King v. The Queen, docket 1999-470-IT-G

Date: 20000907

Dockets: 1999-470-IT-G; 1999-471-IT-G

BETWEEN:

GERALD M. KING,KAREN KING,

Appellants,

and

HER MAJESTY THE QUEEN,

Respondent.

Reasons for Judgment

Margeson, J.T.C.C.

[1] By Notices of Reassessment dated April 8, 1997 the Minister of National Revenue (the “Minister”) reassessed the Appellants for the 1993, 1994 and 1995 taxation years and disallowed the deduction of expenses claimed in relation to the maintenance and showing of horses in the amounts of $22,352, $24,380 and $22,519 in the years 1993, 1994 and 1995 respectively. These amounts were divided equally between the two Appellants.

[2] At all relevant times the Appellants carried on business, in partnership with each other, as a life insurance underwriter operating under the name and style of King & King Associates.

[3] These matters were heard on common evidence and in accordance with an Order of this Court dated the 9^th day of February 2000.

Evidence

[4] Karen King testified that she was the wife of Gerald M. King, the other Appellant. She possessed the degree of Bachelor of Business Administration and Accounting. Before she met the Appellant Gerald M. King, she had ridden horses and was thinking about buying a horse. She had no life insurance sales experience at that time. Subsequent to their meeting, the Appellant Gerald M. King decided to start an insurance broker business and set it up in December of 1982 at an office in Truro, Nova Scotia, under the name of King & King Associates and it was registered as a partnership. The business was never incorporated.

[5] In 1982 the business was operated out of Stewiacke, Nova Scotia and in 1987 they moved the business to Summerville, Nova Scotia.

[6] During the first ten years of the business the Appellant Karen King participated in all sales. Then during the tenth and eleventh years she commenced staying in the office, doing the bookwork and being in charge of the overall care of the horses. She studied for and received a life insurance licence.

[7] Her evidence was that she and her husband went to horse shows and made use of a winnebago to which they invited guests and from which they acquired most of their business. They attended fifteen to twenty horse shows per year in the 1980s all of which were accredited by the Canadian Equestrian Federation, (C.E.F.). Most of these shows were in Nova Scotia although they did attend one in Charlottetown, Prince Edward Island and one in Moncton, New Brunswick.

[8] During the events in the 1980s the Appellant Karen King did not exhibit. She socialized and obtained information on clients as she met them. The purpose of her solicitation was to obtain more clients for the insurance business. In 1987 they sold their original property and obtained a new place at which they became very prosperous. At that place they entertained at approximately 20 to 25 functions per year and business clients came to use the facilities and to attend the annual horse show. After they purchased the new property they continued to carry on in the same way at the horse shows but they also invited people to their home. In the 1980s Gerald M. King showed horses and became a celebrity in the horse world. He was the oldest rider in Canada at the C.E.F. level. He became well known.

[9] At the horse shows in the 1980s the Appellants had signs displayed on their mobile unit and they had banners displayed as well. The horses were owned by King & King Associates. It was her position that the name of King & King was a password in the horse business. She introduced Exhibit A-1 showing the type of horse shows which they attended and indicated that she was a rider at some of these shows. Gerald M. King was also a rider and all of the C.E.F. horse shows took on this format. The same applied in the 1990s.

[10] The business sponsored horse shows by giving money directly to the show and as a result the business was allowed to have displays or banners at the horse shows under the name of King & King Associates. She was able to point out receipts in the book of exhibits relating to the sponsorships by King & King Associates. These were claimed as expenses of the insurance business.

[11] She said that she was familiar with the manner in which her husband attracted clientele to the insurance business. He was well known in the horse world. He could walk up to anyone and talk about horses. He was very favourably received. He cultivated this expertise over a period of time. She said: “You sell yourself to clients”.

[12] It was her position that the insurance business maintained old clients and also obtained new clients through the use of the horses and these horse shows. They were continually updating their lists. The old clientele of the financially well-to-do had increasing insurance needs. She described the “horse connections” as the backbone of their business and indicated that 90 percent of the income from the insurance business was “horse-related” income. She referred to several designations that the business had obtained in the insurance field, one of which required a 90 percent retention rate. She described their business retention rate as 98 percent.

[13] She described the property as being composed of 85 acres with a large barn, a riding ring, a six horse stable and she said that between 1993 and 1995 they owned five horses including four show horses and one fox hunter. The property also contained a pool and a large house.

[14] She described the horses as athletes requiring medical injections, showing and an exercise program. Herself and her husband performed these duties. Two to three hours per day were spent on these duties and they have a person who looks after the horses when they are away.

[15] The Appellants also participated in the Annapolis Valley Fox Hunt. Gerald M. King required a special horse for this event and he also held a position at the annual fox hunt, which was referred to as the “whipper-in”.

[16] Thirty five to forty people might participate in this fox hunt where four people worked “the hounds”. There was an overlapping of persons who attended at the horse shows and the fox hunt.

[17] She described the majority of participants on their circuit as being younger people who are helping their parents but they are also potential clients. Only a handful had been in the business as long as the Appellants who had been in it for eighteen years and who are making a living from it.

[18] This witness referred to Exhibit A-1 at Tabs 11, 12, 13, 14 and 15 which showed the income obtained through horse-related activities for the years 1993, 1994 and 1995. She also described the large variation in profits and indicated that the recession was very difficult for their business in 1991, 1992 and 1993 but in the years 1994 and 1995 things started to improve. She also referred to the schedule showing the amounts disallowed during the relevant years.

