Graeme Nichol v. Her Majesty the Queen, [1993] 2 CTC 2906, 93 DTC 1216

Bowman, T.C.C.J. (orally):—These appeals are from assessments for the appellants 1986 and 1987 taxation years. The appeal for the appellant’s 1986 taxation year has to do with losses sustained by Mr. Nichols in an unsuccessful venture involving a semi-professional baseball team in London, Ontario, the "London Royals”. The appeal for 1987 involves the imposition of a late filing penalty.

I can deal very quickly with the appeal for 1987. Mr. Nichols filed his 1987 return a year late and the Minister imposed a penalty under subsection 162(1) of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the "Act"). Mr. Nichols’ excuse for late filing his 1987 return was he was waiting for the Department to advise him of their position on the deductibility of 1987 losses sustained on the London Royals venture. Subsection 162(1) does not, on the face of it, give the Minister a discretion in the imposition of penalties. Even if subsection 162(1) were susceptible of an interpretation that permitted "a reasonable excuse for not filing on time” as a defence to a penalty under that subsection, or were susceptible of some sort of due diligence defence, a point which I am not deciding, Mr. Nichols’ excuse is certainly not a reasonable one.

The penalty for failing to file a return on time is one of at least strict, if not absolute liability. I am using these terms in conformity with the decision of the Supreme Court of Canada in The Queen v. Sault Ste. Marie (City), [1978] 2 S.C.R. 1299, 85 D.L.R. (3d) 161. Mr. Nichols could easily have filed his 1987 return and claimed the loss. If the Department did not agree with it they would no doubt let him know. The appeal for 1987 is therefore dismissed.

So far as 1986 is concerned the question is whether a loss of $19,440.34 sustained in connection with a baseball team, the London Royals, is deductible by Mr. Nichols as a business loss against his other substantial income as an executive with Federal White Cement Ltd. The Minister disallowed the loss on the basis that in 1986 the appellant did not have a "reasonable expectation of profit” from the operation of the London Royals. This somewhat cryptic reason given in the reply to notice of appeal implies a premise that since there was no reasonable expectation of profit" there was no "business", on the basis of an observation made by Mr. Justice Dickson, as he then was in Moldowan v. The Queen, [1978] 1 S.C.R. 480, [1977] C.T.C. 310, 77 D.T.C. 5213, and that therefore the expenses were not laid out for the purpose of gaining or producing income from a business.

It must be borne in mind that the expression “ reasonable expectation of profit" is lifted from the definition of“ personal or living expenses”, in section 248 of the Income Tax Act. That section read as a whole obviously has no application here. Nonetheless, the Department of National Revenue seems to regard the expression as having a significance and existence independent of the definition of "personal or living expenses”.

I shall deal with the matter as if the Minister’s use of the expression “reasonable expectation of profit” were justified without reference to the definition of “ personal and living expenses”.

Mr. Nichols, in the years in question, was a successful executive with Federal White Cement Ltd., having previously held a number of senior positions with Canada Cement Lafarge. He was born in 1931 and graduated in 1954 from the University of Toronto with a B.Sc.

During his life he has been involved with amateur baseball both in Quebec and the western provinces and he has significant experience in the area of baseball, although not in the field of running a baseball club as a commercial venture.

He moved to London, Ontario in 1981 where he observed that the senior baseball team in London, the London Majors, consisted largely of players over

30. He conceived the idea of starting a new team which could compete with the Majors. He believed that there was a place for a younger baseball team and that it would be commercially viable. He did a certain amount of research having determined the attendance levels at the Majors' games and the sort of revenues that could be expected. Before the 1984 season and before putting the London Royals baseball team together, he made projections in which he projected revenues and expenses for 1984, 1985, 1986 and 1987. He showed the projections to the comptroller of Federal White Cement Ltd., who expressed the view that they looked reasonable. The revenues projected were from a variety of sources including game draws and souvenirs, tickets at the gate, program and advertising, patrons and donations, tournament prizes, player assessments and other revenues. The revenues projected for 1984, 1985, 1986 and 1987 were, respectively, $11,325, $16,100, $25,140, $30,275. They projected expenses as well, $21,600 in 1984, $25,300 in 1985, $24,950 in 1986 and $25,050 in 1987. Therefore they expected losses for the first two years and a profit thereafter.

As it turned out the actual results were quite different from the projections. The projected and actual expenses were relatively close, but the revenues in all of the years fell significantly short of the projections.

The Minister of National Revenue allowed his losses in 1984 and 1985 but disallowed them for 1986 and 1987. The appellant does not dispute the disallowance of the losses for 1987.

The Minister's position is that the London Royals was not a business carried on with a reasonable expectation of profit, but rather was a hobby, a labour of love, or an activity carried on by Mr. Nichols with an idealistic or civic-minded motivation having nothing to do with any commercial animus. There is merit in this position. Such considerations were no doubt a factor in what Mr. Nichols did.

I think, however, that the operation of the London Royals was, albeit risky, a commercially motivated operation in which given Mr. Nichols’ background and business experience it was not unreasonable to expect a profit. Starting and running any enterprise in the sports and entertainment field is highly risky. It is capable of producing large revenues or large losses. I do not think that it is appropriate for the Minister of National Revenue, who is quite ready to share in the success of an enterprise, to deny the deduction of losses where, with the benefit of hindsight, he considers that the taxpayer should have foreseen that his project would fail. The planning and the projections of the London Royals had too many of the badges of trade and, if I may say so, the indicia of commerciality to be dismissed as a mere hobby or an idealistic labour of love.

