Simoneau v. The Queen, docket 97-1830-IT-G

Date: 19990728

Dockets: 97-1830-IT-G; 98-2419-IT-G

BETWEEN:

NOËLLA SIMONEAU,

Appellant,

and

HER MAJESTY THE QUEEN,

Respondent.

Reasons for Judgment

Dussault, J.T.C.C.

[1] These two cases concern appeals from income tax assessments made by the Minister of National Revenue (the "Minister") for the appellant's 1992, 1993, 1994, 1995 and 1996 taxation years.

[2] The appellant is a physician and anesthetist who lives and practises in Rivière-du-Loup, Quebec. She is married to Henri Alcaraz, who has two sons, Philippe and Jean.

[3] The appellant owns a piece of land in St-Adelphe near Trois-Rivières, Quebec, on which she has operated an evergreen tree plantation (the "plantation") since 1987. During the years in issue, her spouse and his sons performed the required work on the plantation.

[4] In addition, since 1984, the appellant has sold trees, shrubs and plants and performed earthwork in the summer and snow removal in the winter in the Québec region under the firm name "Centre Jardin Montchatel enr." ("Montchatel"). The operations managed by the appellant's spouse were carried on from a lot in Loretteville, Quebec, purchased by the appellant in 1983. In 1997, the activities were moved to a leased lot in St-Augustin-de-Desmaures closer to Québec.

Points at Issue

[5] Four questions arising from the aforementioned assessments were initially at issue. First, the appellant disputed the Minister's refusal to allow her a deduction of $29,700 in respect of "management fees" paid to her spouse in computing her professional income for her 1992 taxation year. The appellant now admits that these fees were related to the management of Montchatel and that they should be deducted in computing the income from Montchatel's operations. This has the effect of increasing by that same amount Montchatel's loss of $94,416 claimed by the appellant and disallowed by the Minister for that same taxation year on the ground that the appellant did not have a reasonable expectation of profit from those operations. As a result, the loss disallowed in this respect would amount to $124,116, instead of $94,416, for the appellant's 1992 taxation year.

[6] The second point at issue was the Minister's refusal to allow the appellant a deduction of $11,503 in respect of professional dues for the 1994 taxation year. Counsel for the respondent agreed that this amount could be deducted in computing the appellant's income for her 1995 taxation year. Consequently, the assessment for that year will have to be referred back to the Minister for reconsideration and reassessment on the basis that the appellant may deduct this amount of $11,503 for the 1995 taxation year.

[7] The third issue was farm losses claimed in respect of the plantation for the years in issue. By the assessments for those years, the Minister denied the appellant a full deduction of the losses incurred by treating them as provided for in section 31 of the Income Tax Act (the "Act"). The appellant no longer disputes this decision.

[8] Lastly, the fourth question and the sole point still at issue, is the Minister's refusal to grant the appellant a deduction for losses from Montchatel's operations in computing her income for each of the years from 1992 to 1996 inclusive on the ground that she did not have a reasonable expectation of earning a profit from those operations.

Summary of the Evidence

[9] Montchatel's operations commenced in 1982 or 1983 with the purchase of a lot in Loretteville for which the appellant paid the sum of $48,000. Paragraph 11.cc. of the Reply to the Notice of Appeal (docket 97-1830(IT)G) states that the lot was purchased from a financial institution which had seized it after the appellant's brother-in-law, Jules Alcaraz, declared bankruptcy. The appellant's spouse, Henri Alcaraz, has managed Montchatel's operations from the very beginning.

[10] Since 1984, the appellant has claimed significant losses from these operations, and they were allowed by the Minister for the years from 1984 to 1991 inclusive. However, no figures were provided respecting the taxation years prior to 1988.

[11] By way of an overview of the situation in the last 10 years for which returns of income were filed, that is, from 1988 to 1997, the following table shows, for each of those years, first, in column 1, the appellant's net professional income, then, in column 2, losses claimed in respect of Montchatel's operations and, lastly, in column 3, gross income from Montchatel's operations. Amounts representing Montchatel's total annual expenses and capital cost allowance claimed for each year are indicated in column 4. The figures in this column are simply the totals of the amounts entered in columns 2 and 3.[1]

	(1)	(2)	(3)	(4)
Year	Professional inc. (net)	Montchatel loss (net)	Montchatel revenue (gross)	Montchatel expenses and depreciation
1988	$113,107	($106,825)	$34,984	$141,809
1989	$125,810	($121,495)	$16,041	$137,536
1990	$88,244	($80,832)	$32,129	$112,961
1991	$94,691	($80,438)	$38,076	$118,514
Years é1992	$148,9401	($124,116)1	$63,723	$187,8391
½1993	$147,390	($99,415)	$50,151	$149,566
in ½1994	$163,3202	($123,402)	$47,155	$170,557
½1995	$159,6702	($89,425)	$71,151	$160,576
issue ë1996	$164,550	($72,084)	$82,021	$154,105
1997	$186,145	($55,977)	$74,382	$130,359
Total	$1,391,867	($954,009)	$509,813	$1,463,822

¹ After the adjustment of $29,700 referred to in paragraph [5] above.