[19] This witness pointed out that sometimes they claimed less than 100 percent of the expenses related to some of the horses because during part of the year they would not have been making any money off of these horses as they may not use those horses during part of the year in the business. They claimed 20 percent of the house maintenance as a business-related expense.

[20] She disagreed that the involvement with horses was merely a hobby. She said there was a lot of hard work involved in this part of the business, showing of the horses was very stressful, there are many rules and regulations which created problems for them. You had to get up early in the morning and had to attend shows late at night at different times.

[21] They would not have put as much effort into this aspect of the business if it were merely a hobby. She would not “show” at the different events. Further, if it were merely a hobby she would have a different horse since a riding horse costs about $1,500 and a show horse costs about $20,000.

[22] In cross-examination she reiterated that a hobby horse which is used as a backyard pet would cost about $1,500 whereas show horses can go anywhere from $20,000 to $40,000 in Nova Scotia to one quarter of a million to one million for a competitive show horse. Show horses and jumping horses are not the same thing.

[23] Before her husband became involved in the operation of King & King Associates he was an insurance manager. He was also “show jumping” at that time. At that time he was a manager and was not selling insurance as his main job.

[24] She was referred to Exhibit A-1, Tab 1 at page 2 and she indicated that this was a typical format for horse shows which they attended, in which they participated and advertised and that the name of the horse, the owner and the rider was referred to in these advertisements. She admitted that the name King & King Associates was there but that the name insurance was not included in the advertisement. She admitted that they had never conducted a statistical analysis to determine why people chose King & King as their insurance agent. “Most people do not go to horse shows to get insurance”, she said. They do not usually seek out the agent in the insurance business. However, their business grew as a result of them being there and they “honed their business and developed it as a result of their attendance.” Her husband had a background in showing horses and she was learning. She has a horse riding coach and she indicated that as you improve you have to take on new coaches. She spends one to two hours a week training depending upon which horses are being shown.

[25] She admitted that she obtained some personal satisfaction from this work but said, “it does not hurt our business. My husband has a celebrity status. One lady at the last show approached my husband directly about insurance before leaving for Belgium. Gerald (King) prospects customers all the time.”

[26] She was referred to the Life Underwriters Association Training Course and the concept of “nest prospecting”. She admitted that she and her husband were doing this. They also do general prospecting. She spends two to three hours a day in the down season with the horses. Shows take 12 to 13 hours per day and the season extends from May 1st to the end of October. There are also training shows which they attend which are not C.E.F. shows. They attend these if some of their horses need to attend.

[27] The down season for the C.E.F. was not a down season for their insurance business. They may invite persons to their house or make appointments with them. Most of the prospecting is done in the summer or at least that was the general trend. They attend 25 to 30 horse activities per year and 15 to 20 C.E.F. shows per year. If the use of the horses were not a business she would not “show” at these events. It is too stressful. She indicated that the banners displayed at the shows mentioned the insurance business but that the announcer does not mention their business.

[28] Only in shows that they have sponsored does the program say that they are insurance brokers. They do not claim the turn out area and the ring as part of their expenses. She was referred to an article in Exhibit R-1, Volume 1 at Tab 12, which was a write-up about a meet held at their farm in Summerville. She indicated that the King & King banners are shown at the horse shows and announced at the showing. The rider in this particular picture was a client of their insurance business and Gerald M. King rides in this event.

[29] In re-direct she said that deals are not normally closed at horse shows but at other places. It might take one year to do a year and a half depending upon the need to the client. This year they obtained business from one person that they had known for 18 years. They obtained this business through the horse show.

[30] She referred to Tab 13 Exhibit A-1 and said the capital cost allowance was not indicated there.

[31] Gerald King described himself as a life insurance broker. He was born in Halifax in the county of Yorkshire, England and said that his grandfathers were both prolific horse people. In business he was a textile engineer and came to Montreal in 1966 to run a factory. He stayed with the Signor organization and later on ran mills in Moncton which were operated by the federal government. He obtained an equity position in these mills but when they went out of business he became a life insurance agent. He was a National Life Insurance agent in Moncton, New Brunswick. Then he worked for Excelsior Life Insurance in Halifax. He managed the insurance business and sold insurance for one and a half years. Then he became manager of National Life until he became a broker himself. They moved the business to Truro and they lived in Stewiacke.

[32] The witness said that they realized that they had to go out to see people and they did “nest prospecting” through the horse community. In 1979 he obtained his first horse and started jumping. For the next five to six years his involvement increased. People at the horse shows were the right kind of people to meet for insurance business purposes. They were affluent, they were business people and there was “a nest of prospects there.”

[33] He had taught other agents to “nest prospect”. However, these agents did not have a nest of prospects like the Appellant and his wife did who knew each other and who knew them. He was referred to Exhibit A-1 at Tab 16 and indicated that he was involved in the Life Underwriters Association Training Course for agents. He said that all persons in the “nest” have a common interest. They help each other. There is a good fellowship. The only time they are competing is in the ring for a few moments. At the shows he was cultivating his insurance business. He knew other agents who had tried to cultivate this nest but they did not have the credibility that he enjoyed in the horse community because they were not involved in the showing of horses or the jumping of horses.

