Heard v. The Queen, docket 2000-4569-IT-I (Informal Procedure)

Date: 20010820

Docket: 2000-4569-IT-I

BETWEEN:

GARRY HEARD,

Appellant,

and

HER MAJESTY THE QUEEN,

Respondent.

Reasons for Judgment

Miller, J.T.C.C.

[1]            The Minister of National Revenue has disallowed business losses claimed by Mr. Heard for the 1996 and 1997 taxation years. Mr. Heard maintains the losses of $5,365.00 and $7,029.00 for 1996 and 1997 respectively were incurred in connection with his business of picture framing. The Minister maintains Mr. Heard did not have a business with a reasonable expectation of profit, and even if he did, the expenditures claimed which created the loss cannot be substantiated. Mr. Heard has appealed the Minister's reassessment by way of Informal Procedure.

[2]            Mr. Heard provided his evidence in a clear and straightforward manner and was a thoroughly credible witness. He indicated that in 1988 he determined that he wished to start his own small business, ultimately intending it to be a full-time occupation. He took a number of steps to accomplish this including attending courses in picture framing and matting at Durham College and in starting a small business at George Brown College. He assessed the market in the picture framing and limited edition business by interviewing several galleries, as well as shops already in the business. He determined that the greatest chance of success would be by starting in his home. As a production manager for a company he had considerable business background. He augmented this by obtaining management certificates from the Canadian Institute of Management. While he did not produce a formal business plan at the trial, he testified he had a plan from the outset. All his efforts would support such a claim and I accept that he had a business plan.

[3]            In 1989 he established a studio in his home, which was well located just behind a local Pickering shopping mall. He acquired the necessary equipment and inventory, registered his name for Goods and Services Tax ("GST") purposes as "Finishing Touch", got business cards and invoices with the Finishing Touch logo and sought customers. This he did by leaving cards and flyers on windshields at the nearby Toronto Flea Market as well as at other lots around town. Mr. Heard's evidence was that at this time there was a terrific demand for limited prints and framing; people were actually bidding on prints. Mr. Heard had gross revenues of $9,435.00 in 1989 and $16,976.00 in 1990. He indicated that in 1991 and 1992 and thereafter his business was hit by a lingering recession. The limited edition market dried up; it was this market that drove the framing business. Shops went out of business. Mr. Heard had considered relocating to the main street and had an agent explore possibilities for a year, specifically looking in the antiques area, as that was of particular interest to Mr. Heard. As business did not improve he opted against such a move. Instead he moved in 1993 to less well located premises, though he testified he was able to have a better studio. He realized by 1995 that he was not going to turn this into a full-time operation and in 1996 knew the operation was no longer viable and began winding down, eventually ceasing business in 1997.

[4]            While he ran the business, Mr. Heard's mode of operation was to order inventory on Monday, pick it up on Wednesday, accept orders throughout the week and do the actual framing primarily between 5:00 and 9:00 in the evenings and on weekends. In the busy season, particularly at Christmas-time, he would spend eight or nine hours a day on Saturday and Sunday on the business.

[5]            Mr. Heard accumulated inventory of framing materials and prints over the years. It is the accumulation of these costs that he claims make up the bulk of the proposed 1996 and 1997 write-offs. He did not produce specific receipts for these items, which may go back to the early years of his business, though it was clear his books reflected the ongoing inventory status. Part of the write-off related to limited edition prints which had suffered water damage, and part was in connection to obsolete inventory, which was burned.

[6]            Throughout the 1990's Mr. Heard's business, "Finishing Touches" never made a profit. Gross revenue and losses for the years were as follows:

	Gross Income	Expenses	Net/Profit/(Loss)
1989	$ 9,435.00	$15,355.00	($5,920.00)
1990	$16,976.00	$20,364.00	($3,388.00)
1991	$ 9,343.00	$15,081.00	($5,738.00)
1992	$ 6,639.00	$10,235.00	($3,596.00)
1993	$ 4,093.00	$ 6,831.00	($2,738.00)
1994	$ 6,190.00	$11,578.00	($5,388.00)
1995	$ 4,446.00	$ 8,142.00	($3,696.00)
1996	$ 2,058.00	$ 7,423.00	($5,365.00)
1997	$ 2,308.00	$ 9,377.00	($7,029.00)

                                               

The expenses claimed in 1996 and 1997 can be broken down as follows:

	1996	1997
Utilities	$ 987.00	$ 465.00
Depreciation/Terminal loss	$1,281.00	$3,635.00
Cost of goods sold	$5,755.00	$5,634.00

[7]            Mr. Heard acknowledged that he could have considered winding down the business earlier than he did, in 1995 perhaps, but instead he carried on. He offered no explanation as to the reasons for this, other than not wanting to give up on the business, waiting for the economy to improve.

