Date: 20010710
Docket: 98-2779-IT-G, 98-2781-IT-G, 98-2783-IT-G
BETWEEN:
GEORGE W. PEARY, JOHN W. SHEWAN and ILZE SHEWAN,
Appellants,
and
HER MAJESTY THE QUEEN,
Respondent.
Reasons for Judgment
Mogan J.
[1]
The appeals of George W. Peary v. The Queen (File no.
98-2779(IT)G), John W. Shewan v. The Queen (File no.
98-2781(IT)G) and Ilze Shewan v. The Queen (File no.
98-2783(IT)G) were heard together on common evidence. In each
appeal, the taxation years in dispute are 1993, 1994 and 1995. At
all relevant times, the three Appellants were the only partners
in the ownership and operation of a retail floral outlet in
Mission, British Columbia, operating under the name "Wayside
Flowers". In the three years under appeal, Wayside Flowers
reported losses as follows:
Taxation
Year
Net Loss
1993
$26,123.40
1994
16,206.38
1995
22,199.80
[2]
The above losses were allocated among the three Appellants as
partners. Each Appellant deducted his or her allocated share of
the loss from employment salary in the computation of income. The
Minister of National Revenue reassessed each of the Appellants
for the purpose of disallowing the deduction of such losses. The
Appellants have appealed from those reassessments. The only issue
is whether the Appellants, as partners, had a reasonable
expectation of profit from the operation of Wayside Flowers in
the years under appeal.
[3]
Two of the Appellants, John Shewan and Ilze Shewan, are husband
and wife. For convenience, I shall refer to each individual
Appellant by his or her first name as George, John and Ilze. All
three Appellants are qualified high school teachers in the
Province of British Columbia. At all relevant times, John and
Ilze were employed full-time as teachers at the Abbotsford High
School; and George was employed full time as the principal of
that school. The retail floral outlet, Wayside Flowers, was
located at Mission, a town on the north side of the Fraser River
about 60 kilometres east of Vancouver. Abbotsford is only
12 kilometres south of Mission and south of the Fraser
River. Wayside Flowers was therefore about a 10-minute drive from
the Abbotsford High School where the three Appellants were
employed.
[4]
At the hearing of these appeals, Ilze testified at length and
George testified briefly. Also, there were entered as Exhibits
R-6 and R-7 the questions and answers (respectively) of the
written examination for discovery of Ilze. Exhibit R-6
contains 66 questions. In these reasons, a reference to any
answer in Exhibit R-7 will cite only the number of the
corresponding question.
[5]
Exhibit R-2 is an Agreement of Purchase and Sale dated March 27,
1981 under which Landmore Enterprise Ltd. purchased Wayside
Gardens (the pleadings refer to the operation as "Wayside
Flowers") as a going concern at a price of $110,000 plus the
value of all stock for resale at cost. The purchase took effect
as of the opening for business on April 1, 1981. The issued
shares of Landmore Enterprise Ltd. ("Landmore") were
owned equally by John and George. According to Ilze, Wayside
Flowers had been in the retail floral business for about 35 years
when it was purchased by Landmore in 1981. The statement of
adjustments (Exhibit R-1) shows that the final purchase price
paid by Landmore was $120,890.
[6]
Immediately after the purchase, Landmore operated Wayside Flowers
as a corporate enterprise. Ilze became the de facto
manager of Wayside Flowers because she was on maternity leave.
Even after she went back to full-time teaching, she continued to
manage the Wayside Flowers operation. Because it had operated for
so many years, Wayside had an extensive list of customers,
professionally printed invoices and purchase orders, and an
international connection with florists through
"Flowers-by-Wire" and "Teleflora". They were
required to lay off some staff in 1982 but she kept some
full-time staff and hired new employees in 1984. In order to
build staff loyalty, they provided extra benefits like a medical
plan and paid the going rate for retail work in the Fraser
Valley. Exhibit A-2 is the resumé of an employee hired in
1993 who had prior experience in floral arrangements.