² Professional income for 1994 should be increased by $11,503 and that for 1995 reduced by the same amount as a result of the adjustment referred to in paragraph [6] above.

[12] These figures are troubling to say the least, and I shall return to them below.

[13] Henri Alcaraz and the appellant testified. France Côté, an auditor with Revenue Canada in 1995 and 1996, testified for the respondent.

[14] Mr. Alcaraz, who has managed the operations of Montchatel since its inception in 1983 or 1984, is a farmer's son and testified that he had farming experience as a result of having worked, in particular, for the Department of Agriculture and for the CIL company in the agricultural sector. He also said he had snow removal experience going back to 1975. As stated above, Montchatel's operations began with the purchase of the lot in Loretteville, for which a $50,000 loan had to be taken out. In 1984, the appellant obtained a $60,000 line of credit, half of which was used to finance Montchatel's operations. She then took out other loans up to the amount of $70,000 which were secured by a mortgage on her home in Rivière-du-Loup. No repayment of the principal of the initial loan or of the line of credit was made; interest only was paid each year. The lot has not been used for Montchatel's operations since 1997 and is leased to a shopping centre, which is supposed to purchase it in 2002, which, Mr. Alcaraz said, will make it possible to repay the debts. A capital gain of $56,883 on the lot was crystallized and a capital gains deduction of an equal amount was claimed in 1994. The rent of $5,000 a year is used to repay a portion of the interest on the appellant's debts. The tenant is responsible for paying the property taxes.

[15] Montchatel's operations were quite varied from the outset and evolved and changed over the years. It is difficult, if not impossible, to discern any real business plan for the operation or any specific direction which the appellant and her spouse actually intended to take.

[16] At first, the operations mainly consisted of the retail sale of garden plants and shrubs and the performance of residential earthwork by Mr. Alcaraz. In the winter, Mr. Alcaraz used the purchased equipment, including a tractor, to do snow removal.

[17] Starting in 1983, an attempt was also made to cultivate sweet potatoes. Despite an abundant harvest, the venture met with little success as there was no warehouse and there were difficulties in selling the harvest on the market. And yet the crop continued to be grown until 1987, and buckwheat was even added. These crops were then abandoned as, the appellant said, she wanted to redirect operations toward the cultivation of potted plants in order to supplement the earthwork operations which intensified starting in 1988.

[18] In 1988 and 1989, new loans were taken out and new investments made in machinery and equipment, in particular the purchase of tractors. Used snowblowers were also acquired for the snow removal operations. As to summer activities, both the appellant and Mr. Alcaraz testified that the entry of superstores into the retail plant and shrub market resulted in a net reduction of Montchatel's operations in this area such that, in subsequent summers, the emphasis was placed more on earthwork than on plant and shrub sales. For the winter season, an attempt was made to develop the snow removal clientele, without much success. According to the appellant, commercial snow removal, in particular for apartment buildings, was not profitable and required too much effort for the price that could be charged. Both the appellant and Mr. Alcaraz also mentioned high interest expense and major repairs to used machinery and equipment as causes of the difficult financial situation and the lack of room to manoeuvre until 1990.

[19] From 1990 to 1994, the emphasis was apparently placed on earthwork, an activity which the appellant herself said they were never able to make profitable. Many reasons were given for this lack of profitability. The appellant mentioned first that the contracts were fixed-price contracts generally awarded to the lowest bidder. She then spoke of high labour costs and the vagaries of the weather. In addition, from my understanding of her testimony, the frequent travel required to perform small earthwork contracts also helped increase costs. Mr. Alcaraz stated that half of the earthwork business consisted in the sale of products the cost of which could not be controlled, and half in the supply of labour which was very costly. High interest rates and hard economic times were also mentioned. Problems related to competition from persons working simply [TRANSLATION] "with a pick and a wheelbarrow", as was said, and difficulties caused by the implementation of the goods and services tax ("GST") and the exemption granted to small manufacturers were also cited as contributing to this operation's lack of profitability. And yet they carried on in the same way. Thus, according to the appellant, an attempt was made in 1995 to obtain larger earthwork contracts and more staff was hired. A certain Jean Hamel was even hired specifically to solicit contracts, but the experiment did not prove productive and he left in July. The business nevertheless continued its earthwork operations in 1996, while at the same time reducing labour costs, it was said. It continued to increase its snow removal operations in winter.

