Zahn v. The Queen, docket 89-2827-IT

Date: 19971114

Docket: 89-2827-IT

BETWEEN:

HANS ZAHN,

Appellant,

and

THE MINISTER OF NATIONAL REVENUE,

Respondent.

___________________________________________________________________

Appearances:

Counsel for the Appellant: Gordon Aylward

Counsel for the Respondent: Peter J. Leslie

___________________________________________________________________

Reasons for Judgment

(delivered orally from the Bench in St.John’s, Newfoundland, on January 23, 1992)

Margeson, J.T.C.C.

[1] This matter for decision is the case of Hans Zahn, 89-2827(IT). The issue is with respect to a business loss in the 1984 and 1985 taxation years.

[2] In evidence given before the Court, the Appellant indicated that he started entertaining in 1976. He had a “full-time show” and made a living from it. It was underwritten by corporate sponsors. Due to the fact that the population is very small the possibility of making a profit was limited.

[3] During the early years he had worked part-time in a restaurant as an entertainer. He had been doing it for 4 1/2 years, he did it successfully and was able to make a profit. He had training. In 1962 he went to Europe and he became a member of a German magic society. He was the protégé of a well-known entertainer in Germany, a European illusionist.

[4] He indicated that it is not what you do in this type of business but how you do it.

[5] However, for income tax purposes the question is still that of reasonable expectation of profit. He said that he tried to make a profit, “And I have not shown one yet”.

[6] One of the problems in Newfoundland is the population base. “It’s not there”. His desire was to live and work in Newfoundland. He works at another occupation other than the entertainment business.

[7] In answer to a question by his own solicitor whether there was any potential for profit, his answer was “yes”.

[8] The question before the Court is whether there was a reasonable expectation of profit. Has the evidence shown that in the years in question?

[9] He thought of doing educational work for other entertainers, illusion educational videos. But he also wants to be an entertainer. “You have to be an entertainer,” he said, “in order to be able to produce those videos and to make them saleable.”

[10] In 1986, 1987 and 1988 he filed Returns and they were “estimated Returns”. They were admitted into evidence as Exhibits R-1, R-2 and R-3. In 1997, there was a gross income of $2,000 and a loss of $3,000. In 1988 there was a gross income of $2,000 and a loss projected of $3,000. In 1989, there was a gross income of $800 and a loss projected of $1,500.

[11] In 1984 there were total expenses claimed of $14,052.39, a gross income of $2,395 for a net loss of $11,657.39. In 1985 there was gross income of $2,640. Total expenses of $14,143.37 and a net loss claimed of $11,503.37. This was one year in issue.

[12] He incorporated a company to do work for other magicians in 1980 and 1981. He believed that his corporate business can show a profit. He said “it is clear that I can show a profit from my own business”, that was the business of entertaining as a magician. “It’s not easy to make a profit in this business here”, he said, but I take it from what he said that he expects to be able to do it down the road. He was asked, “When do you expect to make a profit?” He did not say. “This company”, he said, “would pay me a salary in 1985 and in 1986 and the company would make a profit.”

[13] He introduced Exhibit A-1, the Returns for 1985 and 1986 for the video company Videonics Limited. He took the general position that because of the resources of the company and the work that it did, there was evidence that one could make a living in this field.

[14] He was questioned about some aspects of the financial statement in 1984. It showed rental of $2,499.10. His evidence was that this was rental charged to his entertainment business as a result of using space in his own home.

[15] The materials and supplies amounted to $1,977.34. He was working in some other aspects of entertainment. He was working with parrots. He said that this takes a long time.

[16] He was referred to his telephone expenses, $2,972.84, $4,033 travel expenses; bank and interest charges of $2,055.72; capital cost and vehicle and equipment charges. Capital cost allowance on the vehicle was $278.11 and equipment of $1,445.53.

[17] He was asked about his future plans for this business and he said that he intended ultimately to be able to do it full-time, to make a full-time job of it. He was working towards that goal.

[18] In cross-examination he said that there were losses every year as referred to in Exhibits R-1, R-2 and R-3.

[19] He was also referred to Exhibit A-1, which were the financial statements of the company from 1985 to 1986. He said that he drew income from the company of $5,000 to $10,000. “At least”, he said “I suspect that’s what it would have been, in that neighbourhood.”

[20] He was asked what the company’s income was in 1989. He did not know, he did not have the answer to that. He said, “I don’t know what the income was for the company, but the estimates are for costs, the company will make a profit.” He did not know whether his estimates would have included capital cost allowance but believed that it would have allowed for him to draw fees from the company as advisory fees.

[21] He said that since 1969 he has been in the entertainment business. He has never shown a profit from the entertainment business in a Tax Return. He was asked the question, “Without the corporation would there be a profit from the entertainment business?” His answer was, “It’s possible to show a modest profit but it is very very difficult today.”

[22] In 1984 the evidence was that the gross income was $2,395 and in 1985 the gross income was $2,640, basically from banquets, promotions and performance income.

[23] In re-direct he said that he would take out the monies from the corporation by way of fees.

Argument of the Appellant

[24] In argument, counsel for the Appellant said that the business is a legitimate business, it is not just a hobby. He agreed with paragraph 8(1) of the Reply to Notice of Appeal (Reply). Paragraph 8 basically set out the basis on which the Minister made his decision to disallow the losses:

8(a) the Appellant has operated his activities as a magician consistently on a loss basis since inception in 1979;

[25] In regard to 1984 and 1985, where the Reply indicated that there was no reasonable expectation of profit, counsel disagreed. He said that the evidence here disclosed that there was a reasonable expectation of profit. With respect to 8(c):

the Appellant does not rely on his activities as a magician for his major source of income;

He said that he did not know really what the Minister was arguing there. The Appellant did not agree that this was just a hobby.

