan, China in 1982,
his Master of Science of Clinical and Basic Pharmacology in 1985 from the
West China University of Medical Sciences and his postdoctoral training as a
visiting scientist to the University of Illinois College of Medicine at Rockford, Illinois.
[3] The Appellant is presently a manager of laboratory operations for
Diteba Research Laboratories Inc. in Mississauga. Prior to that he held positions as a senior research
chemist, research associate, visiting scientist, associate professor and
lecturer.
[4] The Appellant has invented a new homogenizer system that will be used
in processing tissue samples. The potential customers are laboratories that
process tissue samples – university research laboratories, pharmaceutical
companies, biopharmaceutical companies, hospital laboratories and forensic
laboratories. In the Product and Business Activities booklet introduced as an
Exhibit the Appellant estimates that there are 30,000 laboratories that would
need this kind of product. The features of his new homogenizer system are
described in this booklet as follows:
1. Easy to use for sample processing;
2. No cross-contamination compared to traditional ways and tools;
3. Efficient for number of samples processing;
4. Not expensive
[5] An application for a patent for this product was filed in 2001. Since
that time, the Appellant has been working on the components of the homogenizing
system and resolving issues related to the motor and switches that would be
used, working with the manufacturer to determine how the product will be
manufactured and designing the packaging. The Appellant made more than one
prototype before finalizing the design of the product. The Appellant indicated
that an important step that must be completed before the product can be sold to
his potential customers is that the product must receive the approval of
Underwriters Laboratories Inc. (“UL”). Two quotations from UL were submitted.
The estimated cost of receiving UL approval for the switches is US$21,600 and
for the motors is US$4,700. He has not yet received UL approval for the
switches or the motors.
[6] The unit has two parts – the motorized part that operates the grinder
and the replaceable head set. An invoice dated January 27, 2007 shows that the
Appellant received 50 of the motorized units and 5100 of the replaceable parts
from China.
[7] The Appellant has not yet sold any of the products, but he did have one
of his products in its packaging at the hearing. The Appellant is also working
on two other inventions – a new foot massaging unit and a new bone fracture
fixation system. The expenses claimed in this case relate to the new homogenizer
system.
[8] The issue of whether a person is carrying on a business has been the
subject of previous litigation. In Harquail v. The Queen, 2001 FCA 320,
2001 DTC 5630, [2002] 1 C.T.C. 25, Justice Desjardins of the Federal Court of
Appeal made the following comments on behalf of the Federal Court of Appeal:
62 It is not easy to delimit the content of
the concept of carrying on business. One can see two outside parameters where
the carrying on of business does not occur: on the one hand, when a company,
which has been incorporated, has not actually commenced operation and, on the
other hand, when a company has become dormant and is only holding annual
meetings and filing its returns so as to avoid the forfeiture of its charter.
There are, in between, some activities, however, which are signs that a company
is operating and which should fall within the spectrum of the concept of
carrying on business, even though, for example, the activities are carried on
for the purpose of reaching an agreement which eventually is not reached or
even though they do not result in the earning of income.
63 In this line of reasoning, I find helpful
the comments made by Jackett J. in Canada Starch Co. v. Minister of National
Revenue (1968), 68 D.T.C. 5320 (Can. Ex. Ct.), at 5324 -25. While this
case turns on the notion of deductible business expenses or capital outlay, the
following, which throws some light on the issue of carrying on business, was
said:
[ . . . ] Similarly, in my view, expenses of other
measures taken by a businessman with a view to introducing particular products
to the market-such as market surveys and industrial design studies-are also
current expenses. They also are expenses laid out while the business is
operating as part of the process of inducing the buying public to buy the goods
being sold.
[emphasis added by Justice Desjardins]
64 Again, in Bowater Power Co. v.
Minister of National Revenue (1971), 71 D.T.C. 5469 (Fed. C.A.), at 5481, a
case dealing also with deductible business expenses and capital outlay, Noël,
A.C.J. stated:
[ . . . ] While the hydroelectric development, once
it becomes a business or commercial realty is a capital asset of the business
giving rise to it, whatever reasonable means were taken to find out whether
it should be created or not may still result from the current operations of the
business as part of the every day concern of its officers in conducting the
operations of the company in a business-like way. I can, indeed, see no
difference in principle between all of these cases.
[emphasis added by Justice Desjardins]
65 In my view, Hall River was carrying on
business without interruption since 1978. It was constantly on the look-out for
a market to develop its hydroelectric potential. Hall River, therefore, meets
the requirement of subsection 110.6(1) of the Act, both in terms of “active
business” and in terms of the relevant period, namely “throughout that part of
the 24 months immediately preceding the determination time while it was owned
by the individual”.
[9] The Supreme Court of Canada in Stewart v. The Queen, 2002 S.C.C. 46,
212 D.L.R. (4th) 577, 2002 DTC 6969 (Eng.), [2002] 3 C.T.C. 439, 50 R.P.R. (3d) 157, 288 N.R.
297, [2002] 2 S.C.R. 645, stated as follows:
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. However, this assessment should not be used to
second-guess the business judgment of the taxpayer. It is the commercial nature
of the taxpayer's activity which must be evaluated, not his or her business
acumen.