[7]
The employees worked from 9:00 a.m. to 3:00 p.m. without
supervision. They took telephone orders locally and received
orders by fax and "wire" from florists outside Mission,
B.C. They cleaned the coolers where the cut flowers were stored
and ordered fresh flowers. Ilze would check with the employees by
phone during the day and, after school was out, she would go home
and then directly to the shop. She would cash out at the end of
the day; send out some invoices; and pay some suppliers. On most
days, she would leave the flower shop between 6:30 and 7:00 p.m.
Ilze worked a full day on Saturday as a floral designer because
some of her staff was off. She did the bookkeeping on Sundays and
worked full-time in the summer. She did not draw a salary or
wages because the operation could not afford it.
[8]
Belonging to the wire services (FTD and Teleflora) was important
for the local delivery of flowers ordered from distant cities and
towns, and for taking local orders for delivery in distant
places. Field representatives from the wire services called and
stopped by regularly to make sure that Wayside Flowers was
maintaining required standards. A flower shop could be suspended
by a wire service. Ilze said that she learned on-the-job. She
also attended floral design workshops put on by wholesalers and
wire services. She entered a competition for floral design and
won in her category. She belonged to the Mission Rotary Club as a
professional florist. George and John belonged to the Abbotsford
Rotary Club where John was identified as "florist".
Ilze said that business came from their participation in Rotary.
It was a form of advertising.
[9] I
am satisfied from the testimony of Ilze that she worked hard at
managing Wayside Flowers and she genuinely tried to make the
operation profitable. Notwithstanding her efforts, Wayside
Flowers was not profitable from 1981 to 1987 when it was
operated by Landmore. Exhibit R-4 is a letter dated
November 12, 1988 from Kenneth P. Wiebe, a certified general
accountant, writing in his capacity as accountant for Landmore.
In his letter, Mr. Wiebe referred to the fact that Landmore had
been losing money consistently since 1982; that such losses
exceeded $100,000; and that Ilze (the "key person"
operating Wayside Flowers) had not received any wage or salary
for a number of years. Mr. Wiebe recommended that Wayside Flowers
be sold to a partnership of participating workers who would
provide personal services, and that the partnership lease the
retail premises from Landmore. George and John (on behalf of
Landmore) accepted Mr. Wiebe's advice. Wayside Flowers was
transferred in 1988 to a partnership comprising George, John and
Ilze. See Exhibit R-7, answer 17.
[10] I
conclude from Mr. Wiebe's letter (Exhibit R-4) that Wayside
Flowers had not enjoyed one profitable year after it was
purchased by Landmore in 1981. The following passages taken from
page two of Mr. Wiebe's letter speak for themselves:
6.
It seemed totally obvious that if any one of the following three
events were to occur, the corporation (i.e. Landmore) would be
forced to declare bankruptcy:
a)
Ilze Shewan would stop working or insist on a fair wage;
b)
The shareholders would stop contributing funds to cover cash
shortfalls.
c)
Ilze & John Shewan would insist on payment of their back
wages.
...
Some of the positive results of our recommendations are
already evident. Although no immediate turn-around in
profitability is evident, the participating partners receive some
of the tax loss benefits incurred in the business.
Meetings were held with the shareholders and a program for the
sale of the business and the operation of the partnership were
concluded. Since the corporation was now relegated to rental
income, the corporation's net income became positive and its
deficit equity is now being reduced. The partnership is still
incurring a loss but eventually expects to become a profitable
business.