In a recent decision of this Court in E/b Productions v. MNR, [1991] C.T.C. 2661, 91 D.T.C. 1466, the Court made this observation at pages 2662-63 (D.T.C. 1467-68):

l accept that the money was spent in good faith in the hope and expectation that it would result in a profitable enterprise. The fact thatMr. English made an error in judgment and that his expectations turned out to be wrong is not, in itself, a reason for denying deductibility. As Cattanach, J. observed in a somewhat different context in Gabco Ltd. v. M.N.R., [1968] C.T.C. 313, 68 D.T.C. 5210; it is not the place of this Court or of the Minister of National Revenue, after the event, to second- guess a taxpayer's business acumen. At page 323 (D.T.C. 5216) Cattanach, J. said:

It is not a question of the Minister or this Court substituting its judgment for what is a reasonable amount to pay, but rather a case of the Minister or the Court coming to the conclusion that no reasonable businessman would have contracted to pay such an amount having only the business consideration of the appellant in mind. . . .

Risky enterprises sometimes succeed and become taxable. Where they fail it would be unconscionable for the entrepreneur to be penalized because the Minister, basing his decision on the wisdom of hindsight, concludes that the project was not commercially viable.

I do not accept the respondent's contention that there was no reasonable expectation of profit. In Moldowan, a decision of the Supreme Court of Canada dealing with section 31 of the Income Tax Act. Mr. Justice Dickson, as he then was, stated at pages 485-86 (C.T.C. 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. The factors wi differ with the nature and extent of the undertaking.

Applying the tests enunciated by Mr. Justice Dickson in Moldowan, I think on the evidence that there was a reasonable expectation of profit in 1986.

Essentially, what the Minister is saying is that, at the end of 1985, when the revenues had fallen significantly short of the projections, the appellant should have realized that 1986 would not be a successful year and he should therefore have cut his losses and stopped the business in that year. It is a matter of business judgment whether to start a business and it is a matter of business judgment whether and when to terminate it. This taxpayer made the business judgment to continue the operation for another year notwithstanding the results of the 1985 season. He hoped to turn the business around by forming a new league in 1985, to which the Royals would belong, and in 1986 to improve the team's performance by creating a farm team and by persuading the Canadian Press to give much greater publicity to the Royals’ games.

As it turns out none of these remedial actions worked and he discontinued the operation after 1987. He made what might, in retrospect, be seen as an error in judgment but it was a matter of business judgment and it was not one so patently unreasonable as to entitle this Court or the Minister of National Revenue to substitute its or his judgment for it, or penalize him for having made a judgment call that, with the benefit of 20-20 hindsight, that Monday morning quarterbacks always have, I or the Minister of National Revenue might not make today. We were, after all, not there in 1986.

There is one further point that merits comment since it was mentioned in argument. Of the $19,440.34 loss claimed by Mr. Nichols in 1986 over $12,000 is accounted for by the salary he paid to his wife for her work in the administration of the baseball club. It was not suggested that this was an improper or unreasonable expense, or some disguised form of rudimentary income splitting, although it does have that effect to some degree. Mrs. Nichols presumably included this salary in income and paid tax on it, albeit probably at a lower marginal rate than the appellant. Nonetheless, the effect would be to erode, indeed to completely eliminate, Mr. Nichols’ claim for a marital exemption. As a result the overall loss to the fisc of allowing the loss to Mr. Nichols is less than might at first blush be the case. The alternative, that of disallowing a loss of which about 63 per cent consists of a salary paid to the appellant's wife, viewed in terms of its overall economic impact on the Nichols family unit, would involve an element of double taxation which as a matter of policy seems to me to be undesirable. These considerations do not and should not affect my decision but they are matters of which both the Court and the parties should be aware.

Accordingly, the appeal for 1987 is dismissed. The appeal for 1986 is allowed and the assessment is referred back to the Minister of National Revenue for reconsideration and reassessment to permit deduction in the computation of Mr. Nichols’ income of the loss of $19,440.34. Gentlemen, will you give me some guidance as to costs? You were successful for 1986 and you went down in flames for 1987. It is true there is not too much time spent.

MR. TILLMAN: There was not a lot of time spent on 1987 and certainly the benefit to the taxpayer for the success in 1986 is better than our loss for 1987. I think that in itself should have some merit for consideration of costs. Being successful in 1986 I don't think the taxpayer should be penalized at all for his loss in 1987, little time was spent on the 1987 appeal and the bulk of the evidence was directed towards 1986, let me just put it that way. I think as well there was the ability of both the taxpayer and the Minister to reduce the issues and reduce the amount of evidence that would have been called by either party at trial.

HIS HONOUR: Mr. Leclaire, what do you have to say?

MR. LECLAIRE: Very little can be said, I am up against reasonable counsel who says reasonable things.

HIS HONOUR: I agree he is reasonable, should we just award costs to you?

MR. TILLMAN: Yes.

MR. LECLAIRE: Could I just ask does this day not enter into the calculation?

MR. TILLMAN: Oh sure. I agree totally with that. I think we should have the costs of the day.

HIS HONOUR: Okay. I will make an order for costs in favour of the appellant for one day.

MR. TILLMAN: Thank you.

HIS HONOUR: Thank you gentlemen. Once again let me express my appreciation for the exceptionally fine counsel work done by both counsel.

Appeal allowed in part.