[20] Mr. Alcaraz emphasized that, unlike earthwork, snow removal [TRANSLATION] "required minimum labour and more machinery". However, here again, the appellant and her spouse described difficulties that would explain why there were no profits until 1998. First, some of the machinery was inappropriate for removing snow from small surfaces and some used tractors required frequent and costly repairs. In addition, a number of snowblowers attached to the tractors were of poor quality and soon rusted. In short, the tractors and snowblowers gradually had to be replaced with more recent, more suitable and higher quality machinery and equipment so the work could be done more quickly and effectively. Mr. Alcaraz testified that the move to a new place of business in St-Augustin-de-Desmaures in 1997 and the increase in and concentration of clientele also helped to enhance efficiency and ensure profitability starting in 1998. The appellant thus said that there had been a genuine expectation of profit since 1996 and 1997. She testified that Montchatel's visibility in the snow removal field improved and its clientele increased sharply from 450 customers in 1996 to 650 in 1997 and 850 in 1998. In 1990 and before, excluding commercial customers, the number of customers was only 100 to 150. It stabilized at approximately 250 in the following years. According to Mr. Alcaraz, competition in residential snow removal is enormous, to the point where, apparently, 400 businesses appear every year but 400 also disappear. No details were given as to the territory to which these figures applied.

[21] In 1994, Mr. Alcaraz contacted Société Extrapolation Téléphonique 2000 Inc. ("ET 2000") in the hope of increasing the snow removal clientele (see Exhibit A-1), but this measure did not yield the results he had hoped for.

[22] Consequently, after what the appellant described as a failed attempt, a new effort was made in 1996 which consisted of hiring students to deliver advertising door to door in the Ste-Foy, Cap Rouge, Sillery and St-Augustin-de-Desmaures areas. In 1997, the experience was repeated with the distribution of 8,000 to 10,000 advertising flyers. Then, in 1998, the company turned to distribution by "Publi-sac".

[23] Both the appellant and her spouse, Mr. Alcaraz, believe that Montchatel has now become profitable through constant effort and investment over a 15-year period during which they had to live away from one another for the ultimate purpose of developing a business from which they hoped from the outset to eventually earn profits. During that period, Mr. Alcaraz lived in a trailer placed inside a greenhouse on the lot from which Montchatel was operated.

[24] They said that the sale of the lot in 2002 will also enable them to repay debts the interest on which has had a significant impact on the bottom line. For 1997, the operating loss was $197 before depreciation and $55,976 after depreciation. For 1998, profit was reported as $37,802 before depreciation and $9,802 after depreciation (see Exhibit A-2, pages 2 and 3). Mr. Alcaraz affirmed that 1999 promised to be a very good year.

[25] With respect to the snow removal operation, it is important to point out that Mr. Alcaraz and his two sons, Philippe and Jean, each started up a new business in the same field in 1997. For that purpose, Philippe and Jean Alcaraz each leased a tractor from the appellant, while Henri Alcaraz leased a tractor from a third party. He explained that his sons had worked for Montchatel in previous years and had decided at that time to work for themselves. The payroll journals indeed indicate that Philippe and Jean Alcaraz worked for Montchatel during each of the years in issue. Henri Alcaraz received no salary from Montchatel in 1995 or 1996. He said that he began snow removal operations in his own name in 1997 because he was pushed into it by Revenue Canada, which did not want his wife to pay him a salary. He said that the customers of the business he started up and those of his sons are not the same as those of Montchatel.

[26] Mr. Alcaraz's business is operated from a leased lot adjacent to that leased by Montchatel in St-Augustin-de-Desmaures. In 1997, Mr. Alcaraz reported gross income of $14,372.09 and net income of $8,994.07 from this activity (see Exhibit I-3). However, it was noted that tractor rental expenses do not appear in the income statements filed. I will simply state here that the splitting of snow removal operations will undoubtedly not enhance Montchatel's prospects for profitability.

[27] It is important to note that, in cross-examination, the appellant obviously admitted that the significant losses claimed had the effect of reducing her professional income by the same amounts each year.

[28] France Côté of Revenue Canada testified as to her audit of Montchatel's operations for the 1992, 1993 and 1994 taxation years. The audit was conducted in 1995 and 1996. She said she was satisfied that the reported income and expenses claimed were in order. She also stated that she had had some difficulty conducting the audit since the income statement for the plantation also included snow removal income. It should also be noted that a single payroll journal was used for Montchatel and the plantation. However, she concluded that Montchatel's operations were not carried on with a reasonable expectation of profit during the years dealt with in her audit, particularly since she felt that the business had been given a chance in that the Department had allowed the deduction of losses from 1984 to 1991 inclusive.