[34] He knew that this was a nest where he had some authority and credibility and was a competitor as well. The competitors in this horse business do not get angry with each other and competition does not hurt the insurance prospects. “At the horse shows you talk and ask questions. You listen to the other horse people. Then you ask to see them later.” Everyone in the horse business knows that he is in the insurance business. Thirty to forty percent of the people are clients of his business. They tell others about his business. “You have to build a fence around them because others would love to get in. I like to get references for others who were not at the horse show. Some customers recommend me to others. Persistence is the main thing. We try to retain 99 percent of our clients by being there, not by pestering them. The average retention rate in the industry is 89 percent.”

[35] It was his position that if he did not have horses he would soon be forgotten. He would lose the exposure and people would forget about him. His business is growing all of the time as a result of his involvement in the horse community. He has reached a prominent level in the insurance business.

[36] He reiterated that the recession hurt their business as estate planning was down. However, they did not change their system. They obtained new business from the existing clients and they are getting new business all of the time.

[37] In cross-examination he said that he knew where the business was coming from. He is a successful rider and this helps his business. He maintains a high profile and enjoys competing at these events. He was asked how he could keep others out of the “nest” and he said by doing what they know best. They remained friends with the horse community. He has developed his credibility. He has been at it for thirty years. If he had one bad client it could be disastrous for his business. He is doing business in a community of people that he knows and at a level that they understand.

[38] He trains horses about an hour per day and he works 16 hours per day at his insurance business. With respect to the horse shows he said that very little time was spent in the show ring. The rest of the 8 to 10 hours are spent doing other things including meeting people and preparing the horses. If they were not at the shows for business purposes they would be continuing to take part in the fox hunt but they would only have a horse for riding.

[39] When he was manager of National Life Insurance in Halifax he was just getting back into the horse business. He knew that he had to go out and provide a “nest” of people and the only way that he could think of doing this was through the horse community. When he was into management there were no horses involved.

[40] At the beginning he was just a person with a horse and he had to get recognition. He obtained a good horse after that and started to make money and he obtained recognition. After 1985 he was still competing and the insurance business was growing. He said, “an insurance agent who has to speak to strangers does not get very far. We work very hard at getting to know people.”

[41] The horse community enabled the Appellants to develop a very successful insurance brokerage firm. The percentage of non-horse-related sales in this insurance business is very low. He was dealing with very affluent people. For many years he did not have much to do with horses.

[42] Fox hunting starts in September. In the spring there may be a “walk”. That is all laid out by scent. Ten to thirty five people participate. Most fox hunting people are not show people. They are farmers and they are clients and they are families of clients. Horses are the key to all of it.

[43] He had horses in Stewiacke but not in Moncton. He did not participate in horse jumping or horse showing. Most of his sales are completed after the horse shows.

[44] He was referred to Exhibit R-1 at Tab 41 at page 8 which was an article with respect to show jumping and he said they went to a show in Toronto and the people there were clients of their insurance business. However, he did not compete at that level. He spends a maximum of one hour per day on the horses.

[45] After questions by the Court he indicated that he would always have a horse but he would travel more and watch more and show less in the event that he was not involved in the horse-related activities for business purposes.

[46] Robert Siteman was an automotive dealer from Dartmouth, Nova Scotia. He said that he had involvement with horses as an owner since the early 1980s. He was not a rider. He did attend equestrian events in Nova Scotia and Quebec approximately seven to fifteen times a year. He goes to events where his children are not riding and he owns jumpers and race horses.

[47] This witness had known the Appellant Gerald M. King for several years beginning in the mid-80s. He met him in his showroom in Dartmouth. He was introduced by someone who knew that his children were involved in horses. He discovered at a horse show event that Mr. King was an insurance agent and he tried to set up an appointment with him for the next week. He referred to Mr. King as being “persistent”. Mr. King and his wife were both at these events. They had their own jumpers. There were banners all over the place at Gerald’s house with respect to the insurance business.

[48] This witness bought insurance from the Appellant’s business and he did the bulk of his insurance with him. His son and his associate buy from the Appellant’s business as well. There was a connection between the purchase of insurance by this witness and his associate from the Appellant’s business and the horse activities. The business resulted from their common interest in horses.

[49] In cross-examination he said that the first meeting between himself and Mr. Gerald King was not at a horse event. However, he did say that Mr. King was very persistent, sometimes to the point of irritation.

[50] Eleven months after he first met Gerald King he bought a “buy and sell insurance plan” from him. He would bump into him every two weeks at a horse-related event and more than ten times in eleven months.

[51] His personal life insurance was through Canada Life.

[52] In re-direct he said that he purchased the “buy and sell insurance plan” from Gerald King eleven months after the meeting although meetings were ongoing in the interim. Mr. King was doing sales with other persons as well. He said, “I went to a horse person to get my insurance”.

[53] Charles Hardy was the President of Hardy Appraisals who have been commercial real estate specialists since 1972. He had partners. He grew up in Yorkshire in England and now owns 13 horses. His wife was very interested in horses as well. In 1978 they bought their first horse.

[54] They owned show horses as well as breeding horses. One time he did ride and show horses but he does not do that now. His children ride in shows in the events and in fox hunting.

[55] He knew the Appellant Gerald King for twenty years. He met him at the Salmon River Show Jumping Event in Truro. The Appellants were there as showers and had a winnebago as an insurance office.

[56] Gerald King came to the tack shop at the show and this witness said that there was a sign on the winnebago with respect to insurance. He went in and discussed insurance with Gerald King.

[57] He was looking to buy insurance. Mr. King told them about a “whole life insurance plan” and he bought from him. They bought the insurance plan in the winnebago and also bought insurance plans afterwards. He attends the events every week to two weeks in the summer and the Appellants are usually there. They are usually showing horses there. Insurance is mentioned when he speaks with Gerald King and afterwards it often results in sales of policies by Mr. King. He probably bought from him eight or nine times. He has also recommended Mr. King’s business to his partner who is not involved in horses.