[8]            Counsel for the Respondent argued that there was no business and no reasonable expectation of profit. Alternatively he argued the expenses could not be substantiated. As appears standard practice in these business loss cases, the principle in the Supreme Court of Canada case of Moldowan v. Her Majesty the Queen, 77 DTC 5213, is presented as requiring a reasonable expectation of profit for there to be a source of income subject to the Income Tax Act ("Act"). The Moldowan case has been moulded over the years, though as recently as in Stewart v. Her Majesty the Queen, 2000 CarswellNat 259, 2000 DTC 6163, [2000] 2 C.T.C. 244, 254 N.R. 326, the Federal Court of Appeal have indicated:

The Moldowan principle is that in order to have a source of income, the taxpayer must have a profit or reasonable expectation of profit. No subsequent Supreme Court authority has altered the Moldowan principle.

In Stacey v. Her Majesty the Queen, 1997 CarswellNat 85, [1997] 2 C.T.C. 2703 case, former Judge Sobier put the issue succinctly:

The issue in this appeal is whether the Marina operation was a business and whether there was a reasonable expectation of profit from the operation.

I view the test similarly to former Judge Sobier as requiring both the determination of a business and a determination of reasonable expectation of profit from that business. In answering the former question I look to indices of commerciality including the behaviour of the taxpayer acting as a business person versus his behaviour for personal benefit.

[9]            This was neither a passion Mr. Heard pursued nor a lifelong hobby. This was a deliberately planned and researched small business. Mr. Heard did some considerable preliminary investigation of a potential business, consisting of taking courses, contacting galleries and assessing the market before he actually opened shop in 1989. The first two or three years appear to have been cause for some hope that he might achieve his objective of turning this into a full-time business. However, the economy dipped downward and this had a serious prolonged effect on Mr. Heard's business. But a business it was. I am satisfied he meets the standard stipulated by Associate Chief Judge Bowman in Kaye v. Her Majesty the Queen, 1998 CarswellNat 575, 98 DTC 1659, [1998] 3 C.T.C. 2248:

Would a reasonable person, looking at a particular activity and applying ordinary standards of commercial common sense, say 'yes, this is a business'?

[10]          There were sufficient indices of commerciality including registration of the business name, use of business cards, invoices, a studio, considerable carrying of inventory and advertising by flyers. Though he did work full-time as a production manager elsewhere, Mr. Heard devoted an appropriate amount of time to ensure the ongoing business activities. He acquired the necessary equipment to conduct the business and at one point investigated expansion to incorporate an antique aspect into the business. I am satisfied there was a business. The issue then is whether the business had a reasonable expectation of profit.

[11]          Factors that I consider in this analysis are:

                (1)            Profit and loss of past years

                (2)            Training

                (3)            Motivation and intended course of action

                (4)            Capability as capitalized to show a profit

                (5)            Nature and stage of business

[12]          While Mr. Heard reported no profits from the business throughout its existence, all other factors I find in Mr. Heard's favour as pointing to a reasonable expectation of profit in regards to the business. He certainly had the training from a management background as well as having taking specific courses related to framing and running a small business. His motivation from the outset was to earn a living from his own small business. His plans were to grow the business and he investigated moving to accommodate these plans. But for the economic downturn, I find the capital and equipment and inventory could reasonably have been expected to sustain a profit. The business however never got a chance as the market dissolved during the nineties. The difficulty is that while I find there was a reasonable expectation of profit, I must ask whether that changed in 1996 and 1997 when Mr. Heard acknowledged his business was in the stage of winding down.

[13]          It seems to lead to something of an absurdity that the reasonable expectation of profit test be applied to businesses that are winding down and do not expect a profit in the twilight period of their demise. Such legitimate businesses could never pass the test. I do not accept an application of the test leading to such a result. I do however draw on the concepts enunciated in cases relying on Moldowan such as the Stewart case where the Federal Court of Appeal indicated:

The reasonable expectation of profit test is not an opportunity for the Minister to second guess the business judgment of the taxpayer and it cannot justify the disallowance of losses caused by the unforeseen development of an unfavourable economic environment.

[14]          Mr. Heard's evidence was the economic picture changed dramatically and although he hung on longer than many might have, that was a business judgment, as was his decision to ultimately close his doors in 1997. Counsel for the Respondent relied on the following statement in Landry v. Her Majesty the Queen, 94 DTC 6624 (F.C.A.):

There comes a time in the life of any business operating at a deficit when the Minister must be able to determine objectively, after giving someone a head start for a number of years, as the case may be, that a reasonable expectation of profit has turned into an impossible dream.

