Arthur v. Carew v. Her Majesty the Queen, [1994] 2 CTC 2008, 94 DTC 1415

Sarchuk, J.T.C.C.:—At issue in this appeal is the claim of the appellant to deduct for tax purposes the amounts of $16,412.94, $18,366.53 and $18,245.15 in the 1983, 1984 and 1985 taxation years respectively.

Certain facts are not in dispute. The appellant is employed by Industry Canada and was at all relevant times resident in Ottawa. As at June 1, 1980 the appellant and his brother Alfred S. Carew each owned a 50 per cent interest in a partnership called A & A Enterprises. The partnership carried on two activities, Newfoundland Tourist Lodge (Tourism) and Québec Timber Limits (Timber).

From 1983 to 1985 Tourism produced the following income:

The appellant, in his returns of income for the years in issue, sought to deduct these losses as expenses incurred for the purpose of producing income. In addition to these losses the appellant deducted the amounts of $3,688.17, $4,753.25 and $9,294.09 respectively for property, office, general overhead and vehicle expenses incurred by the partnership.

The Minister of National Revenue (the Minister) disallowed the losses claimed by the appellant with respect to tourism as well as 50 per cent of the additional expenses claimed which related to tourism as follows:

The disallowance was based on the Minister’s assumption that the appellant did not have a reasonable expectation of profit from tourism during the taxation years in issue.

The appellant testified that attracting tourists to Newfoundland was a high priority for the provincial Department of Tourism, Recreation and Culture (the Department). He said that as early as 1980 the partnership considered developing a project designed to provide accommodation for tourists. The original plan was to engage in a charter group tour business in order to utilize local historical sites and recreation facilities. Apparently a provincial official was actively promoting this approach and, according to the appellant, the Department actively encouraged them. Various individuals were consulted, a “professional business plan" was prepared and a decision was taken by the partnership to proceed.

According to the appellant, the province had enacted strict legislation with respect to the licensing of tourist establishments. In 1976 it passed the Tourist Establishment Regulations, Nfld. Reg. 287/78 under the Tourist Establishments Act, R.S.N. 1970, c. 376. These regulations were comprehensive, defining various types of tourist establishments, and controlling construction and renovation thereof. They set minimum building requirements, laid down standards for water supply, fire prevention and prescribed minimum equipment and furniture standards. Section 55 of these regulations provided that no person other than the holder of a licence issued and valid under the regulations shall operate a tourist establishment in the province. The appellant was aware that the venture they were contemplating was subject to compliance with these regulations.

On April 21, 1981 the partnership acquired three furnished cottages at a price of $17,000 (bill of sale, Exhibit A-3). It is not disputed that they failed to meet provincial regulations. The appellant spoke of acquiring the land as well, and that in fact appears to be the case, however no evidence as to its cost was presented. The cottages were located in Avalon south of St. John’s in an area appropriate for tourism. It was intended, he says, to ultimately utilize them to support charter tours originating in St. John’s. The partnership proposed to gradually bring them up to required standards and then to build an additional six rental units as funds became available. In the interim they were to be available for limited recreational pursuits such as hunting, fishing, etc., since the fact that they did not meet licencing standards did not preclude such use. The appellant claims the cottages were offered for rent during the years in issue at the rate of $35 per night.

The partnership's plans were interrupted by an unexpected turn of events in 1982. That year the Department received a consultant's report which recommended a different approach to tourism (Exhibit A-6). The focus now was to be on a “destination area” concept. Primary destination areas were "of national or international significance because they contain attractions which are unique and of interest to national or international markets". St. John’s was an example of such an area. The report also identified a secondary destination area as one which offers "attractions which are distinctive but appeal to a smaller more specialized market". The partnership's project was located in such a secondary destination area. This approach by the Department forced the partnership to reconsider the charter tour approach previously contemplated.