[58] Other insurance agents often approached him but he never looked anywhere else other than to Mr. King’s business for his insurance. The deals with Mr. King were made as a result of the first horse show in Truro. The horse connection was important as he saw him on a regular basis there.

[59] This witness visited the King’s home in Summerville, sees him in horse shows, sees him at the Annapolis Valley Hunt, at sleigh rides and at other social events. He identified a picture at Exhibit R-1, Tab 12 of Volume 1 as a picture of his daughter riding a horse. He said that insurance always crops up at these meetings and some times leads to other meetings if he needs to upgrade his insurance coverage.

[60] In cross-examination he said that he had a good personal and business relationship with Gerald King. They did not always discuss insurance in his house. The horse factor was number one in their insurance relationship. Normally he has an aversion to insurance persons but the fact that Mr. King and he were together at the horse shows made a difference in this relationship. The Kings often had a presence at shows when they were not competing. He does not go to shows to discuss insurance but he may discuss it when he is there. He provided no professional services to the Appellants except once when they were residing in Stewiacke which was over 10 years ago.

[61] He noticed the King insurance sign at the very first event which was a show in 1979 or 1980. He said that Mr. King enjoys it and that is where he does a lot of business. He is riding gentler horses now.

[62] Donald Keddy was in the motel business, in real estate and in construction. He has had an interest in horses all of his life. He rode horses himself and now has three. At times he had eight to ten horses including show horses. He attended horse shows all the time before he was hurt. These horse shows took place in Nova Scotia, New Brunswick and Prince Edward Island.

[63] He has known the Appellants for twenty to twenty-five years. He first met them at a horse show. He was told that Mr. King was in the insurance business. He has seen him at horse shows and at the fox hunting events. Mr. King was at many of these events. He had banners and different forms of advertisement at the shows.

[64] This witness bought a life insurance policy from the Appellant because he got to know him at the horse shows. He purchased life insurance, company insurance, childrens’ insurance including approximately 8.5 million dollars worth of insurance for himself.

[65] At these meetings between himself and the Appellants they talked about horses and then got on to insurance talk. He has also been to the Kings’ home. Horses were an important part of his life. He dealt with Mr. King due to the relationship with horses. There was a mutual bond between them.

[66] In cross-examination he said that the Appellants did sponsorship as King & King Associates as an insurance business. He also said that the starter of the fox hunt bought a policy from Mr. King who rode in it and was a “whipper in” at the show.

[67] Mr. King made many connections at these events and one in particular with a prominent person by the name of Ron Sutherland whom Mr. King would not have even got close to had it not been for his connection to horses. This person was involved with Spruce Meadows Farm although the witness did not know whether Mr. King had sold him a policy or not.

[68] He described Mr. King as being as passionate about horses as he was. At smaller shows you run into the same people but at Halifax and in the larger shows you do not as they are exhibitions. The Kings attended these events when they were not showing but they did sponsoring events. He has been at Mr. King’s house for six different fox hunt events and Mr. King has been at his house.

[69] The Respondent called Mr. W. Williams who was an auditor with Canada Customs and Revenue Agency. He has been an objections officer since 1996. Prior to that he had been an auditor with Revenue Canada.

[70] He reviewed the facts set out in the objection filed by the Appellants in the summer of 1997. He reviewed the working papers, contacted the Appellants and made an objection report. He referred to his notes made after the discussion with the Appellants and Mr. Harris and these are set out in Exhibit R-1, Volume 1 at Tab 12. The purpose of the meeting was to obtain more information and to debate the issues involved.

[71] He concluded that the expenses involved here were not laid out to produce income. He relied upon Mr. King’s indications that he was always involved in showing horses for most of his life and he said that if he was not in the insurance business he would still be showing horses. Mr. King told him that he could not afford it. The witness then asked him if he won the lottery would he still be doing it and he said that he would. He would get the best horse.

[72] The Appellant Gerald King explained what was meant by the concept “nest marketing”. Insofar as this witness was concerned in his discussion with Mr. Gerald King, it came across that expenses were laid out to connect the special interest he had in horses and his insurance business. His involvement in horses was already there. Consequently only the expenses that were made directly with respect to the business were deductible and not to the extent that they were claimed.

[73] This witness related Mr. Gerald King’s expenses regarding the nest concept to his own insurance agent attempting to claim the expenses of his university education with respect to his insurance business. The expenses involved here were very large in comparison to those expended by other insurance people in earning income and therefore these expenses must have been for a personal reason. He allowed some expenses and did not allow others due to the amount involved. It was his position that the amount of the expenses did not seem to be justified by the income generated. It was questionable if the Appellants really knew how much income they received from the horse-related activities.

[74] The expenses that he did allow in the amounts of $650 in 1993, $100 in 1994 and $1,225 in 1995 were related to sponsoring events at horse shows for advertising and these were allowed. The disallowed amounts were all personal insofar as he was concerned. He considered the documents found in Exhibit R-1 at Tabs 41 to 43 but he concluded that the Appellants were using the expenses to advance their personal way of life. He also raised some question as to why the Appellants did not claim all of the costs related to horses if any of the costs were laid out to earn income including all of the costs related to the operation of the farm.

