J. Geoffrey M. Parker v. Her Majesty the Queen (Informal Procedure), [1995] 2 CTC 2641

Mogan J.T.C.C.:-On September 14, 1982, the appellant entered into a three-page agreement with Martin Yachts Ltd. of Vancouver under which the appellant was granted the right to distribute the "Martin 242" sailboat in the Province of Ontario using the business name "Martin Yachts Ontario". The object of the business was to sell within Ontario the Martin 242 which was a particular model of sailboat made by Martin Yachts Ltd. The appellant began to operate the business in 1983 as a sole proprietor. The profit and loss statements of the business showed a loss in each of the six years from 1983 to 1988 inclusive. For each year, the appellant reported the loss from the business on his income tax return and deducted that loss from employment income. The appellant’s deduction of the losses in the years 1983 to 1986 was not challenged by the Minister of National Revenue.

For 1987 and 1988, however, the Minister of National Revenue assessed tax on the appellant’s income and disallowed the deduction of the losses from other source income on the basis that the purported business of selling Martin 242 boats did not have a reasonable expectation of profit in those years. The appellant has appealed from those assessments. The only years under appeal are 1987 and 1988 and the only issue is whether the appellant’s sole proprietorship "Martin Yachts Ontario" had a reasonable expectation of profit in those years. The appellant has elected the informal procedure.

The appellant has considerable marketing experience and, in all of the relevant years, was a full-time employee in the area of marketing, primarily selling advertising for different publications. The appellant also has 20 years of experience as a recreational sailor including ten years of competitive racing. He is a member of the Royal Canadian Yacht Club in Toronto and the Royal Vancouver Yacht Club. It was through his activity as a recreational sailor that the appellant came to know the Martin 242 which is a 24-foot sailboat that can be used for either racing or cruising. Through his experience as a sailor, the appellant knew that Martin Yachts Ltd. had an excellent reputation as a boat builder. In the year prior to the date (September 1982) of the appellant’s distributorship agreement, Martin Yachts Ltd. had sold 24 of its Martin 242 boats in the Vancouver/Victoria area. On the basis of those sales, the appellant concluded that Ontario represented an excellent market in which he could sell the Martin 242. The appellant thought that he was well prepared to sell these boats in Ontario on the strength of his lengthy sailing experience in Ontario and his knowledge of the sailing market which came from that experience. The appellant knew that the Martin 242 had considerable success at racing competitions in the Vancouver/Victoria area, and he hoped that winning races at Ontario regattas would be an effective method for selling the boat in Ontario. In February 1983, the appellant prepared a three-year business plan for selling the Martin 242. This was a serious document (Exhibit R-5) comprising approximately 16 pages in which he projected sales of six boats in 1983, ten boats in 1984 and 20 boats in 1985. He intended to promote the Martin 242 by (i) displaying the boat each January at the Toronto International Boat Show; (ii) winning races at various regattas;

(iii) finding selective dealers who would display the boat in their showroom or at their marina; and (iv) after a few sales, forming an Ontario association Gf sailors who each owned a Martin 242. The appellant used his business plan to obtain bank financing and, anticipating the success of his business plan, he purchased five boats in June 1983 for an aggregate price of approximately $78,000. He had already purchased one boat in 1982 when he was living in Vancouver (1980-83) but sold it when he moved back to Toronto. He thought that it was important to have an inventory of boats to ensure quick delivery following a sale.

With the purchase of the five boats in June 1983, the appellant was really in business. He was lucky because the Martin 242 was described at some length and given a favourable design review in the May 1983 issue of "Canadian Yachting" magazine just prior to his purchase of the five boats. He used one of the five boats as a demonstrator to race in regattas around Ontario in 1983 at Toronto, Sarnia, Kingston and at "Dockside 83", an annual boat show held at Toronto each September. In January 1984, 1985 and 1986, he exhibited the Martin 242 at the Toronto International Boat Show which the appellant regarded as one of his best marketing vehicles. Also, he continued to race the same demonstrator Martin 242 at regattas in southern Ontario and at Erie, Pennsylvania in the summer of 1984, 1985 and 1986. He purchased his sixth "inventory" boat from Martin Yachts Ltd. in 1985. Notwithstanding his genuine selling efforts, the appellant sold only one boat in 1983, two boats in 1984, one boat in 1985 and not even one boat in 1986. At the end of 1986, the appellant had two boats on hand including the one he used as a demonstrator. His actual sales are in stark contrast with his business plan in which he projected sales of six boats in 1983, 10 in 1984 and 20 in 1985.