[29] Ms. Côté emphasized the size of the losses claimed over the years and the fact that they appeared to be mainly caused by the salaries paid and machinery repair costs. In a conversation they had had, Mr. Alcaraz had not told her of any recovery plan for the years in issue, except as regards the eventual sale of the lot in Loretteville and the fact that he intended to stop earthwork operations.

[30] In April 1996, Ms. Côté met the appellant and Mr. Alcaraz to provide them with a preliminary assessment. Carol Lévesque, Ms. Côté's team leader, also attended the meeting. On this occasion, Mr. Alcaraz emphasized the high interest and labour expenses and expressed his intention to abandon earthwork operations in the summer. As for wages, he stated that there was one employee, a Mr. Hayet, he could not do without and that he also employed his sons. Ms. Côté said she again noted that wages were high and were still being paid year-round. She also stated that again she had discerned no real recovery plan to increase gross revenue and reduce expenses. Mr. Alcaraz told her that he did not advertise or solicit, although he mentioned a telephone survey conducted by ET 2000. This survey, mentioned above, was conducted in 1994. During the meeting, the sale of the land and the intent to halt the unprofitable summer operations were once again mentioned. Mr. Alcaraz said as well that he intended to increase snow removal activities in winter thanks to his son Philippe, whom he described as a [TRANSLATION] "good salesman". However, Mr. Alcaraz also mentioned that each of his sons intended to start up a snow removal business and that they would in that case have a [TRANSLATION] "cooperative garage" with Montchatel. Ms. Côté said she wondered how creating two new businesses could be a positive factor for Montchatel and observed that, if Philippe started up his own business, it was unclear how he could then expand Montchatel's clientele. She further emphasized that this clientele, which they wanted to increase through Philippe's efforts, had not expanded while he was working for Montchatel.

[31] In completing my summary of Ms. Côté's testimony, I would emphasize that she also referred to the matter of unused machinery which the appellant did not want to sell, preferring [TRANSLATION] "to let it rust in a field". At the hearing, the appellant explained that this was not the case, that the machinery in question was a tractor purchased at the start of operations and that it was poorly suited to residential snow removal work. She said that she had tried to sell it a number of times, but without success, and that Mr. Alcaraz still used it from time to time.

Appellant's Position

[32] Counsel for the appellant emphasized that the appellant definitely had a business plan for Montchatel's operations, although it was not in writing. She reminded the Court of the efforts and investment the appellant and her spouse had described and she emphasized the fact that the plan was moreover submitted to Ms. Côté at the April 1996 meeting. The plan then was to increase the snow removal clientele and reduce labour costs by discontinuing summer work in future. At the same time, the sale of the Loretteville lot had been planned and that sale was to enable them to reduce debt. As regards efforts to expand clientele, counsel for the appellant noted the telephone survey and the advertising done in subsequent years. Counsel also mentioned what she thought were the causes of the repeated losses, namely increased interest rates, the introduction of the GST, clandestine work and competition in Montchatel's fields of operation. She concluded by saying that the unfavourable economic situation was the main reason why it took so many years to make a profit. She contended that the appellant had finally managed to do so, which, she said, demonstrated that the appellant had a genuine business plan and a reasonable expectation of profit. In support of her arguments, counsel for the appellant referred in particular to the decisions in Moldowan v. The Queen, [1978] 1 S.C.R. 480; Cook v. M.N.R., 85 DTC 167; Howland v. M.N.R., 87 DTC 186; Carpenter v. M.N.R., 87 DTC 331; Landry v. The Queen, 94 DTC 6624;Tonn et al. v. The Queen, 96 DTC 6001; Mastri v. Canada, [1998] 1 F.C. 66.

Respondent's Position

[33] Counsel for the respondent relied on the decisions in Moldowan, Tonn, Mastri and Landry,supra, and on my decision in Audet v. Her Majesty the Queen (an unreported decision of February 26, 1999, docket 97-2417(IT)G).[2] Relying mainly on the tests stated in the Federal Court of Appeal's decision in Landry, supra, she contended that the appellant had no reasonable expectation of making a profit from Montchatel's operations.

[34] Counsel for the respondent began by emphasizing that the appellant did not make a profit from 1984 to 1997. On the contrary, she said, she incurred considerable losses over a 14-year period from Montchatel's operations, which would not have been carried on for such a long period of time if there had not been the possibility of reducing her professional income by the amount of the losses each year. Counsel noted that a commercial undertaking could not have operated this way year after year without significant corrective action being taken. She also pointed out that, despite the heavy losses incurred in previous years, the number of tractors was nevertheless increased in 1989 and 1990 without conducting a market study or revenue impact analysis. In her view, the existence of a permanent debt that had remained unpaid since 1984 and the fixed costs which it generated as well as the major repairs required by the machinery in poor condition meant that the necessary ingredients for making a profit were simply not present.

