Victoria E. Dait and Stephen R. Dait v. Her Majesty the Queen, [1995] 2 CTC 2022

O’Connor J.T.C.C.:—These appeals were heard on common evidence at Calgary, Alberta on February 6, 1995 pursuant to the informal procedure of this Court and relate to the years 1989, 1990 and 1991. The appellants were represented by their agent, Ron Hewitt, a chartered accountant.

Issue

The sole issue is whether the Minister of National Revenue ("Minister”) was correct in disallowing business losses claimed by the appellants in each of the years in question.

Facts

Victoria E. Dait ("Victoria”) and Stephen R. Dait ("Stephen"), her husband, during the years in question operated a partnership known as Rivod Enterprises. The activity of this partnership was the retail sale of Amway products and the development of a network of downline distributors of Amway products. The operations were carried out principally in Calgary and Edmonton and from the appellants’ home. Revenues were derived not only from direct sales but also from bonuses based upon the sales affected by the downline distributors.

During the years under appeal, Victoria was employed full time as a nurse and had employment earnings of $39,086.13 in 1989, $33,628.65 in 1990 and $53,545.46 in 1991. Stephen also had employment income in the years in question, principally from Canada Post. The amounts of such employment income as shown on his returns were $19,391.69 in 1989, $24,080.18 in 1990 and $5,952.07 in 1991.

The Amway operation had commenced prior to 1987. The following is a summary of the business income, expenses and losses from 1987 to 1991. There was no claim for any income or business losses in 1992.

It is to be noted that the Minister allowed the deduction of the business losses in 1987 and 1988 but denied them for the years 1989 through 1991. Also of note is that for the first three years the partners were on a 50/50 basis, whereas for 1990 it became 55/45 in favour of Stephen and for 1991 it was 60/40 in favour of Victoria.

Testimony was given by both appellants and was generally to the effect that they spent a considerable amount of time in promoting the Amway operation. They referred to log books indicating various trips and meetings. They also referred to brochures outlining the various conventions and meetings which they attended. They explained that the vehicle expenses were higher than normal because considerable travel was necessary and the vehicles used, being old, required considerable maintenance and repair. They acknowledged that one vehicle was used by Victoria to go to and from her nurse work and that their son also used the vehicles from time to time. The material submitted was voluminous and there appears to be little doubt that the appellants did expend considerable time and effort. Floods on two occasions in the appellants’ house resulted in the loss of receipts, invoices, etc., for the 1989 and 1990 years but substantial documents were submitted to the Minister for 1991.

Stephen was involved in an accident in September 1988 which, together with the medication required after the accident, reduced his ability to contribute to the operation. Further, the appellants concentrated on "high ticket" items such as encyclopedias, vacuum cleaners and water filters as such items led to greater profits. Victoria, who kept the records and prepared their income tax returns, explained the changes in the partnership percentages in 1990 and 1991 as being tax motivated. This is readily apparent for 1991 where Victoria, who had employment income in excess of $53,000 compared to Stephen’s employment income of approximately $6,000 was the obvious one to benefit from allotting to her the larger percentage of the business loss. She also indicated that her nursing income greatly increased in 1991 because she decided, of necessity, to put in considerably more nursing hours in 1991 as it had become evident that the Amway operation was not profitable and Stephen’s contribution to family income was greatly reduced.

Appellants’ submissions

It is the submission of the appellants that they ran a legitimate Amway business in an attempt to supplement their employment incomes. They expected their profit eventually to derive mostly from the downline distribution system which would increase their bonuses. They argue they had a reasonable expectation of profit from this business and that the business losses should be allowed.

Respondent ’s submissions

It was the submission of counsel for the respondent that adequate books and records had not been kept, that there was a paucity of receipts and other documentation for certain years resulting from, as alleged by the appellants, floods which destroyed records. A detailed analysis of the precise items of expenses being disallowed was not presented. The larger expenses with respect to the vehicles, office (in the home), entertainment, travel and conventions were highlighted and, according to counsel, were unreasonable when compared with the meagre amounts of profit. Also argued was the appellants’ admitted lack of business experience and the absence of plans to improve profits, especially after it became apparent the Amway operation was losing money. Respondent’s counsel concluded that the activity had no reasonable expectation of profit and that this was readily evident from an examination of the figures referred to above. As to the appellants’ contention that they were looking to increased downline bonus payments to improve profits, counsel pointed out that these bonuses were only $1,438 in 1989, $517 in 1990 and $255 in 1991.