Several other circumstances are alleged to have frustrated the orderly development of their initial plan. The partnership, at some point of time in 1982, acquired five property leases (cottage lots) from the Crown. These were apparently adjacent or contiguous to the cottage sites. The partnership did not plan to build on these lots during the years in issue. However when the Crown refused to grant an extension of time to commence construction they were forced to go ahead, failing which the leases would have been terminated. In 1984 basements were dug and foundations were poured, which according to the appellant was sufficient compliance with the Crown requirement. This, he added, required capital and deflected them from their original plan. A further circumstance which is alleged to have affected the partnership's ability to earn revenue during that period of time was the fact that charter tours suffered a decline in business as a result of a drastic increase in the price of gasoline.

These events led the partnership to put the three cottages "on hold". An unsuccessful effort to acquire adjacent property to enlarge the septic fields followed. In 1986 the partnership attempted to obtain a commercial block of land to provide camping trailer sites. The concept was accepted by the Department but final approval was not obtained by the partnership until 1988. In 1987 the additional five units were partly completed, i.e., they were enclosed and were ready to be finished on the inside. However, once again the partnership did not have sufficient capital to do so or to furnish the cottages to required standards.

At some time in 1989 or in 1990 [1] the partnership retained a consultant to prepare a marketing and development plan for the site premised on the destination concept and to prepare a financial plan for the partnership. The objective was to have six to nine cottages available to be marketed to longer term tourists. Provision was to be made for on-site attractions such as boat rentals, paddle boats, swimming, mini golf, etc. Concurrently they decided to change the "management structure" of the partnership and this resulted in the incorporation of Horse Chops Tourist Resort Inc. (Horse Chops) in December 1991 to carry on the business. It obtained a licence for the 1992 season which was renewed in 1993 and 1994. Included in this restructuring was the infusion of a substantial amount of new capital.

Appellant's position

1. The facilities were purchased in 1981 solely for tourist business purposes and a comprehensive business plan was prepared with the assistance of a highly qualified professional;

2. The business was conducted properly and all steps that reasonably could have been taken were in fact taken to implement the business in a timely and professional manner;

3. The business commenced operations in 1982 and revenues were earned in each of the taxation years;

4. Delays in reaching viability are not unusual in a project of this nature. The losses in the years in issue were merely start-up costs.

The appellant referred to Moldowan v. The Queen, [1978] 1 S.C.R. 480, [1977] C.T.C. 310, 77 D.T.C. 5213; Lemieux v. M.N.R., [1991] 1 C.T.C. 2180, 91 D.T.C. 450 (T.C.C.); The Queen v. Gorjup, [1987] 2 C.T.C. 129, 87 D.T.C. 5348 (F.C.T.D.); Whitmore v. M.N.R., [1990] 1 C.T.C. 2145, 90 D.T.C. 1018 (T.C.C.) and Interpretation Bulletin IT-364.

Respondent's position

During the 1983, 1984 and 1985 taxation years the appellant did not have a reasonable expectation of profit from tourism as that term is defined in Moldowan v. The Queen, supra, and as applied in Coupland v. The Queen, [1988] I C.T.C. 414, 88 D.T.C. 6252 (F.C.T.D.), Dreger v. M.N.R., [1985] 1 C.T.C. 2131, 85 D.T.C. 142 (T.C.C.), Deschênes v. Canada, [1993] 2 C.T.C. 107, 93 D.T.C. 5234 (F.C.T.D.).

Conclusions

Whether the venture under review is farming or some other type it is indisputable that Moldowan, supra, sets out the principles to be applied in determining what constitutes a business and whether a taxpayer can be said to have had a reasonable expectation of profit. In that case Dickson, J. (as he then was) said the following at pages 485-86 (C.T.C. 313-14, D.T.C. 5215):

Although originally disputed, it is now accepted that in order to have a "source of income” the taxpayer must have a profit or a reasonable expectation of profit. Source of income, thus, is an equivalent term to business: Dorfman v. M.N.R., [1972] C.T.C. 151, 72 D.T.C. 6131. See also paragraph 139(1)(ae) of the Income Tax Act which includes as “personal and living expenses" and therefore not deductible for tax purposes, the expenses of properties maintained by the taxpayer for his own use and a benefit, and not maintained in connection with a business carried on for profit or with a reasonable expectation of profit.