[26] The Appellant referred to the Moldowan v. The Queen, 77 DTC 5213. He agreed that in order to have a source of income there must be a business. There must be a reasonable expectation of profit, that this is an objective test. Some of the criteria are the profit and loss possibilities, the intended course of action of the taxpayer and the consideration of capital cost allowance. When you consider all the factors as set out in Moldowan, supra, and the factual situation here as it applies, that even though the Appellant has not shown a profit yet, there was a reasonable expectation of profit. There is enough evidence to show that there was a reasonable expectation of profit.

[27] Counsel referred also to Coupland v. The Queen, 88 DTC 6252 and particularly to the last page of that case. He used that case to show that Moldowan, supra, applies, where the Court said:

“Counsel referred to the fact that some cases have held that taxpayers might be expected to incur up to ten years of start up losses before it is reasonable to expect them to turn a profit. These cases relate to the establishment of dairy herds and breeding cattle stock, which activity, by its very nature, requires a long period of development. The establishment of a campground is not of this nature. It is a business where a long start up time is not required.”

[28] He also referred to Madronich v. M.N.R., 89 DTC 5093 at paragraph 23. According to that particular case it might take from 30 to 40 years to make a profit.

[29] That case was a tree operation situation and it had to do with reforestation. The fact that the ultimate harvest from the anticipated crop was some 30 or 40 years removed did not prevent the Court in that case, the Federal Court, from finding that there was a reasonable expectation of profit, not merely a notional one.

[30] It was also argued by the Appellant that the corporate Return showed that there might be profit in the future if the Appellant drew corporate fees. If you look at the corporate Returns and use the monies that the Appellant would intend to take out of that business as fees paid to a consultant, then there was a reasonable expectation of profit.

[31] Counsel was prepared to concede that the only expenses allowed should be those that were proved, as the Respondent indicated. Originally the losses were disallowed, then some losses were allowed and then others were not allowed.

Argument of the Respondent

[32] Counsel said that the Court is dealing only with 1984 and 1985 as the years in question. He referred to the Coupland, supra, case as well, but obviously for different reasons than the Appellant did. He argued that it stands for something other than what the Appellant said it did.

[33] That was a case that required a start up time, unlike, he said, the present type of business. There was no evidence here to show that a long start up time like that was required. In any event, up to 1989 there would have been 17 years in business and each year was predicated on a loss. In this type of business it would be completely ridiculous to expect that you could wait that long to make a profit.

[34] There was no plan of action shown which was cohesive and which showed that there was a reasonable expectation of profit within a reasonable period of time. The best that the Appellant could argue was that hopefully, in the future, he would draw a salary from the Videonics company to offset his losses. This statement does not show that the corporation would show profits to offset his losses.

[35] The idea of a reasonable expectation of profit was at best a notion or a hope. There was no hard or fast evidence to suggest that there was a reasonable expectation of profit within a reasonable period of time.

[36] Further, he questioned whether or not the salary that he drew out of the business could be considered income. That was not relevant to whether or not there was a reasonable expectation of profit in his magician business. That was a private enterprise and it is separate and apart from the business in issue.

[37] There were two distinct businesses. Different assets were used in the two businesses and the income in one cannot offset a loss in the other. It cannot be added on to the income in the other magician business to show a profit.

[38] All you have to do is compare the percentage of loss to the income that was generated by the magician business. The answer is clear-cut. There was no reasonable expectation of profit.

[39] What was the specific plan of action as Moldowan, supra, requires? In this particular case there was no specific plan of action. There was only hope that there would be a profit. The only plans that there were related to the corporate business and not to the entertainment business. Therefore, even if there was any hope of profit, it was not in the entertainment business.

[40] He agreed that the Appellant was an experienced entertainer, but the business was not profitable. After 17 years of losses the evidence of profitability would have to be overwhelming. There was none here.

Analysis and Decision

[41] The question before the Court today is whether or not there was a reasonable expectation of profit from the entertainment business which the Appellant was engaged in during the years 1985 and 1986 having regard to the cases that have been mentioned and to other cases and having due regard to the rules set out in Moldowan, supra.

[42] The evidence was clear that the entertainment business has shown consistently, since its inception back as far as 1979, a loss. There was no evidence before the Court from which it could conclude that there was a reasonable expectation of profit.

[43] Indeed, if one looks at the financial statements submitted, and there was no question about their accuracy, the amount of the gross income in 1984 was $2,395. In 1985 it was only $2,640. Opposed to that you have total losses of $7,964 and $7,182.27. Certainly in order to convince the Court that there was a reasonable expectation of profit, there would have to have much more evidence than that.

[44] The Appellant was employed on another basis and the Court concludes that the entertainment business was just a hobby for him. But even if it was more than a hobby, the evidence does not disclose that there would be a reasonable expectation of profit within a reasonable period of time.

[45] In spite of the Moldowan case and the others referred to, the Court is unable to conclude that the Appellant has proved on a balance of probabilities that there was a reasonable expectation of profit. Consequently, the appeal is dismissed and the assessments are confirmed.

"T.E. Margeson"

J.T.C.C.