[75] In cross-examination he said that he had no accounting designation and had no legal training. He admitted in cross-examination that Mr. King did not say that he would jump and show horses all the time as this witness had indicated in direct-examination. He also admitted that the friend that he referred to was not in the insurance business when he was in university even though he considered that to be his nest. He confirmed that the expenses in issue here in the years in question were as earlier indicated and here he referred to Exhibit R-1 at Tab 13. The horse expenses were going up and the revenues were not. He did admit that there was little change. Again he was referred to Exhibit R-1 at Tabs 13, 14 and 15 and he admitted that the income was rising substantially in the years 1994, 1995 and 1996. When he was referred to Exhibit R-1 at Tab 13 with reference to an analysis of income from the new clients he admitted that there were clients in the 1995 list that were not in the 1993 list. He said that he did not take into consideration whether or not a child was a horse owner or whether or not the client was referred to the Kings by a horse owner. He did not consider that old clients had to be cultivated in order for them to renew their policies or buy new policies.

[76] He admitted that he had not done an analysis to see if the bulk of the income from the business was from horse-related activities. It was this witness’ position that there had to be a cause and effect relationship between the expenditure and the income and that you had to be able to show that an expenditure lead to income being earned.

[77] He zeroed in on the personal aspects of the operation since the Kings would be involved in horses anyway even when they were not involved in horses in order to produce income. He did admit that there might be more than one purpose in making an expenditure.

[78] It was also important to him that the Appellants had not claimed some of the costs relevant to the Summerville property because if they were truly involved in making the expenditure for business purposes they would have claimed all of the expenses as an integral part of their business. However, he did admit that it is not unusual for taxpayers to make an attempt to divide the personal expenses from the business expenditures where they are mixed.

[79] He was not arguing that the expenditures that were made were unreasonable. However, he did use the amount of the expenses as a basis for establishing that what the Kings were doing amounted to a hobby and not a business.

[80] In re-direct he said that in 1995 the expenses of the Appellants amounted to 30 percent of the income whereas in the comparison that he used the expenses of other persons were 24 percent of the income. This other person was a female in an urban area of Nova Scotia but he did admit that there could be a difference between the situation of that person and that of the Appellants.

[81] He had nothing to indicate that the Appellants said that they would have to spend such large sums of money to earn the right to be in the million-dollar club and that anyone else earning this kind of money would also have to spend such amounts.

Argument on behalf of the Appellants

[82] In written and oral argument, counsel for the Appellants said that the pattern followed by the Appellants was clearly set out. All the witnesses attested to the strong and intimate connection between maintaining horses and the insurance business of the Appellants. This horse connection in which the Appellants were involved was not a hobby as the Minister says. It was organized and businesslike, produced much strain and stress far beyond any personal interest and the Appellants would not have been involved in it to that extent if it were only a hobby. The use of their home for raising the horses and for entertaining business clients was a professional like business use of the premises.

[83] The Respondent argued that the insurance business did not tie in with the horse connection. However, it did because Mr. King’s presence and the way he cultivated clientele are a result of the horse connection. The Appellants knew their own business and they knew where to get clients. Three prominent businessmen testified as to why they were clients of the Appellants. Their relationships with the Appellants started with the horse connection and continued on throughout the relationship. The business of the Appellants was an evolution from the early 1980s. In this relationship they found a nest and they set about cultivating that nest and tying in the relationship between the horses and their business.

[84] If they were not in it for business purposes they would have done it differently. Everyone at the horse shows knew what the business of the Kings was. Mr. King took advantage of his interest in horses to sell insurance.

[85] Insofar as counsel was concerned the interest of Mr. King in horses was the “foot in the door” that made him successful where other insurance agents had failed. Sometimes this took a great deal of time such as in the case of Mr. Siteman where the business did not materialize for 11 months. However, Mr. Siteman met him at the horse shows. The connection with horses was number one in this relationship.

[86] Insofar as the Minister was concerned, Mr. Williams misdirected himself in a number of ways as to how the Appellants were going about their business. He was misguided about what Mr. King had said. Mr. King did not say that anyone in the million-dollar club would have to spend that kind of money on expenses. Revenue Canada is not in a position to be able to tell the Kings how to go about earning income.

[87] Mr. Williams placed a great deal of reliance upon the comparison that he made with his insurance friend. However, his insurance friend was not a good analogy. Mr. Williams was incorrect when he concluded that there had to be a cause and affect relationship between the income and the expense. Section 67 of the Act is not in dispute.

[88] Counsel argued that in most cases when an expenditure is found to have been made or incurred for the purpose of earning income from a business, so as to meet the requirements of paragraph 18(1)(a) of the Act, it will also not be a “personal or living expense”, so that its deduction would not be prohibited by paragraph 18(1)(h) of the Act.

[89] The Court has held, in numerous cases, that to pass the test of paragraph 18(1)(a), a business must be carried on, and, for there to be a business, the taxpayer must have “a reasonable expectation of profit”. There is no question that that requirement has been met in the case at bar. The definition of “personal or living expenses” in subsection 248(1) of the Act is only a partial one. Under paragraph (a) that definition addresses the “hobby” issue by excluding from the definition the expenses of properties (such as horses) “maintained in connection with a business carried on for profit or with a reasonable expectation of profit”. In such a situation, the expenses will have been clearly for the purpose of gaining or producing income from the business, consequently meeting the requirement of paragraph 18(1)(a) of the Act.

