Grace Ellis v. Her Majesty the Queen (Informal Procedure), [1994] 1 CTC 2349, 94 DTC 1731

Rowe, D.J.T.C.C.:—This appeal was heard under the informal procedure of this Court.

The appellant appeals from a reassessment of income tax for the 1988, 1989 and 1990 taxation years. In computing income for the 1988, 1989 and 1990 taxation years, the appellant claimed business losses in the amounts of $7,884.05, $9,699.96 and $5,343 for each year, respectively. In reassessing the appellant for the years under appeal, the Minister of National Revenue (the "Minister"), inter alia, disallowed expenses in respect of interest, utilities, property taxes, insurance and Class 3 capital cost allowance (CCA) on the oasis that expenses incurred in respect of the work space in the home cannot be used to create or increase a loss from the business for which the work space was used in accordance with subsection 18(12) of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the "Act"). Further, the respondent disallowed expenses in the sum of $1,512.87 in respect of purchases prior to the 1988 taxation year on the basis they were not incurred for the purpose of gaining or producing income from a business or property within the meaning of paragraph 18(1 )(h) of the Act.

The appellant’s position is that her business commenced during 1987 which impacts on the calculation for the capital cost allowance in the 1988 taxation year and also that the Minister is incorrect in the determination that the work space used by the appellant was part of the self-contained domestic establishment of the taxpayer and therefore subject to the limitations imposed by paragraph 18(12)(b) of the Act. Also at issue was whether or not the Minister was incorrect in partially disallowing, as an expense, certain material purchases which were made by the appellant prior to the 1988 taxation year for the purpose of earning income.

The appellant testified that she resides in Melfort, Saskatchewan and, beginning in 1950, had been a teacher in music and home economics in the local school system. She has always been interested in art and took various classes throughout the years intending to use those acquired skills in operating her own Business, dealing in pottery and stained glass, when retirement from teaching would permit her the opportunity. In 1980, she began to gradually accumulate supplies for her intended business. She chose a name for the enterprise—Gifts of Grace—and had stickers made up for use in the business to identify her products. At that time her name was Grace Carlson but in 1985 she remarried and became Grace Ellis. In 1986, through an early retirement offer forthcoming from her employer, she was able to leave her teaching position and to pursue her business plans. She went to Regina and obtained information about starting a small business. In the autumn of that year she looked for office space in Melfort at the local mall and discovered the rent was too expensive for her needs and also that the regulations did not permit the operation, inside the mall, of a natural-gas kiln, which was needed for making pottery. After some further consideration of space requirements, she decided to build a studio at her residence over top of a flat-roofed garage which was attached to the house. She also made plans for the construction of a kiln shed at the rear of the property. On March 25, 1987, she registered the business name, Gifts of Grace, with the Saskatchewan Ministry of Consumer and Commercial Affairs. In this document (Exhibit A-2) she indicated the starting date of the business would be November 1, 1987. In June, 1987, the appellant opened a business account at the Melfort Credit Union. She obtained the necessary building permit to undertake the construction necessary to build the studio and work commenced in September, 1987. The exterior work was completed by December, 1987 but there was interior work remaining which was completed by the appellant and her husband, except for the installation of drywall.