[11] Although
Wayside Flowers (as a retail floral outlet) was transferred from
Landmore to the three Appellants as partners in 1988, it
continued to operate at a loss from 1988 right through to the
three years under appeal. Ilze confirmed in her examination for
discovery (Exhibit R-7, answer 19) that, from 1987 to 1995,
Wayside Flowers reported losses as follows:
|
Taxation Year
|
Gross Income
|
Expenses
|
Net Income (Loss)
|
|
1987
|
$65,413.00
|
$89,922.00
|
($24,509.00)
|
|
1988
|
58,425.00
|
90,669.00
|
(32,244.00)
|
|
1989
|
96,346.00
|
131,666.00
|
(35,320.00
|
|
1990
|
130,194.00
|
148,538.00
|
(18,344.00)
|
|
1991
|
134,299.00
|
174,109.00
|
(39,810.00)
|
|
1992
|
124,974.00
|
133,868.85
|
(8,895.75)
|
|
1993
|
95,606.00
|
121,729.40
|
(26,123.40)
|
|
1994
|
87,741.00
|
103,947.38
|
(16,206.38)
|
|
1995
|
74,850.00
|
97,049.80
|
(22,199.80)
|
|
TOTAL
|
$867,848.00
|
$1,091,530.30
|
($223,652.33)
|
The above losses were allocated among the three partners as
follows:
|
Taxation Year
|
George
|
John
|
Ilze
|
Total
|
|
1987
|
($8,188.00)
|
($9,246.00)
|
($7,075.00)
|
($24,509.00)
|
|
1988
|
(8,005.00)
|
(13,210.00)
|
(11,029.00)
|
(32,244.00)
|
|
1989
|
(9,453.00)
|
(14,505.00)
|
(11,362.00)
|
(35,320.00
|
|
1990
|
(3,335.00)
|
(15,010.00)
|
1.00
|
(18,344.00)
|
|
1991
|
(8,976.00)
|
(15,417.00)
|
(15,417.00)
|
(39,810.00)
|
|
1992
|
4,028.89
|
(7,419.90)
|
(5,504.74)
|
(8,895.75)
|
|
1993
|
(4,847.84)
|
(11,551.93)
|
(9,723.63)
|
(26,123.40)
|
|
1994
|
(3,601.68)
|
(6,210.76)
|
(6,393.94)
|
(16,206.38)
|
|
1995
|
(3,249.18)
|
(9,557.21)
|
(9,393.41)
|
(22,199.80)
|
[12] As stated
above, the three years under appeal are 1993, 1994 and 1995. In
those years, each Appellant deducted in computing income his or
her allocated share of partnership loss shown in the above table.
The share of partnership loss deducted by each Appellant was
disallowed as a deduction in the reassessments under appeal on
the basis that Wayside Flowers did not have a reasonable
expectation of profit in any one the years under appeal. In
Moldowan v. The Queen, 77 DTC 5213, Dickson J. wrote
the reasons for judgment for the Supreme Court of Canada and
stated at page 5215:
Although originally disputed, it is now accepted that in order
to have a "source of income" the taxpayer must have a
profit or a reasonable expectation of profit. Source of income,
thus, is an equivalent term to business: ...
There is a vast case literature on what reasonable expectation
of profit means and it is by no means entirely consistent. In my
view, whether a taxpayer has a reasonable expectation of profit
is an objective determination to be made from all of the facts.
The following criteria should be considered: the profit and loss
experience in past years, the taxpayer's training, the
taxpayer's intended course of action, the capability of the
venture as capitalized to show a profit after charging capital
cost allowance. The list is not intended to be exhaustive. The
factors will differ with the nature and extent of the
undertaking: ...
The principle taken from the decision of the Supreme Court in
Moldowan is that a particular activity carried on by a
taxpayer (or a number of taxpayers in partnership) will not be
regarded as a "source of income" or as a
"business" for income tax purposes unless that activity
has a profit or a reasonable expectation of profit.
[13] The
Federal Court of Appeal in Tonn et al v. The Queen, 96 DTC
6001 stated that the "reasonable expectation of profit"
test taken from Moldowan should be applied sparingly when
the circumstances indicated that a business loss was not made for
a personal or non-business motive. The Federal Court of Appeal
seemed to be concerned with a situation which was not purely
commercial - a situation in which the taxpayer claiming the
loss had a personal involvement like renting out part of the
taxpayer's dwelling or renting a future retirement home
"in some balmy southern climate".