[10] It is clear that in this case, this activity was being undertaken by
the Appellant in pursuit of profit. There is no suggestion that there is any
personal element in this endeavor. The Appellant is very proud of his
invention, but taking pride in his invention and wanting to bring a product to
market does not make this a personal endeavor. Therefore the Appellant was
carrying on a business. The fact that it has taken several years to bring the
product to market is more as a result of the nature of the product itself and
the fact that it is a new invention that requires time to work out problems and
obtain the necessary approvals rather than any indication that the Appellant
was not carrying on a business.
[11] However, the next issue is the appropriate amount that the Appellant is
entitled to claim for each of these years. The Respondent admitted that most of
the amounts claimed by the Appellant had been incurred by the Appellant. The
Respondent however admitted that a lesser amount had been incurred for office
expenses for 2004 and for food for 2003 than had been claimed and the
Respondent did not admit that any amount had been incurred in relation to the
other business expenses of $12,000 for each of 2003 and 2004. The Appellant and
the Respondent also disagreed on the deductibility of the amounts spent.
[12] While the Appellant is very well‑educated and has a lot of
experience in the medical and pharmaceutical fields, he is not a good
bookkeeper. The records maintained by the Appellant are not adequate. The amount claimed for office expenses includes several items that
should be capitalized and items for which there is another separate category of
expenses that were claimed. The appropriate amount that is related to the
purchase of capital assets, based on the use of such asset in the business,
should be added to the appropriate capital cost allowance schedule and the
Appellant can then claim capital cost allowance in relation to these items in
accordance with the provisions of the Act and the Income Tax
Regulations.
[13] There are amounts included in the claim for office expenses for 2003
that were amounts spent on capital assets. There is an amount of $229.99 for a
TV dish. This amount cannot be fully deducted, even if the TV dish was used to
connect to the internet, as it is a capital asset. There is also a claim for
$88.47 identified as unknown and a claim for $20 for parking tickets but there
is also another category of expenses claimed for parking. The total for the
list of the 2003 revised summary of office expenses that was submitted was
$727.23 but the total amount claimed by the Appellant for 2003 was $570.79. No
list was submitted to show what was included in the $570.79. It is difficult to
determine the exact amount of office expenses that were incurred in 2003, but I
will allow $350 as office expenses for 2003.
[14] The amounts claimed as office expenses for 2004 appear mostly to be for
capital expenditures or amounts for expenses (such as cell phone cards) for
which a separate amount is also claimed. As a result, no amount will be allowed
for office expenses in 2004.
[15] With respect to the amounts claimed for food, the Appellant stated that
these amounts related to meetings that the Appellant had with various
colleagues and friends in relation to the business. These individuals worked in
laboratories that would be potential customers of the Appellant's product. The
amount spent for food will be allowed, subject to the application of section
67.1 of the Act which will limit the amount claimed to one‑half of
the amount incurred. The amount claimed by the Appellant for 2003 was $550.63.
The Respondent acknowledges that $486 was incurred in 2003 for meals and the
Appellant accepted the amount of $486 for 2003 as acknowledged by the
Respondent. The Appellant and the Respondent agreed that $641 was incurred in
2004. Therefore the amount that will be allowed for the food will be $243 for
2003 and $320 for 2004.
[16] With respect to the amount claimed for telephone/cellular, the
Appellant stated that he would use his phone for both business and personal use
and his estimated business use was 35%. I accept his testimony on this and
therefore 35% of the amount claimed for the telephone/cellular will be allowed.
[17] With respect to the amount claimed for the motor vehicle expenses, the
Appellant stated that the business use of his car would be approximately 40%. I
accept his testimony on this matter and therefore 40% of the amount claimed for
motor vehicle expenses will be allowed as a business expense. The Appellant
also testified that the amounts claimed did not include the amount that he
spent on automobile insurance. These amounts were $1,159.48 for 2003 and $1,436
for 2004. Forty percent of the amounts spent on automobile insurance will also
be allowed as a business expense.
[18] With respect to the amount claimed for parking, these amounts were for
parking tickets that the Appellant had received. In 65302 British Columbia Limited v. The Queen, 99 DTC
5799, [2000] 1 C.T.C. 57, Justice Iacobucci stated that:
23 At issue in the present appeal is whether
levies, fines and penalties may be deducted as business expenses from a
taxpayer's income. The resolution of this issue involves questions of statutory
interpretation and the extent to which public policy considerations may enter
into this interpretation. It is my opinion that as a general principle, it is Parliament,
and not the courts, who should decide which expenses incurred for the purpose
of earning business income should not be deductible. Parliament has made such
decisions on many occasions; this is simply not one of them. As such, levies,
fines and penalties which are incurred for the purpose of earning income are
deductible business expenses.