In November, 1987, a teacher at the school became ill and the appellant returned to teaching to fill that vacancy on an interim basis. It turned out that she taught for the ensuing five months and was unable to work on her business except-in the evenings. After completing her duties as a replacement teacher, the appellant placed her name on a list of teachers available for substitute teaching and drew unemployment insurance benefits for a certain period. The doors to the studio were opened to the public on December 16, 1988. At that point, the shelves were fully stocked and the inventory, previously stored in a former recreation room in the house, was moved to the new work space. Beginning in 1987 and throughout 1988, the appellant had manufactured pottery, stained glass, made up gift baskets and other items which were made available for sale upon the opening of the business for retail sales. She obtained business advice from a local accountant on keeping business records and purchased supplies for that purpose. During the preceding years, she had maintained a system of keeping receipts for business purposes in separate envelopes and recorded only those items which were eventually to be used in the business. She had followed this practice since 1976, always with the view in mind that she would open up her own shop. Filed as exhibits were the synoptic (Exhibit A-3) and a series of envelopes (Exhibits A-4 to A-10, inclusive) containing invoices for purchases of various items from 1981 to the end of 1987. The appellant stated that by March 25, 1987 she had on hand boxes of raw clay, sheets of raw glass, craft supplies and several items which had been created from these materials. The materials were generally worth more than their original cost as prices had risen in the interim and value had been added by the addition of artistic endeavour. She consistently segregated those purchases which were for personal use. In order to carry out the construction of the studio over the garage and the erection of the kiln shed, and otherwise to be able to open her business, the appellant borrowed the sum of $25,000 from the Credit Union and later obtained additional financing to complete the project. In order to permit access of potential customers to the studio there was an outside entrance with stairs leading to the upper level. A sign was placed outside a large window facing the street and there was a sign on the highway indicating the existence of the business known as Gifts of Grace. In addition, the City of Melfort had installed a street sign pointing out to passersby the location of her craft shop. In May, 1993 the appellant and her husband, created a videotape (Exhibit A-12) for the purpose of explaining the nature of the work done and the physical set-up of her business premises. The stages of construction were demonstrated by the use of photographs, developed as slides, and then captured on video film. The video displayed the exterior and interior of the premises and the separate kiln shed at the rear of the property. Customers entered the studio by walking from the street to the house and then following a concrete path between the edge of the house and a fence on the property line, to a set of stairs leading upwards to the studio. The appellant stated the studio at the end of December, 1988 was basically the same as that depicted by the video, created in May, 1993. Located in the studio were two electric kilns, operated on high voltage current, two glass grinders, a water source, and a permanent fixture used as a table for working on glass. A bathroom was located on the business premises with a shower as her work required exposure to lead and other chemicals and she would change clothes prior to re-entering the ordinary living portion of her house. The appellant explained she was able to gain access to the master bedroom in the house from the studio and also by means of a catwalk connecting the two areas. The house has three bedrooms and a full basement and the appellant stated the studio portion was never used for sleeping. In fact, there was never any other use of the studio except for business purposes.

In cross-examination, the appellant identified the loans for the business as follows: June 25, 1987—$25,000, and October 26, 1987, an additional sum of $15,000. The construction of the studio began in September, 1987 and was completed about the end of November white the kiln shed was completed early in 1988. The appellant agreed that in her 1988 taxation year she received unemployment insurance benefits in the sum of $10,922, as set forth in her return of income, but the only work available to her would have been in the field of substitute teaching. In the 1989 taxation year, her unemployment insurance benefits were in the sum of $599. The appellant indicated that some materials purchased over the years had been used by her in various classes but that she regarded those expenditures as enabling her to become ready to open her business. She agreed the Minister allowed 100 per cent of all 1988 purchases and 75 per cent of all 1987 purchases as being for the purpose of the business but that other purchases made as early as 1979 were not properly recognized by the Minister as being for the business. The appellant stated the house and studio shared the same water service and electrical supply, with the addition of a special service panel to handle the load demanded by the electric kilns. The natural gas supply was on the same meter. The business licence issued by the City of Melfort is a homeoccupation licence and there were no separate property taxes levied in respect of the portion of the overall premises occupied by the studio and the home insurance package covered the entire property.

Counsel for the appellant submitted that the appellant was entitled to an additional sum of $1,512.87 for purchases made for business purposes prior to the 1988 taxation year. Further, he submitted the business was commenced prior to the end of 1987, and the Minister should calculate CCA on that basis, instead of allowing only 50 per cent on Class 8 assets. Counsel submitted that the kiln shed at the rear of the premises was clearly a separate facility and that the studio, having regard to the overall context of the business operation, was also a separate premise from the house and should therefore not be treated as subject to the limitation imposed by subsection 18(12) of the Act.

Counsel for the respondent submitted that the business premises were part of the appellant’s residence and that apart from the shared utilities, there were two access routes from the studio to the house, one through the appellant's bedroom. As for the remaining portions of the reassessment, the Minister had been generous in allowing purchases for business purposes and there was no need to disturb those calculations.

First, I will deal with the main issue as to whether or not subsection 18(12) of the Act applies to limit the losses of the appellant. That particular subsection provides as follows:

18 (12) Notwithstanding any other provision of this Act, in computing an individual's income from a business for a taxation year,

(a) no amount shall be deducted in respect of an otherwise deductible amount for any part (in this subsection referred to as the "work space") of a self- contained domestic establishment in which the individual resides, except to the extent that the work space is either

(i) the individual’s principal place of business, or

(ii) used exclusively for the purpose of earning income from business and used on a regular and continuous basis for meeting clients, customers or patients of the individual in respect of the business;

(b) where the conditions set out in subparagraph (a)(i) or (ii) are met, the amount for the work space that is deductible in computing the individual's income from the business for a taxation year shall not exceed the individual's income from the business for the year, computed without reference to the amount; and. . . .