The appellant offered a number of reasons for his failure to come even close to the sales projected in his business plan. He had overestimated the popularity of the boat in Ontario relying on actual sales in Vancouver in 1982. He was unable to set up a network of dealers to display the boat. And there were no dramatic successes in Ontario racing which caused the Martin 242 to stand out among comparable boats.

Apart from the boat which the appellant used as a demonstrator, the other boats which he held as inventory were stored on the farm of a friend near Orangeville, Ontario. They were not on display at any location to be seen by potential dealers or customers. I should have thought that a person with the appellant’s marketing experience would have worked out a consignment arrangement with some dealer or marina (i.e., no financial outlay or risk to the dealer or marina) in order to keep more of his boats in the public eye. The net losses which the appellant reported for his business Martin Yachts Ontario in the years 1983 to 1986 were:

1983 $25,661

1984 $30,449

1985 $25,330

1986 $26,111

The above losses were not challenged by Revenue Canada and were allowed as deductions from employment income in the respective years. The appellant’s gross profit in 1986 was nil because he sold no boats in that year. His gross profit in the years 1983-84-85 ranged from a low of $1,991 to a high of $3,678. The net losses shown in the table above are in substance an accumulation of his operating expenses each year.

The following facts were well established by December 31, 1986: (i) the appellant had sold only four boats in the years 1983, 1984 and 1985;

(ii) no boats were sold in 1986; (iii) the Martin 242 had failed to make any significant impression in the Ontario boat market from 1983 through 1986; (iv) the appellant’s sole proprietorship operating under the name "Martin Yachts Ontario" had accumulated losses of approximately $107,000 in the years 1983 through 1986; and (v) the appellant’s 1983 business plan was a disastrous forecast of the Ontario market for the Martin 242. In the year 1986 when the appellant made no sales at all, he should have cut his losses; dumped his remaining two boats at sacrifice prices; and got out of the business. In my opinion, there was no reasonable expectation that the appellant’s business could recover and earn a profit in 1987 or 1988.

I cannot help but conclude that the appellant’s continuing efforts in 1987 and 1988 to sell the Martin 242 in Ontario were intertwined with the personal pleasure he derived as an avid sailor from competitive racing with his "demonstrator" boat. As an objective businessman, the appellant should have known by December 1986 that his business in sailing terms was becalmed. It was deprived of wind. It was dead in the water.

In Moldowan v. The Queen, [1978] 1 S.C.R. 480, [1977] C.T.C. 310, 77 D.T.C. 5213 Dickson J. (as he then was) wrote the judgment for the Supreme Court of Canada and stated at page 313-14 (D.T.C. 5215):

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.

In my opinion, the appellant’s profit and loss experience in past years (1983-1986) should have induced him to discontinue the business at the end of 1986. He had no training or experience in the distribution and sale of costly recreational products like sailboats. The retail price of a Martin 242 was in the range of $18,000. And finally, the appellant did not have adequate capital to display his variety of boats himself or finance one or more dealers to display the Martin 242. The allowance of the losses in the years 1983 to 1986 is understandable and consistent with a policy of allowing a new business to get started if at the beginning there is a reasonable expectation of profit. Three or four years of hard business experience can, however, change that expectation from "reasonable" to "no chance at all" after the third or fourth year. This was the hard experience of the appellant by the end of 1986.

My first instinct was to dismiss these appeals for 1987 and 1988 when the appellant reported the following financial results of Martin Yachts Ontario:

1987 1988

It can be seen that the remaining two boats were sold at losses of $2,519 in 1987 and $8,413 in 1988. I assume that these losses would have been realized if the remaining two boats had been sold at the end of the 1986 sailing season when, in my view, they should have been sold. Because these two amounts represent losses on the disposition of residual inventory which was on hand at the end of 1986, I will allow the appeals for 1987 and 1988 only to permit the deduction of $2,519 in 1987 and $8,413 in 1988. The appellant is not permitted to deduct any amounts with respect to operating expenses or capital cost allowance for 1987 or 1988. The appeals are allowed in part without costs.

Appeals allowed in part.