There is a vast case literature on what reasonable expectation of profit means and it is by no means entirely consistent. In my view, whether a taxpayer has a reasonable expectation of profit is an objective determination to be made from all of the facts. The following criteria should be considered: the profit and loss experience in past years, the taxpayer's training, the taxpayer’s intended course of action, the capability of the venture as capitalized to show a profit after charging capital cost allowance. The list is not intended to be exhaustive. The factors will differ with the nature and extent of the undertaking: The Queen v. Matthews [1974] C.T.C. 230, 74 D.T.C. 6193. One would not expect a farmer who purchased a productive going operation to suffer the same start-up losses as the man who begins a tree farm on raw land.

Applying these principles to the evidence before me I conclude that the venture in which the appellant was engaged with his brother in taxation years 1983, 1984 and 1985 was not carried on with a reasonable expectation of a profit.

A great deal of reliance is placed by the appellant upon the purported success of the project in 1992, 1993 and 1994. A draft financial statement for the year ended November 30, 1992 discloses gross revenues of $103,413 and net income of $3,131 (Exhibit A-1, Alfred V. Carew) [2] . That is small comfort to the appellant since the commercial venture as it existed in 1992 is light years removed both from what was initially planned for the site and, more to the point, what was actually done by way of "carrying on a business” during the relevant years. Thus, the results in terms of gross revenues and potential profitability are of limited relevance to my determination of the issue.

What is significant with respect to the years in issue is that the partnership never intended to have more than the three original cottages available for rent and then only on an extremely limited basis. They could not be rented to tourists because they did not meet provincial standards. It is also of some interest that the Federal Business Development Bank (FBDB) financial plan prepared in 1990 refers to these cottages in the following terms:

While the property contains three cabins, they are considered to be of nominal value without the benefit of $70,000 renovations included in program.

It was not until 1992, after Horse Chops was incorporated, that the Department issued a licence permitting the operation of a tourist establishment on that site.

With regard to the appellant’s so-called business plan (Exhibit A-5) I note that it is said to be based on a consultant’s report prepared for the partnership prior to the acquisition of the property in 1981. Only five pages of this plan were provided to the Court. The first page purports to be a balance sheet as of January 1, 1982. There is no mention of the partnership therein nor is there any other notation in the document to identify it as having been prepared for the tourism venture. If it is intended to show the financial status of this venture as of January 1, 1982, it is on its face inaccurate. For example: land is valued at $500 and the aggregate value of the buildings, furniture and fixtures is stated to be $44,000. Both are inconsistent with other evidence before me. The second page of this plan purports to be an income statement which according to the appellant projected income of $100,000 for year ending December 31, 1982. This document raises a number of questions: who was the author and what are his qualifications; what factors were taken into account by him; what is the basis for the payroll expense projections; how are the building expenses determined; what do the loan interest payments reflect; what is the capital required? Absent such evidence I cannot justify giving much weight to this document. Furthermore, there is no evidence that any steps were taken by the partnership with respect to the organization, financing or implementation of the "charter tour concept".

As to the appellant's assertion that the use of the three cottages for nonlicenced recreational purposes would produce a sufficiently reasonable return to allow the partnership to continue with its plan, I note the following. This assertion is based on the rentals proposed and the length of the season, being May 15 to October 15. The rent the partnership proposed for the cottages was $35 per night. Documentary evidence, however, indicates that in 1983 they were occupied by relatives for a period of 97 days at $10 per night; by another relative for eight days at $20 a night and by work crews hired by the partnership for 39 days at a rate of $15. Similarly in 1984, relatives occupied the three units for a total of 98 days at rates from $15 to $20 per night while a work crew utilized the units for 28 days at $15 per night (Exhibit R-4). No record is available for 1985 but the evidence is that the rentals were similar in nature and revenue.