[90] Counsel took the position that it was not relevant as to what other people did in order to earn income. He referred to the case of The Royal Trust Company v. M.N.R., 57 DTC 1055 (Ex.Ct.) and argued that the connection between the Appellant’s gaining or producing income from its business and the payments made by it was not remote in any sense of the term. In any event the appropriate section does not talk about remoteness.

[91] The reference to “nest marketing” in the life insurance literature indicates that the use that the Kings made of their connection with horses was in accord with accepted business practices. The evidence is compelling that the expenses that are in issue here were incurred for the purpose of gaining or producing income from the Appellants’ business. They were used again and again to attract business, they provided the main basis on which business was attracted and over the years they have achieved that purpose.

[92] The fact that Mr. and Mrs. King enjoyed their association with horses does not make these expenses any less incurred for the purpose of gaining or producing income, just as the fact that any business or professional person enjoys what he or she is doing to earn income does not affect the deductibility of related expenses.

[93] From the cited cases, even the presence of a personal motivation accompanying a business purpose has been held not to affect the fact that the requirements of paragraph 18(1)(a) have been met. See, for example, Olympia Floor & Wall Tile (Quebec) Ltd. v. M.N.R., 70 DTC 6085. In the case at bar there was evidence that if there had been no business purpose, the Kings would have enjoyed the horses much more by participating in horse shows on a different basis. In any event, the fact that the Kings might have maintained horses even if the horses had no connection with their business is not relevant, any more than the fact that a professional racing car driver might still have race cars if he or she had some other occupation. We are concerned with what is, not with what might have been.

[94] As already noted, the Respondent’s Reply to Notice of Appeal refers to section 67 of the Act but does not make any argument based upon that section.

[95] The Tax Court generally takes the position that it is for the taxpayer, as a matter of business judgment, to determine what business expenses are reasonable, particularly where the expenses are successful in generating business income as they were in the case at bar. Only in egregious cases such as the payment of large bonuses to family members who are not active in the business world, will the Tax Court accept a second-guessing by tax auditors of business decisions concerning what expenses are appropriate.

[96] Counsel referred to the case of Leffler v. M.N.R., 71 DTC 476 as a case that might at first sight appear to favour the Respondent’s position. However, counsel argued that the case has to be scrutinized very carefully as it was a decision on the facts that a significant connection had not been established between keeping horses and selling life insurance – a connection that, it is submitted, is strongly established here. As well, it is an old decision of the former Tax Appeal Board and uses the obsolete language of “remoteness” – instead of the purpose of gaining or producing income – as a criterion in deductibility. This language indicates that the Board was much influenced by the case law under the more restrictive language of the Act. This distinction was noted by the Supreme Court of Canada in British Columbia Electric Railway Company Limited v. M.N.R., 58 DTC 1022, among other cases. The much more liberal current approach to the deductibility of business expenses is illustrated in the recent decision of the Supreme Court of Canada in 65302 British Columbia Ltd. v. The Queen, 99 DTC 5799.

[97] In any event, it is submitted that the basic reasoning in Leffler, supra, is inconsistent with the finding of facts of the Federal Court of Appeal in Kuhlmann et al. v. The Queen, 98 DTC 6652. While section 31 of the Act was involved in that case, the Court’s discussion of the “personal element” and of the issue of personal enjoyment is directly applicable here. A long association of one of the Appellants in that case with horses was regarded as a positive factor, rather than an impediment, in establishing deductibility. Again, the Court took Revenue Canada to task for “second guessing” the taxpayer’s business decisions.

[98] Counsel for the Appellants also discussed the case of Symes v. The Queen et al., 94 DTC 6001 and he pointed out that the decision to disallow the claimed deductions turned on the existence of a specific and limited deduction provision under section 63 of the Act and the fact that the child care expenses were not clearly connected to the taxpayers’ business activity. In the case at bar there is no comparable provision in the Act and the evidence is that the show horses were directly used by the Appellants in the course of gaining their business income.

[99] In conclusion, counsel argued that the expenses in question were incurred for the purpose of gaining or producing income from the Appellants’ business, as required by paragraph 18(1)(a) of the Act; they were not “personal living expenses”, within the meaning of paragraph 18(1)(h) and subsection 248(1) of the Act because they were closely integrated with the operation of a profit-making business. There is nothing to suggest that they were unreasonable in amount having regard to the purpose and the way in which the Appellants carried on their business.

[100] Counsel asked that the appeals be allowed, with costs.

Argument on behalf of the Respondent

[101] In written and oral argument, counsel for the Respondent referred to Exhibit R-1, Volume 1 at Tab 12, particularly at page 4 where this note is contained:

I asked Mr. King if he would show horses if he no longer had an insurance business. He said he could not afford to. I said what if you won a lottery and had lots of money available. He said he would get the best horses money could buy and ride all the time.

Counsel argued that this was one factor which tended to show that the horse-related activity was not business-related. Counsel took the position that the Appellants could have had access to the “nest” and all of its benefits even without expending all of the monies that they did and going to that level. Any expenses related to that level were therefore personal and not business related. He pointed out that the evidence of Robert Siteman was that he met Mr. King at his car dealership not at a horse show.