[35] Counsel for the respondent stressed the lack of planning in the multiple activities carried on from the outset, since farming, earthwork and snow removal were tried simultaneously, without any effort to analyze the negative impact that these activities might have on each other. Counsel for the respondent emphasized more particularly here the continuation of earthwork operations at the end of the season which prevented any increase in the number of snow removal contracts. She added that the appellant had had her chance since the Department had allowed the losses claimed from 1984 to 1991. Counsel also emphasized that there was no business plan, written or otherwise, indicating a specific structure or direction which might have ensured the profitability of the investments made, despite competition and other factors that might affect performance. According to counsel, what was described as a lack of structure at all levels caused the losses, extremely heavy in relation to the appellant's professional income, incurred since 1984. These losses can only be explained by the fact that there was a tax benefit to be derived by the appellant from being able to deduct them from her professional income year after year. The appellant was aware of this benefit from the outset and that is what induced her to continue.

[36] In short, counsel for the respondent argued that the appellant did not meet any of the tests stated by the Federal Court of Appeal in Landry, supra, and that she therefore had no reasonable expectation of profit from Montchatel's operations during the years in issue, that is, from 1992 to 1996 inclusive. She further pointed out that the time and energy devoted to an activity are not on their own sufficient to transform that activity into a business.

Analysis

[37] It is well known that the question of whether there is a reasonable expectation of profit from a given activity must be determined on the basis of the tests developed in the case law over the past 20 years or more, and the Supreme Court of Canada's decision in Moldowan, supra, provides the starting point, as it were, for this purpose. In recent years, the Federal Court of Appeal has elaborated on the relevant tests and their application in various situations. The decisions in Landry, Tonn and Mastri, supra, and in Mohammad v. Canada, [1998] 1 F.C. 165 address the applicable principles. Although I do not intend to conduct a detailed analysis of these decisions, certain elements appear to me to be more relevant to the outcome of the instant case and should be emphasized.

[38] I admit from the outset that activities like those carried on by Montchatel, such as the sale of plants and shrubs, earthwork and snow removal are commercial activities likely to generate a profit despite competition and the other components of the economy at any given period. The economic situation is a reality which no one can escape and which must normally be considered, as far as possible, by anyone starting up a business with a reasonable expectation of subsequently making a profit from it. I use the word "subsequently" since it is well known that certain activities can reasonably be expected to require a longer start-up period than others before they can become profitable. The specific circumstances of each situation must obviously be considered.

[39] These introductory remarks lead me directly to the words of Dickson J. of the Supreme Court of Canada in Moldowan, supra, who states at page 485 of that judgment:

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: Dorfman v. M.N.R.²

_______________________________

² [1972] C.T.C. 151.

Further on Dickson J. adds:

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 Queen v. Matthews³.

________________________________

³ (1974), 74 D.T.C. 6193.

[40] In Landry, supra, Décary J.A. of the Federal Court of Appeal emphasizes the fact that the factors identified by Dickson J. are not exhaustive and will vary with the nature and extent of the undertaking. He continues at page 6625, saying:

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.

[41] Then, referring to a number of decisions, Décary J.A. enumerates at page 6626 the tests used by the courts over the years, as follows:

Apart from the tests set out by Mr. Justice Dickson, the tests that have been applied in the case law to date in order to determine whether there was a reasonable expectation of profit include the following: the time required to make an activity of this nature profitable, the presence of the necessary ingredients for profits ultimately to be earned, the profit and loss situation for the years subsequent to the years in issue, the number of consecutive years during which losses were incurred, the increase in expenses and decrease in income in the course of the relevant periods, the persistence of the factors causing the losses, the absence of planning, and failure to adjust. Moreover, it is apparent from these decisions that the taxpayer's good faith and reputation, the quality of the results obtained and the time and energy devoted are not in themselves sufficient to turn the activity carried on into a business.⁵

(Footnote omitted.)

[42] Moreover, in Tonn, supra, the Federal Court of Appeal pointed out the following at pages 6012 and 6013:

The primary use of Moldowan as an objective test, therefore, is the prevention of inappropriate reductions in tax; it is not intended as a vehicle for the wholesale judicial second-guessing of business judgments. . . . Errors in business judgment, unless the Act stipulates otherwise, do not prohibit one from claiming deductions for losses arising from those errors. . . . [T]he Moldowan test should be applied sparingly where a taxpayer's "business judgment" is involved, where no personal element is in evidence, and where the extent of the deductions claimed are not on their face questionable. However, where circumstances suggest that a personal or other-than-business motivation existed, or where the expectation of profit was so unreasonable as to raise a suspicion, the taxpayer will be called upon to justify objectively that the operation was in fact a business. . . .

...[A] detailed look at the business in the context of its operations is what is required, and that reasonableness is to be assessed on the basis of all the relevant factors.