[15]          In that case the taxpayer's activities did not constitute a business and is readily distinguishable. Mr. Heard's activity was a business. The cost of inventory acquired over a number of years was incurred over a time period when I find he had a reasonable expectation of profit. Once Mr. Heard determined the reasonable expectation of profit had become an impossible dream he took steps to wind down the business. He should not be penalized for doing so. I distinguish Mr. Heard from both the taxpayer who does not recognize the business has become the impossible dream, though it has, and also from the taxpayer who recognizes it has become the impossible dream but takes no steps to pack it in. If Mr. Heard's business judgment can be reproached at all, it is that it took him longer to wind down than some might consider commercially reasonable. Given the nature of the expenses he is ceasing to claim, this is not significant.

[16]          I conclude that there was a source of income in this case. Mr. Heard's business is past the gate keeping section of the Act, section 3, and now must be subjected to the other provisions of the Act, specifically section 18.

[17]          Counsel for the Crown did not argue this alternative vigorously but relied solely on Njenga v. The Minister of National Revenue, 1996 CarswellNat 1559, 96 DTC 6593, [1997] 2 C.T.C. 8 as requiring written substantiation of expenditures, specifically paragraph 3 of the Federal Court of Appeal decision:

The Income tax system is based on self monitoring. As a public policy matter the burden of proof of deductions and claims properly rests with the taxpayer. The Tax Court Judge held that persons such as the Appellant must maintain and have available detailed information and documentation in support of the claims they make. We agree with that finding. Ms. Njenga as the Taxpayer is responsible for documenting her own personal affairs in a reasonable manner. Self written receipts and assertion without proof are not sufficient.

[18]          Mr. Heard did not present in evidence receipts for the costs of the framing materials or limited editions. He left me with no doubt whatsoever that his records and books of account tracked these costs. I do not take Njenga as standing for the principle that taxpayers must provide written substantiation in this Court for all expenditures in dispute or the expenditures will be disallowed. The taxpayer runs a serious risk if he does not keep complete and accurate records. If he does not provide them to this Court it casts a doubt on their existence. That doubt in this case is overcome by Mr. Heard's clear and adamant answers regarding accumulated inventory costs. These were not one time expenses he could point to, but an ongoing reporting of inventory in and out. I believe Mr. Heard kept such an accurate reporting.

[19]          I accept the expenses as reported by Mr. Heard in 1996 and 1997. Apart from utilities he has made no claim for any other expenditures in 1996 and 1997 other than those directly attributable to the winding down of the business; that is depreciation and terminal loss and the write off of inventory. This is a reasonable approach.

[20]          I allow the appeal and refer the assessment back to the Minister for reconsideration and reassessment on the basis that the losses for Mr. Heard's 1996 and 1997 taxation years are to be allowed. I award costs of $100.00 to Mr. Heard for his travel and incidental costs.

Signed at Ottawa, Canada this 20th day of August, 2001.

"C. J. Miller"

J.T.C.CCOURT FILE NO.:                    2000-4569(IT)I       

STYLE OF CAUSE:                                               Garry Heard and The Queen

PLACE OF HEARING:                                         Toronto, Ontario

DATE OF HEARING:                                           August 2, 2001

REASONS FOR JUDGMENT BY:                      The Honourable C. J. Miller

DATE OF JUDGMENT:                                       August 20, 2001

APPEARANCES:

Agent for the Appellant:                                     Joan Vanderbeke

Counsel for the Respondent:                              Steve Leckie

COUNSEL OF RECORD:

For the Appellant:                

Name:                     

Firm:                       

For the Respondent:                             Morris Rosenberg

                                                                Deputy Attorney General of Canada

                                                                Ottawa, Canada

2000-4569(IT)I

BETWEEN:

GARRY HEARD,

Appellant,

and

HER MAJESTY THE QUEEN,

Respondent.

Appeals heard on August 2, 2001 at Toronto, Ontario

by the Honourable Judge Campbell J. Miller

Appearances

Agent for the Appellant:                       Joan Vanderbeke

Counsel for the Respondent:                Steve Leckie

JUDGMENT

          The appeals from the assessments made under the Income Tax Act for the 1996 and 1997 taxation years are allowed, and the matter is referred to the Minister of National Revenue for reconsideration and reassessment in accordance with the attached Reasons for Judgment.

          The Appellant is awarded costs fixed in the amount of $100.00.

Signed at Ottawa, Canada this 20th day of August, 2001.

"C. J. Miller"

J.T.C.C.