[102] Counsel also referred to the case of Leffler, supra, particularly at page 2 where the Court referred to the case of Paul G. Arsens v. M.N.R., (1969) Tax Appeal Board Cases one in saying:

It might be noted that in the present matter there is no reason for me to doubt Mr. Leffler’s evidence that his hobby of training and showing horses brought him in touch with people of common interests who, at least, came within the description of being possible prospective buyers of life insurance, and that, in pursuing his aforesaid hobby, he found that he was often in a favourable position not only to make suggestions to but also to be consulted by such possible prospective buyers of life insurance thereby increasing the potential of his life insurance agency business to produce income. Be that as it may, before the Board can give a decision on the deductibility of the alleged items of expense in question herein amounting to the sums of $962.10 and $2,491.73 in the 1966 and 1967 taxation years, respectively, it would appear to be necessary for me to consider whether the aforesaid items of expense which were involved in maintaining the taxpayer’s hobby of training and showing horses in the said taxation years can reasonably be held to have been incurred by him for the purpose of producing income from his life insurance agency business pursuant to section 12(1)(a) of the Act.

[103] Counsel argued that the facts in that case were similar to the facts in the case at bar and that the personal interest of the Appellants was exhibited to such an extent that it outweighed the business purpose.

[104] Counsel referred to Tonn v. R., [1996] 1 C.T.C. 205 where Mr. Justice Linden addressed activities that contained a strong personal element from which the taxpayer would attempt to deduct the costs of the personal expenditure and likened the facts in that case to the case at bar where the Appellants at best had a secondary motive of producing income from the horse-related activities and this amounted to nothing more than seeking a tax subsidy.

[105] Counsel took the position that the basis of the argument in the present case was whether or not the expenses fall under section 18(1)(a) of the Act.

[106] Counsel again referred to Leffler, supra, and argued that the Minister’s position in the present case of rejecting such deductions, as in that case, was based upon ordinary common sense as the Court said:

In addition to the clear legal basis for supporting the Minister’s position herein embodied in the Board’s reasons for judgment in H.G. O’Connell Limited v. M.N.R., 42 Tax Appeal Board Case 174, that result appears to be overwhelmingly supported by ordinary common sense when one visualizes for a moment the great variety of claims there would otherwise be of taxpayers attempting to make deductions from income in respect of their myriad of hobbies, recreations and activities of all kinds including everything from yacht racing to car rallying, the said activities being regarded as helpful in promoting and expanding their businesses by assisting them in the first place to make friends and influence people to use a phrase composed by Dale Carnegie. It should be observed for the record that, in accepting the substantial deductions from income made by the appellant for sales promotion other than his expenses in dispute herein for maintaining, training and showing horses in his 1966 and 1967 taxation years, the Minister appears to have acted in a fair and generous manner.

[107] In that case the Court rejected the taxpayer’s positions and confirmed the assessments in issue. Counsel argued that the facts in the case at bar can be distinguished from 65302 British Columbia Ltd., supra, at page 5800 where the Supreme Court of Canada held:

Thus, the deduction of penal fines should not be disallowed for public policy reasons, but because their deduction, if not specifically authorized by the Act, would frustrate the expressed intentions of Parliament in other statutes. The over-quota levy in this case was primarily compensatory, and not penal. It was, therefore, akin to a "fee for service" incurred to produce income, as Lamarre, T.C.C.J. of the Tax Court had determined. Hence, it was deductible.

Such is not the case here.

[108] Counsel again referred to Tonn, supra, where the Court said at page 225:

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. Suspicious circumstances, therefore, will more often lead to closer scrutiny than those that are in no way suspect.

[109] Counsel took the position that any desire for profit in the context of this case was nothing more than a “pious wish” or “fanciful dream”. It was only a secondary motive for having set out on the venture. What was really going on was that the taxpayer was seeking a tax subsidy by deducting the cost of what, in reality, was a personal expenditure.

[110] The Kings were enjoying a lifelong hobby of theirs that they would continue to participate in regardless of whether they continued to sell insurance.

[111] With respect to the nest prospecting the Appellants’ position that it was their nest prospecting within the show jumping community that lead to their increased clientele within the insurance business. The Respondent submitted that the Appellants have cultivated a personal lifestyle of being around horses, of showing horses and jumping them and associating with others of similar interest and they enjoyed this lifestyle. This has enabled them to capitalize on their contacts within horse showing and jumping circles to further the insurance underwriting business by identifying themselves as reliable, informed and competent insurance underwriters. This does not make the expenses deductible. The expenditures claimed by the Appellants were of a personal nature and the facts of this case are similar to those indicated in Leffler, supra, previously referred to.

[112] Counsel’s position was that the appeals should be dismissed, with costs.

Rebuttal

[113] In rebuttal, counsel for the Appellant again took issue with Mr. Williams’ notes and the insertion that he made at some unknown time into the notes and said that it had nothing to do with show horses. All of the evidence indicated that without showing horses and raising them the Appellants would not have had the “nest” that they cultivated. Mr. King had to keep a prominent profile in the horse community. It was not possible for him to do it on one occasion and to “rest on his laurels”. Their business judgment was that they had to do it the way that they did it and it was successful. It is not advantageous to the Respondent’s position to say that you could have done it some other way because this would amount only to second guessing the actions of the taxpayer.

[114] Mr. Siteman said that it was the horse show connection that sold him. It was not enough for the Appellants to appear at horse shows. It was because of the credibility of Mr. King at the horse shows that he was able to attract this business. He had to participate in the fox hunt and not just stay on the sidelines. Otherwise, he would have lost this business. You cannot separate the personal and business aspects in the case at bar. The line is not there.

[115] Counsel agreed that in the case of 65302 B.C. Limited, supra, there was no personal element but in that case the Court refused to read in the public policy argument to paragraph 18(1)(a).