(My emphasis.)

[43] In Mastri, supra, the Federal Court of Appeal clarified the meaning of above remarks as follows at pages 67 and 68:

Tonn did not intend to establish a rule of law to the effect that even though there is 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 in Tonn to the Moldowan test being applied sparingly was intended as a common sense guideline for the Tax Court. "Sparingly" was meant to convey the understanding that in cases where, for example, there is no personal element, the judge should apply the reasonable expectation of profit test less assiduously than if such a factor were present.

[44] In this case, the appellant incurred major losses from Montchatel's operations in the eight consecutive years from 1984 to 1991. Deductions were allowed in respect of her losses. The appellant now claims a deduction for losses totalling $508,442 for the period from 1992 to 1996. The evidence adduced also shows a loss for 1997. In 1998, the operations apparently generated a slim profit after depreciation. Objectively speaking, I believe one can no longer refer to the years in issue as a start-up period and that special importance should be attached to the structure of the activities themselves or to certain specific factors that may explain the total lack of profitability over a 14-year period. The explanations provided by the appellant and her spouse, Mr. Alcaraz, as to the causes of their lack of success must of course be considered. However, I find that the reasons given only partly explain the disastrous results achieved.

[45] In the first place, the Court is surprised to observe that, after a number of years of losses, the appellant and her spouse, who managed Montchatel's operations, did not consider continuing these operations during years in issue in a more systematic fashion, implementing a genuine business plan that could bring about the necessary corrective action or at the very least provide elements of solutions planned in an orderly way based on an analysis of the probable causes of the difficulties that had arisen. Yet for 1991 we note not only that the operations were not profitable after eight years, but that the loss claimed was still more than twice the gross revenue generated, which makes one wonder. This is all the more striking when one considers that the situation remained virtually the same over the following three years (see the table in paragraph 11 above). The situation was alarming long before the years in issue and should have demanded major corrective action. And yet, despite the experience Mr. Alcaraz said he had, his testimony gives the distinct impression that Montchatel's operations were not managed in a very disciplined manner based on planned objectives. One senses that they were planned on a very short-term basis and in reaction to events. Apart from this aspect, the information presented, if it accurately reflects the actual situation, might also lead one to suppose that other objectives than that of making a profit may have been pursued, which might have had an impact on Montchatel's performance.

[46] The parties filed voluminous documentary evidence. Some documents merit more thorough examination than they received at the hearing. Let us therefore examine certain figures a bit more closely. While the losses claimed by the appellant for the five years in issue amount to $508,442, one notes first that the losses before depreciation were $271,258, which means average losses before depreciation of more than $54,000 annually, compared to average gross revenue of $62,840 during those years.[3]

[47] With respect to expenses, it may be seen that interest and financial expenses amounted to $75,437.33 (Exhibit A-2, page 1) during the same period and thus represented 24% of the reported total gross revenue of $314,201 for the period. It was adduced in evidence that these expenses consisted of interest on debts incurred in large part at the start of Montchatel's operations, in particular to purchase the lot, and that the principal amount of these debts was never repaid. While it can be said that the interest expense was high, one surely cannot invoke high interest rates or indeed large increases in interest rates from 1992 to 1996 to justify a lack of performance. The interest expense was high because the total debt had been high from the outset and the situation was never corrected. The appellant was simply counting on selling the lot in Loretteville in 2002 to repay the debt. There is no need to discuss at length the effect that high financing charges can have on potential return. However, the impact of other factors must still be analyzed.

[48] Another expense item often referred to in the testimony is wages. During the period in issue, wages amounted to $218,212 (see Exhibit A-2),[4] that is, more than 69% of gross revenue generated. That figure breaks down as follows for the years in issue:

Year Revenue Wages

1992 $63,723 $64,638

1993 $50,151 $23,639

1994 $47,155 $43,876

1995 $71,151 $54,134

1996 $82,021 $31,924

[49] Here again, it goes without saying that these wage levels were not such as would permit any expectation of profit either during those years. The years 1992 and 1994 are particularly noteworthy in this regard.

[50] In their testimony, the appellant and her spouse, Henri Alcaraz, placed considerable emphasis on the fact that labour costs were particularly high for the earthwork operations and much less so for snow removal.

[51] While we note a significant progression in revenue from snow removal between 1991 and 1996—they went from $16,049.83 in 1991 to $65,031.74 in 1996—no pronounced variation can been seen in revenue from summer operations, which ranged from approximately $16,500 to about $22,000 a year over the same period.[5] Thus, to the extent that summer operations were relatively stable during the period in issue, it is hard to understand how labour costs could have been appreciably reduced over that period.