[14]
Subsequent decisions of the Federal Court of Appeal have
restricted the application of Tonn. In Attorney General
of Canada v. Mastri, 97 DTC 5420, Robertson J.A. quoted a
lengthy passage from Tonn and then stated at page
5423:
... It is simply unreasonable to posit that the Court
intended to establish a rule of law to the effect that, even
though there was no reasonable expectation of profit, losses are
deductible from other income sources unless, for example, the
income earning activity involved a personal element. The
reference to the Moldowan test being applied
"sparingly" is not intended as a rule of law, but as a
common-sense guideline for the judges of the Tax Court. In other
words, the term "sparingly" was meant to convey the
understanding that in cases, for example, where there is no
personal element the judge should apply the reasonable
expectation of profit test less assiduously than he or she might
do if such a factor were present. It is in this sense that the
Court in Tonn cautioned against
"second-guessing" the business decisions of taxpayers.
...
Similarly, in Stewart v. The Queen, 2000 DTC 6163,
Rothstein J.A. stated at page 6164:
It is argued by the appellant that Moldowan has no
application unless the particular activity or property has an
element of personal use. We do not think Moldowan is
necessarily so limited. The Moldowan principle is that in
order to have a source of income, the taxpayer must have a profit
or a reasonable expectation of profit. No subsequent Supreme
Court authority has altered the Moldowan principle.
[15] Following
the decisions of the Federal Court of Appeal in Tonn,
Mastri and Stewart, I think it is still good law to
ask whether a particular activity has a reasonable expectation of
profit. This is what Dickson J. (as he then was) described as
"an objective determination" (Moldowan, page
5215). When a trial judge in this Court determines that a
particular activity does not have a reasonable expectation of
profit, and that the taxpayer does not have a personal
involvement in the activity, the Federal Court of Appeal is
concerned that the trial judge not "second-guess" the
business judgment of the taxpayer. This is particularly important
when losses have been disallowed in the first years of the
taxpayer's operation of the activity, as was the case in
Tonn. In my opinion, however, it is less important when
the activity has a long history of losses prior to the years in
dispute when certain losses have been disallowed.
[16] Having
regard to all of the evidence, I conclude that Wayside Flowers,
as a retail floral outlet, did not have a reasonable expectation
of profit at any time in 1993, 1994 or 1995. The first table in
paragraph 11 above shows that Wayside Flowers accumulated
aggregate losses of $223,652 over a nine-year period ending with
the three years under appeal. That is an average loss of
approximately $25,000 per year in circumstances when the manager
(Ilze) was not paid any salary or wages. In Moldowan,
Dickson J. referred to "the profit and loss experience in
past years". The years under appeal are not the first years
of ownership as in Tonn. Indeed, the Appellants did not
start Wayside Flowers from scratch but purchased it as a long
established business. The Appellants led evidence to show that
they were earnest in their endeavours but they did not lead any
evidence to show how they could turn Wayside Flowers around in
1993, 1994 or 1995 after such a long and consistent history of
losses. According to Ilze, Wayside Flowers was closed down in
1997 or 1998.
[17] Returning
to Mr. Wiebe's letter of November 12, 1988 (Exhibit R-4), I
conclude that Wayside Flowers had no reasonable expectation of
profit even in 1988 because (i) there were prior losses back to
1982 which could have been carried forward and applied against
future profits if earned in a reasonable number of years; (ii)
instead of relying on the carry forward of prior losses, the
losing enterprise was transferred to the three Appellants as
partners; and (iii) if Ilze (the "key person" in
Wayside) had stopped working or insisted on a fair wage, Landmore
would have been bankrupt. It appears that there was not a
profitable activity (i.e. Wayside) to sell in order to avoid
insolvency.
[18] There is
no obvious personal involvement of any particular Appellant in
the commercial activity of Wayside Flowers but there are two
circumstances which disturb me. First, Ilze stated in her
examination for discovery that there was a partnership agreement
(Exhibit R-7, answer 39) but no copy of that agreement was
entered in evidence. One of the important purposes of any
partnership agreement is to define the way in which a partnership
profit or loss will be shared and allocated among the partners.