[19] Following this decision of the Supreme Court of Canada, section 67.6
was added to the Act. This section provides as follows:
67.6 In computing income, no deduction shall be made in respect of any
amount that is a fine or penalty (other than a prescribed fine or penalty)
imposed under a law of a country or of a political subdivision of a country
(including a state, province or territory) by any person or public body that
has authority to impose the fine or penalty.
[20] This section is applicable to fines and penalties imposed after
March 22, 2004. This section is not pleaded in the Reply nor was
there any evidence with respect to when the parking tickets were issued in
2004. Counsel for the Respondent did not argue this section in relation to the
amount claimed for the parking tickets in 2004. As there were no assumptions
made in the Reply in relation to the parking tickets, the Respondent had the
onus of establishing any facts that would be required to determine if this
section would be applicable to the amount claimed for the parking tickets.
[21] In Pollock v. The Queen,
[1994] 1 C.T.C. 3, 94 DTC 6050, Justice Hugessen, on behalf of the Federal
Court of Appeal, made the following comments:
Where, however, the Minister has pleaded no assumptions, or where
some or all of the pleaded assumptions have been successfully rebutted, it
remains open to the Minister, as defendant, to establish the correctness of his
assessment if he can. In undertaking this task, the Minister bears the ordinary
burden of any party to a lawsuit, namely to prove the facts which support his
position unless those facts have already been put in evidence by his opponent.
This is settled law.
[22] In Loewen 2004 FCA 146, Justice
Sharlow, on behalf of the Federal Court of Appeal, made the following comments:
11 The constraints on the Minister that
apply to the pleading of assumptions do not preclude the Crown from asserting,
elsewhere in the reply, factual allegations and legal arguments that are not
consistent with the basis of the assessment. If the Crown alleges a fact
that is not among the facts assumed by the Minister, the onus of proof lies
with the Crown. This is well explained in Schultz v. R. (1995), [1996]
1 F.C. 423, [1996] 2 C.T.C. 127, 95 D.T.C. 5657 (Fed. C.A.) (leave to appeal refused, [1996]
S.C.C.A. No. 4 (S.C.C.)).
(emphasis added)
[23] Leave to appeal the decision of the Federal
Court of Appeal in Loewen to the Supreme Court of Canada was refused
(338 N.R. 195 (note)).
[24] Since the Respondent has not led any evidence with respect to the facts
that would be required to determine whether section 67.6 of the Act will
apply in this case (and in particular whether the parking tickets were issued
after March 22, 2004), I cannot consider whether this section would
be applicable to the parking tickets issued to the Appellant. The Appellant
indicated that 80% of the amounts for the parking tickets would relate to the
business. I accept his testimony and 80% of the amounts spent on parking
tickets will be allowed as a business expense for each of 2003 and 2004.
[25] With respect to the amount claimed for cable TV, the Appellant failed
to establish the necessary connection between the use of the Cable TV and his
business. Therefore no amount will be allowed as a business expense for the
Cable TV.
[26] With respect to the amount related to the Internet, the Appellant
indicated that he used e-mail in relation to his business and the percentage of
business use of the Internet would be 50%. I accept his testimony in this
regard and 50% of the amount incurred for the Internet charges will be allowed
as a business expense.
[27] The amount claimed for other business expenses claimed in each of 2003
and 2004 was an amount of $12,000 in each year. These were amounts that were
paid by the Appellant to his brother in China who was dealing with the manufacturer. The receipt
indicates that these amounts were for consultation fees and amounts related to
the trial production of the product. Throughout 2003 and 2004 the Appellant was
dealing with the manufacturer to try to work on the design of the product and
the manufacturing process. I accept the Appellant's testimony in this matter
and the Appellant is allowed a claim of $12,000 for each year. In 2004 the
amount paid to the Appellant's brother was more than $12,000 but the Appellant
is only claiming $12,000 for 2004.
[28] As a result, the appeals are allowed, with costs, and the matter is referred
back to the Minister of National Revenue for reconsideration and reassessment
on the basis that the Appellant is entitled to the following deductions in
computing his income for 2003 and 2004:
|
Expense
|
Amount
allowed for 2003
|
Amount
allowed for 2004
|
|
Office Expenses
|
$350
|
0
|
|
Food
|
$243
|
$320
|
|
Telephone/Cellular
|
$230
|
$268
|
|
Motor Vehicle Expenses:
|
|
|
|
▪ Car Repairs
|
$324
|
$371
|
|
▪ Gas
|
$552
|
$406
|
|
▪ CAA
|
$31
|
$39
|
|
▪ Insurance
|
$464
|
$574
|
|
Parking
|
$136
|
$50
|
|
Cable TV
|
$0
|
$0
|
|
Internet
|
$55
|
$80
|
|
Other Business Expenses
|
$12,000
|
$12,000
|
|
|
$14,385
|
$14,108
|
Signed at Fredericton, New Brunswick, this 31st day of March 2008.
“Wyman W. Webb”
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