[52] In Exhibit A-2 filed in evidence, the appellant shows revenue of $74,381.96 for 1997 and wages paid of approximately $7,000. For 1998, she shows revenue of $124,773 and approximately $10,000 in wages paid. Thus it may be seen that the wages amounted to only 8.5% of revenue for those two years. This is a remarkable turnaround in the situation, far removed from the average 69% of revenue for the five years in issue, and more particularly 1992 when wages exceeded revenue, and 1994, when they represented 93% of earned revenue. This sudden efficiency seems suspect at first glance, and one wonders how, in 1998, the business could have served the 850 snow removal customers the appellant said she had in addition to doing the other work required, while paying only $10,000 in wages to the operators of the 10 or 12 tractors used, according to the evidence presented, by Montchatel in that year. However, this is not the question I must answer, and I now return to the issue at hand.

[53] If correct, these figures provided by the appellant herself reflect a radical change in procedure starting in 1997 and strikingly show that an abnormal situation prevailed during the previous years, more particularly during the period in issue. In fact, the figures entered in the payroll journal for the years in issue raise more questions than they provide answers.[6]

[54] First, it is in evidence that there was only one payroll journal for recording the remuneration paid to employees for the work performed for Montchatel and for the plantation, whereas it was admitted that these were two separate operations. Moreover, the appellant produced a separate income statement for each of the years. As the auditor Ms. Côté noted in her testimony, some confusion was caused by the fact that revenue from snow removal was also reported in relation to the plantation operations. In addition, in my view, keeping only one payroll journal for the two operations, in which were entered only weekly wages paid and deductions, where applicable, is utterly unacceptable and is also likely to create confusion since there is nothing on which an adequate audit can be based.

[55] Second, I must note the significant discrepancies in the wages paid to certain employees for various periods each year, which seem hard to reconcile with the work they were supposed to have done. For example, Henri Hayet, who Henri Alcaraz said worked as a mechanic, mainly in winter, was paid a salary of $500 a week from January to April 1992. From May to December of that same year, his salary was only $70 a week. Roughly the same variation appears for 1993. In 1994, Mr. Hayet received a salary of $500 a week from mid-January until July, and it is indicated that his employment was terminated on July 10. He received remuneration of only $70 a week from September to December 1994 and he continued to receive that amount in January 1995. Then, from February to early July, with it being indicated that his employment was terminated on July 7, his remuneration was increased again to $500 a week. In October, it fell again to $70 a week until the end of December. In 1996, the remuneration level of $70 a week was, in defiance of all logic, maintained in January and February. From March until mid-August, with it being indicated that his employment was terminated on August 12, his remuneration was once more increased to $500 a week. It is in evidence that most of the tractors were mainly used in winter, for snow removal, and that the mechanic's services were mainly required during that time of the year. Mr. Hayet's mode of remuneration is utterly incomprehensible, having regard to the explanations provided, and points rather in another direction.

[56] I take as a second example Jean Alcaraz, one of the sons of the appellant's spouse. In 1992, his remuneration was $70 a week from January until mid-June, when it was increased to $500 until October 17, then reduced again to $70 in November and December. In 1993, virtually the same variations can be observed. The situation was different in 1994: his remuneration was $60 a week from January to May, then raised again to $500 a week from early August until Christmas. In 1995, the remuneration indicated was $60 a week from the end of April until early May. It then rose to $500 a week from mid-June until mid-October, then was reduced to $63 a week from mid-November until the end of December. In 1996, this salary of $63 a week was maintained until the beginning of April.

[57] The third example concerns Philippe Alcaraz, the other son of the appellant's spouse. For 1992, his recorded remuneration was $270 a week from mid-June until mid-November. In 1993, it was $280 a week from the end of May until early November. In 1994, the recorded remuneration is $280 a week for September, then $320 a week from October until the end of December. In 1995, his remuneration remained unchanged for the months from January to March, and the payroll shows that his employment was terminated on March 25. He was taken back on in November and worked until the end of December at a salary of $350 week. In 1996, this remuneration of $350 a week was maintained from January to the beginning of April, with it being indicated that his employment was terminated on April 6.

[58] With regard to the preceding two examples, it is difficult to understand the mode of remuneration, which was maintained at a high fixed amount for months, then at a minimum fixed amount over another long period. This is particularly striking considering the winter period, when the snow removal operation depended even more on the weather and clearly could not be divided equally over all the weeks and months of the season. The intensity of the work required to perform residential snow removal obviously varies from day to day, week to week and month to month, a fact not at all reflected in the pay structure.

[59] A few additional examples will be sufficient to illustrate what may be considered as anomalies. From 1992 to 1996, the payroll journals also show that a number of employees were paid fixed remuneration of $56, $60 or $70 a week, as the case might be, during the winter months only. The appellant and Henri Alcaraz explained that, for snow removal, they hired individuals who were available on call and guaranteed them wages representing 10 hours a week. As noted above, in view of the vagaries of the weather, it is surprising here to note the same fixed minimum remuneration from week to week during the entire season, as though the work required was always distributed evenly and all these employees always worked only the guaranteed minimum of 10 hours a week.