The term, "self-contained domestic establishment" is defined by section 248 of the Act as follows:

“self-contained domestic establishment” means a dwelling house, apartment or other similar place of residence in which a person as a general rule sleeps and eats;

In the present appeal, the appellant constructed a studio as a work space over a garage which was attached to the house in which she lived. The question is whether or not the area referred to as the studio, used exclusively for business purposes, was "any part of" a self-contained domestic establishment in which the appellant resided. The studio space was connected to the rest of the house by two interior passages, one through a bathroom into the appellant’s bedroom, both of which could be locked to prevent public access. Webster’s Dictionary, 1988 edition, defines "part" as ‘’a portion, fragment or section of a whole’’. The 1986 edition of the Oxford Reference Dictionary, Clarendon Press, defines "self-contained" as "complete in itself; (of accommodation), having all the necessary facilities and not sharing these".

Counsel for the appellant referred to the decision of the Supreme Court of Canada in Bell v. Ontario (Human Rights Commission), [1971] S.C.R. 756, 18 D.L.R. (3d) 1, in which the Court held a three-room flat, without a separate outside entrance, may well have been a "dwelling unit" but was not one that was "self-contained". The argument on behalf of the appellant is that she eats and sleeps in her residence and does not use the studio/store premises, which does have a separate outside entrance, for any of those domestic purposes. In my view, for the purposes of the subsection, that is looking down the wrong end of the telescope. The fact is that the studio/store area, falling within the definition of work space, is clearly a part of the residence of the appellant, which is indeed a self-contained domestic establishment. By comparison, the kiln shed at the rear of the property, standing alone without physical attachment to the house, is not. Although potential customers could enter the business premise from the outside, the studio was still physically connected to the house and was accessible therefrom without having to go outside and shared the electrical, water and heating facilities. It is probably safe to assume the legislators in enacting the subsection at issue had an eye on the typical home office in which a portion of the residence, although possessing a business identity, is still readily identifiable as forming a part of the domestic establishment. The appellant, for reasons of practicality and cost efficiency found it expedient to construct her business premises in the manner she did, and from the perspective of the public, was able to create a sense of a separate entity by design, provision of walkway, stairway and entrance, and by the appropriate use of signs. In such a way she was able to distinguish her business from what might ordinarily be expected from an “in-home” business establishment. However, such distinction by way of perception, does not detract from the fact the studio was an area which formed a part of the appellant's residence. In order to apply, the subsection does not require the smell of home-baked bread wafting into the work space. The Minister was correct in applying the limitation imposed by subsection 18(12) of the Act to the years under appeal.

I am satisfied the appellant kept a record of purchases made between 1979 and 1988 with a persistent view to using them in her business either as raw inventory or a value-added product. However, it is clear that she regarded the cost of certain classes in pottery or glass staining and the requisite instructional materials as being a business expense. It was not a business expense as none existed prior to 1987 and in any event the tuition and material for the classes would be a capital item. There is no evidence upon which I can be satisfied that the Minister was incorrect in disallowing portions of the appellant's claim to deduct certain purchases of material acquired prior to 1988.

Originally, the Minister found the start of business to have been December 16, 1988 and allowed 15/365 CCA on Class 8 assets. Later, the Minister allowed one-half of the CCA on Class 8 assets acquired between 1979 and 1987 on the basis the appellant did not use these assets in the business until the 1988 taxation year. I am satisfied on all of the evidence that the appellant was in business by November 30, 1987. She had registered her business name, opened a bank account, borrowed money for construction, obtained building permits, hired contractors and undertook a process of manufacturing, collecting, and sorting items for sale in her retail premises. She and Mr. Ellis worked on preparing the interior of the premises and installing the necessary fixtures and equipment. The appellant had acquired various items for sale over the years and was continually preparing for the day upon which the doors would be open to the public. Having regard to all of the evidence and in accordance with the jurisprudence (see M.N.R. v. M.P. Drilling Ltd., [1976] C.T.C. 58, 76 D.T.C. 6028 (F.C.A.)), I find the appellant was in business as of November 30, 1987. On that basis the appeal is allowed and the matter is referred back to the Minister for reconsideration and reassessment as it affects calculations of CCA or any other matters dependent on the starting date of the business.

The degree of success attained by the appellant is not sufficient, under the Rules, to entitle her to costs.

Appeal allowed in part.