Law

The most relevant provisions of the , R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the ’’Act") are paragraphs 18(l)(a), 18( 1 )(h), section 67 and the definitions of "business" and "personal or living expenses" in subsection 248(1). These read:

18(1) In computing the income of a taxpayer from a business or property no deduction shall be made in respect of

(a) an outlay or expense except to the extent that it was made or incurred by the taxpayer for the purpose of gaining or producing income from the business or property;

(h) personal or living expenses of the taxpayer, other than travelling expenses incurred by the taxpayer while away from home in the course of carrying on his business;

67. In computing income, no deduction shall be made in respect of an outlay or expense in respect of which any amount is otherwise deductible under this Act, except to the extent that the outlay or expense was reasonable in the circumstances.

"business" includes a profession, calling, trade, manufacture or undertaking of any kind whatever and, except for the purposes of paragraph 18(2)(c), section 54.2 and paragraph 110.6(14)(f), an adventure or concern in the nature of trade but does not include an office or employment;

“personal or living expenses" includes

(a) the expenses of properties maintained by any person for the use or benefit of the taxpayer or any person connected with the taxpayer by blood relationship, marriage or adoption, and not maintained in connection with a business carried on for profit or with a reasonable expectation of profit….

Analysis

As mentioned, there appears little doubt that the appellants expended considerable time and effort in attempting to make their Amway distributorship profitable. The question remains however as to whether in the years in question there was a reasonable expectation of profit. The Minister allowed the deduction of the business losses for the years 1987 and 1988. This certainly does not estop the Minister from proceeding differently in subsequent years. However the appellants may have been led to believe that the Minister must have concluded that they had a reasonable expectation of profit in the years 1987 and 1988 and perhaps that same conclusion would not change for subsequent years.

When one examines the summary mentioned above, it is to be noted that the gross income increased from $9,307.50 in 1987 to $16,984.84 in 1988 and to $20,968.82 in 1989. Also, during those years, 1987, 1988 and 1989, expenses were reducing.

Based upon the pattern established over the years 1987, 1988 and 1989 I have concluded that the appellants, on a reasonable balance of probabilities, did have a reasonable expectation of profit in the 1989 year. I cannot, however, conclude the same for the 1990 and 1991 years. Three years had passed with continuing losses which were not diminishing. In 1990 the expenses increased substantially. The negative effect on the business operation resulting from Stephen’s accident had become apparent. In 1991 the expenses were reduced but this failed to produce much of a change in the net loss in 1991 when compared with the net losses in the 1987, 1988 and 1989 years.

The leading cases on the general concept of reasonable expectation of profit were canvassed. Also reviewed were six different decisions all dealing with Amway distributors and claims for losses. Most of these decisions, however, addressed disallowance of specific deductions such as promotion expenses, convention/meeting expenses, vehicle and home office expenses and personal and living expenses. They did not offer a consideration of when the amounts of expenses, considered generally in relation to gross income and losses, can lead to a determination as to whether or not there exists a reasonable expectation of profit. Two decisions require specific mention.

In Friesen v. M.N.R., [1990] C.T.C. 1 2002, 89 D.T.C. 682 (T.C.C.), Teskey J.T.C.C., in a judgment rendered orally, indicated that the Minister had acknowledged that there was a reasonable expectation of profit in that case as some expenses had been allowed. I believe what was meant however was that, as stated in other decisions, allowing some expenses in certain circumstances is an acknowledgment of the existence of a business but not necessarily an acknowledgment of a reasonable expectation of profit from that business.

In Boychuck v. M.N.R., King D.J.T.C.C., in an unreported decision dated June 27, 1991, considered the Amway activity of a teacher/principal in Saskatchewan who reported losses over a long period of time and concluded that no reasonable expectation of profit existed. The facts in Boychuck are more extreme (against the taxpayer) than those in the present case but of all the Amway decisions cited this was the only one that decided the issue on the basis of what generally gives rise to a reasonable expectation of profit and the decision went against the Amway distributor.

For all of the above reasons, the appeals for 1989 of both appellants are allowed and the appeals for 1990 and 1991 of both appellants are dismissed. There shall be no costs.

Appeal for 1989 allowed; Appeals for 1990 and 1991 dismissed.