[60] The Court moreover notes that Jules Alcaraz, the brother of the appellant's spouse, was paid $750 a week from the end of October until mid-December 1993. One wonders what might have justified such high remuneration paid for such a limited time, which remuneration was even greater than the maximum of $2,700 a month paid to the appellant's spouse Henri Alcaraz in 1992.

[61] The appellant's spouse was indeed paid $2,700 a month for a total of $29,700 in 1992. We know that this salary was initially claimed as a deduction from the appellant's professional income for that year. At the hearing, it was admitted that it was related to the Montchatel operations. In 1993, Mr. Alcaraz received remuneration of $2,400 a month only in January, February and March, for a total of $7,200. In 1994, he received $1,280 a month from May to October, then $1,600 in November and $1,920 in December, for a total of $11,200. In 1995 and 1996, Mr. Alcaraz drew no salary. His remuneration was clearly not determined on the basis of work performed since he managed Montchatel's operations year-round from the very outset, and it would thus have been entirely normal to pay him a salary comparable to what a third party would have been paid. The significant variations in remuneration in 1992, 1993 and 1994, as well as the total absence of remuneration in 1995 and 1996 cannot be explained on the basis of the conditions of employment and the responsibilities. It is not difficult to imagine the impact that payment of a normal and regular salary would have had on the level of losses claimed.

[62] It can very definitely be inferred from a review of the structure of the remuneration paid during the years in issue that other objectives than the carrying on of operations with a reasonable expectation of profit were being pursued. Suffice it to say that the pay structure shows anomalies which are in addition to the other elements cited above.

[63] From 1992 to 1996, the total of interest and financial expenses ($75,437) and wages paid ($218,212) was equal to 93.46% of the reported gross revenue of $314,201. It is difficult to say that there was any room to manoeuvre since depreciation also had to be considered in addition to all the other expenses. With such negative elements characterizing the structure of an operation, I believe that, failing major corrective action, it cannot be said that there was a reasonable expectation of profit. As noted above, 1997 marked a radical change in remuneration, a change which, I believe, cannot be explained solely on the basis of the greater efficiency spoken of by the appellant and her spouse. I cannot help but emphasize the coincidence with the assessments made in 1996 as a result of the audit of the first three years in issue.

[64] Other changes also occurred in 1997. First, operations were moved to St-Augustin-de-Desmaures, nearer Québec, which was undoubtedly a positive factor. However, operations were also split up as Mr. Alcaraz and his two sons each started up a parallel snow removal operation to that of Montchatel. Instead of using all her tractors, the appellant leased one to each of her spouse's sons, while her spouse leased a tractor from a third party. The Court notes that, starting in the first year of his own operation, Mr. Alcaraz reported a profit of $8,994, while Montchatel again reported a loss: $197 before depreciation and $55,976 after depreciation. And this was after 14 years of operation.

[65] Where, after a reasonable start-up period, an operation still displays certain characteristics to such a degree that it becomes unthinkable that a business operated on a strictly commercial basis could have continued in that manner for more than a few years, the reasons for its continued existence must be sought elsewhere. Apart from any speculation as to reasons, the possibility of cancelling out or reducing considerably otherwise taxable income by deducting losses from an unprofitable activity constitutes a kind of subsidy that makes the continuation of that activity less burdensome to the extent of the income tax thus saved. This factor in addition to others that can readily be suspected are likely to result in such benefits that they relegate the earning of a profit from the activity itself to a position of secondary importance.

[66] Having regard to the whole of the evidence, and more particularly the high debt level since the start of operations, the number of years during which losses were incurred, the size of those losses relative to gross revenue generated, the pay structure as revealed by the documentary evidence, and the absence of any significant corrective action during the years in issue, I do not believe that the appellant has objectively shown that she had a reasonable expectation of making a profit from Montchatel's operations during those years.

[67] The appeals for the 1992, 1993, 1994 and 1996 taxation years are therefore dismissed.

[68] The appeal for the 1995 taxation year is allowed and the assessment is referred back to the Minister of National Revenue for reconsideration and reassessment on the basis that the appellant may deduct an amount of $11,503 in respect of professional dues. The appellant is entitled to no other relief for that year.

[69] The whole with costs to the respondent.

Signed at Ottawa, Canada, this 28th day of July 1999.

"P.R. Dussault"

J.T.C.C.

[OFFICIAL ENGLISH TRANSLATION]

Translation certified true on this 31st day of May 2000.

Erich Klein, Revisor

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