Analysis and Decision

[116] In this case the Court finds that the evidence of both Appellants was very credible, as was the evidence of the other witnesses called on behalf of the Appellants. There was clear evidence given by reputable businessmen that they became clients of the Appellants because of their horse-related activities. The Court is satisfied that without this association these businessmen at least would not have become clients of the Appellants and so there is a clear line showing the relationship between the expenditures made by the Appellants and the creation of income even though the cases make it clear that it is not necessary to show a cause and effect relationship between the expenses and the income. Mr. Williams took the position that this was necessary and the Court does not accept this position.

[117] There was also clear evidence that other business was obtained indirectly by reason of the horse connection. Further, the concept of “nest marketing” is significant in this case and the Court is satisfied that it was not sufficient merely for the Appellants to make initial contact with this group of potential clients but under the circumstances as shown by the evidence, it was necessary for the Appellants to continue to cultivate this nest and a considerable amount of their business came from renewals. The Court is satisfied that if they had not continued to cultivate this “nest of clients” they would not have been successful in retaining this business which accounted for a considerable amount of the income of their business.

[118] There can be no question that the business of King & King Associates was very successful. Mr. King consistently qualified for the million dollar round table and the national quality award. The business obviously prospered and continued to grow and the evidence was that this business attracted clients where others had indeed failed. The evidence showed that selling a policy to one client was not the end of the marketing effort by the Appellants for that client. The Appellants sought to maintain the market, sought to persuade the clients to obtain more insurance as their insurance needs grew and indeed to obtain insurance for other family members such as spouses, children, grandchildren and to a certain extent, other business partners or acquaintances.

[119] The Court is satisfied that the raising, maintaining, showing, sponsorship and riding of show horses was not a hobby of the Appellants but indeed was a way of doing business. All of these activities were an integral part of the business plan. The evidence showed that in the event that the Appellants were not involved in the business, they would have enjoyed their horse-related activities in a far different manner.

[120] The Court is satisfied that the Appellants enjoyed their association with horses but this does not mean that the expenses were any the less incurred for the purpose of gaining or producing income. As counsel for the Appellants pointed out, the Respondent did not really take any issue under section 67 of the Act. The Court accepts the argument of counsel for the Appellants that it is up to the taxpayer, as a matter of business judgment, to determine what business expenses are reasonable, within certain restrictions as referred to in Tonn, supra, and others, in particular where the expenses were successful in generating business income as in the present case. There would appear to be nothing in the facts of this case that would lead this Court to conclude that the expenses incurred here were so egregious that the Court should second-guess the actions of the taxpayer.

[121] The Court is satisfied that the facts in the case at bar can be distinguished from the facts in Leffler, supra, and it is satisfied that a significant connection has been established in the case at bar between the keeping of horses and the selling of life insurance not only through the evidence of the Appellants but also through the evidence of the other witnesses called on behalf of the Appellants who were significant business persons and who testified to that very same effect.

[122] The finding of deductibility in this case of the expenses in issue is not inconsistent with the conclusions of the Court in Kuhlmann et al., supra, B.C. Electric Railway Company Ltd., supra, 65302 B.C. Ltd., supra, and Symes, supra, which the Court is satisfied turned on the existence of the specific but limited deduction provisions of section 63 of the Act. The facts in the case at bar can be distinguished from the facts in that case because the child care expenses were clearly not connected to the taxpayer’s business activity. This was not a comparable factual situation to the case at bar and the Court is satisfied that the evidence here shows that the horse-related activities were directly used by the Appellants in the course of earning their business income.

[123] With respect to the evidence of Mr. Williams there was some inconsistency about what the Appellants allegedly said, but in any event, these statements made by the Appellants are not damning to their position in the end result in light of the evidence which was adduced.

[124] The Court is satisfied that the comparison used by Mr. Williams with respect to his university friend and the business of the Appellants is not comparable. Further, there was no evidence from which the Court could conclude that Mr. Williams could have drawn any meaningful conclusions about the Appellants’ business here by comparing their financial situation with that of some other operator about whom the Court has no knowledge.

[125] It was also clear from the evidence given by way of financial statements that Mr. Williams may have misinterpreted the financial statements in believing that the horse expenses were going up while their revenues were not. In the end result he said that there was little change but the financial statements showed clearly that a substantial amount of business, as much as 90 percent, was from clients who were obtained through horse-related activities. This is made quite clear when one reviews Exhibit A-1, Tabs 12 and 13.

[126] It is also evident from perusing the financial statements that the net income of the Appellants’ business increased dramatically between the years 1993 and 1995 which seems to be inconsistent with the position taken by Mr. Williams when he reviewed the financial statements.

[127] The Court does not accept Mr. Williams’ position that the Appellants would have been doing the same activities with respect to horses even if they had not been involved in the business. Both Mr. and Mrs. King made it clear that they would not have acted the same way. Further, the Court does not find anything untoward about the fact that the Appellants did not claim every expense related to their farm operation and it is not unusual for taxpayers to make an attempt to divide personal and business expenses where they are mixed as in the case at bar.

[128] In the end result the Court is satisfied that the expenses in question were incurred for the purpose of gaining or producing income from the Appellants’ insurance business, as required by paragraph 18(1)(h) of the Act; they were not “personal or living expenses”, within the meaning of paragraph 18(1)(a) and subsection 248(1) of the Act and they were not unreasonable.

[129] The appeals are allowed, with costs, and the matter is referred back to the Minister of National Revenue for reassessment and reconsideration based upon these findings.

Signed at Ottawa, Canada, this 7^th day of September 2000

"T.E. Margeson"

J.T.C.C.