Looking at the second table in paragraph 11 above, I cannot find
any consistency in the way that losses are allocated. See for
example 1990 when a loss of $18,344 was allocated exclusively to
George and John. See also 1992 when a loss of $8,895 was expanded
to $12,923 and allocated to John and Ilze when George reported a
profit of $4,028 to bring the net loss back down to $8,895. In
1994, Ilze's allocated loss was a little greater than
John's but, in 1995, John's allocated loss was a little
greater than Ilze's. The allocation of losses seems
arbitrary.
[19] The
second circumstance which disturbs me is the fact that the
partnership (Wayside Flowers) paid rent to Landmore to help pay
down the mortgage on the original retail site purchased in 1981.
Also, Exhibit A-10 is a series of documents describing a
transaction in 1991 when the three Appellants purchased a
property in Mission, B.C. identified as 7057-7059 Mershon Street.
The Notice of Appeal for each Appellant indicates that cash was
"diverted" out of Wayside Flowers to pay off the
mortgage on Mershon Street. Paragraph 2 of the Notice of Appeal
states in part:
2.
... That Revenue Canada reviewed nine years of operation in
isolation of other monetary facts of the operation of Wayside
Flowers such as the acquisition of property in anticipation of
the future growth and eventual expansion of the Mission retail
town centre to the "waterfront development area". That
this property acquisition decision by the Appellant diverted from
cash flow of Wayside Flowers the sum of $1,000 per month ($12,000
per annum) towards the servicing of the property purchase
mortgage of the subject property. That this cash flow, if not
diverted, would have produced a significant taxable profit of the
operations of Wayside Flowers for the years under review.
In other words, there may have been what Tonn referred
to as a "personal element" in the operation of Wayside
Flowers. The partners may have been using cash from Wayside in
the guise of rent to Landmore in order to pay down the purchase
price of a real property investment. There was an obligation on
the Appellants to prove that losses were not being inflicted on
Wayside Flowers in order to permit the financing of a real estate
purchase outside the partnership. That obligation was not
discharged.
[20] The
appeals are dismissed, with costs. Because the pleadings are
almost identical, and the appeals were heard on common evidence,
costs will be determined as if there were only one appeal.
Signed at Ottawa, Canada, this 10th day of July, 2001.
"M.A. Mogan"
J.T.C.C.
COURT FILE
NOS:
98-2779(IT)G, 98-2781(IT)G and 98-2783(IT)G
STYLE OF
CAUSE:
George W. Peary, John W. Shewan and
Ilze Shewan
PLACE OF
HEARING:
Vancouver, British Columbia
DATE OF
HEARING:
July 12, 2000
REASONS FOR JUDGMENT BY: The
Honourable Judge M.A. Mogan
DATE OF
JUDGMENT:
July 10, 2001
APPEARANCES:
Agent for the
Appellants:
John W. Shewan
Counsel for the
Respondent:
Lisa MacDonell
COUNSEL OF RECORD:
For the
Appellants:
Name:
N/A
Firm:
For the
Respondent:
Morris Rosenberg
Deputy Attorney General of Canada
Ottawa, Canada
98-2779(IT)G
BETWEEN:
GEORGE W. PEARY,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
Appeals heard on common evidence with the
appeals of John W. Shewan (98-2781(IT)G) and Ilze
Shewan (98-2783)(IT)G), on July 12, 2000,
at Vancouver, British Columbia, by
the Honourable Judge M.A. Mogan
Appearances
Agent for the
Appellant:
John W. Shewan
Counsel for the
Respondent:
Lisa MacDonell
JUDGMENT
The
appeals from assessments of tax made under the Income Tax
Act for the 1993, 1994 and 1995 taxation years are dismissed,
with costs.
Signed at Ottawa, Canada, this 10th day of July, 2001.
J.T.C.C.
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