The financial results in the 1986 and 1987 years were no better, the appellant claiming $8,047.90 and $4,541.60 as his share of partnership losses from tourism. [3]

What is most striking about this venture is the lack of capitalization during the years in question. For example, as late as 1987 funds were still not available to complete the additional five units to required standards. This situation existed at all relevant times until at least 1991. A proposal for financing was made by the FBDB on August 27, 1990 (Exhibit A-3, Alfred V. Carew). [4] It contemplated an ACOA contribution in the amount of $275,000 and a term loan from the FBDB for $75,000. While these are the amounts discussed in the financial projections there is little evidence as to the final amounts advanced by the FBDB. However it can safely be assumed that they were substantial.

The appellant also argued that the activities in the taxation years in issue were sufficient to categorize the expenses incurred in those years as start-up costs, and that it was necessary to consider the partnership enterprise as a whole following a reasonable period of operation which must include taxation years 1991,1992 and 1993. He relied on Lemieux, supra, and argued that the respondent had acted prematurely in deciding that there was no reasonable expectation of profit in the three years in issue.

In my view the appellant was never carrying on a business in any sense of the word in the years in issue. On any objective assessment of the evidence the only conclusion is that if a tourism business was carried on at any time it did not begin until 1991 when Horse Chops was incorporated and when sufficient capital was injected into the venture. Only then might it be rationally argued that a reasonable expectation of profit existed.

The appellant also argued that the partnership's business during the taxation years in issue was the rental of "housekeeping tourist cottages" which was analogous to the operation of a hotel. Thus the date when the business commenced was not the day when it opened its door to guests but would be such earlier time when construction of the hotel was underway and arrangements were being made on preliminary requirements of an operating hotel. This he said was the Minister’s position as set out in his Interpretation Bulletin and was applicable to the partnership’s business.

The appellant’s argument presupposes the existence of a business. But that is not the case here. An analysis of the appellant's course of action in the taxation year in issue; the capability of the venture, as capitalized, to show a profit and its actual performance in terms of gross revenues unequivocally demonstrates that no genuine business was being carried on. The losses incurred are not in my view the start-up losses of a business.

I turn next to the property, office, vehicle and general overhead expenses. The appellant has failed to establish, on a balance of probabilities, that the Minister’s assessment limiting the deduction to 50 per cent of the amounts claimed was wrong.

Second issue

The appellant also argues that the Minister of National Revenue failed to comply with the provisions of paragraph 165(3)(a) of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the "Act") which read:

165(3) Upon receipt of a notice of objection under this section, the Minister shall,

(a) with all due dispatch reconsider the assessment and vacate, confirm or vary the assessment or reassess, or. . ..

and he shall thereupon notify the taxpayer of his action by registered mail.

The appellant argued that there were unwarranted delays in the Department's review of his notice of objection. The excessive length of time was inappropriate and caused undue hardship to the appellant.

The reassessments were made on December 5, 1988 and February 26, 1989. notices of objection were filed shortly thereafter and confirmations of the assessments were dated April 16, 1991. While two years may be longer than one expects the Minister should take to review the notices of objection and to issue notices of confirmation, the fact remains that the appellant had at his disposal a most expedient method to accelerate the process. I am referring to the provisions of subsection 169(1) which reads:

169(1) Where a taxpayer has served notice of objection to an assessment under section 165, he may appeal to the Tax Court of Canada to have the assessment vacated or varied after either

(a) the Minister has confirmed the assessment or reassessed, or

(b) 90 days have elapsed after service of the notice of objection and the Minister has not notified the taxpayer that he has vacated or confirmed the assessment or reassessed;

but no appeal under this section may be instituted after the expiration of 90 days from the day notice has been mailed to the taxpayer under section 165 that the Minister has confirmed the assessment or reassessed.

In these circumstances I do not believe the appellant is entitled to the relief sought.

The appeal is dismissed with costs to be taxed.

Appeal dismissed.