Christopher S. Lobban v. Minister of National Revenue, [1992] 2 CTC 2552, 92 DTC 2196

Margeson, T.C.C.J.:—In 1984 and 1985 the appellant claimed business losses in the amount of $14,809.60 and $21,295 respectively with respect to his activities of writing and editing. The Minister of National Revenue in reassessing him for those years allowed only a portion of the expenses claimed and disallowed the amounts of $10,125.19 in 1984 and $18,928.14 in 1985. The reassessments were confirmed and from these confirmations the taxpayer appealed.

Facts:

The facts, as disclosed by the evidence before me, prove that the appellant at all relevant times was a professor at the University of New Brunswick. He was also an author and editor and indeed the respondent has conceded this point.

The appellant has a Ph.D. from Simon Fraser University in British Columbia and is presently employed at the University of Guam as a professor of biology. The expenses that are in issue were largely incurred while the appellant was writing a book on "Food Crops" which was introduced as Exhibit A-5 and entitled a manuscript to the "Gastronomic Garden". Exhibits A-1 to A-9 were introduced into evidence and attest to the appellant's expertise and knowledge, not only in the field of biology but also as an author and editor. He has been writing and editing since his teens.

The avowed intention of the appellant was to make money as a writer and editor. He stated that he did not consider his writing to be a mere hobby or pastime but rather a business. He commenced work on Exhibit A-5 in 1984 out of an interest in food crops. There did not seem to be a book available on this subject, especially one which showed what food crops looked like and he felt that this kind of work would sell well in bookstores. In order for it to be successful in the marketplace the book would have to have large glossy pictures and so photographic expenditures were a significant element in the cost structure.

Before the book was started the appellant looked at the existing literature to see what the competition was like and concluded that there was none and that this project could be a profit-making venture. He commenced by collecting photographs of plants. He was a photographer himself with twenty years' experience and felt it was cheaper for him to take his own photographs rather than buy them from publishers where the cost might vary from $150 to $1,000 per photograph.

The evidence disclosed that he took 20,000 photographs between the years 1984 and 1987 with respect to the Food Crops" book and this required him to travel to many different parts of the country and to foreign countries as well, also requiring him to purchase equipment for these tasks and incur substantial travel expenses. The appellant said that the primary purpose of these trips was research and in making use of the trip to gather information for his book. He stated that the claimed expenses related only to his book and that the research part of the trip was often paid for by the university and he had not claimed these expenses.

The appellant said he had contacted possible publishers with respect to the relevant work directly and through a literary agent. He testified that he contacted Cambridge University Press as to the proper direction for the book in order to make it” publishable” and "profitable".

When the appellant moved to Guam it was necessary to postpone completion of the work, there were also new editors at Cambridge University Press which necessitated such action but he said that the publishers now seemed ready to proceed with it and he contemplates finishing his work by the end of 1992, completing the manuscript by the summer of 1993, having the work published in 1994 and having royalties from it by 1995, with most of his remuneration coming in 1996.

In direct examination the appellant was referred to paragraph 7 of the reply and pointed out that the cost of the supplies and materials referred to books and materials that had to be obtained, photographic expenses, postage for processing and printing and the cost of camera equipment. When referred to paragraph 8 of the notice of appeal he explained that there were more expenses for materials and supplies in 1985 than in 1984 because they took more photographs and did more travelling.

In very general terms, the appellant explained that he had hired an assistant, who later became his partner, and later his wife, and this assistant was paid either a salary or an honorarium for such duties as "doing the leg work, doing research, finding plants, obtaining photographs" and in general, assisting the appellant as he requested.

An effort was also made to explain why a portion of the cost of rental of various properties was charged to this project, be it a room or part of a room and the appellant said that it was based upon the percentage of floor space used and that the space was used solely for business purposes. Further the appellant said he prorated the expenses of various trips such as Jamaica.

When referred to various other expenses such as interest on his line of credit he said that this was necessary to enable him to travel and to buy equipment. When referred to the claims for motor vehicle expenses he said that they related solely to the business and were not for his own personal use.

In concluding his direct testimony, the appellant said that he became interested in publishing this work as a venture and expected to earn $5,000 a year from it over a period of ten years.

In cross-examination the appellant said that ten years was a common length of time to spend on a book before it came to fruition. He did admit that when he started in 1984 his timetable was to finish the work by 1989, publish it by 1990 and obtain revenue from it by 1991, but as he now knows this was optimistic, but even if he had known it would take this long, he still maintained that he would have started the work.

The appellant was shown a letter to Revenue Canada from him in 1986 in which he indicated he expected to finish the work by 1986, publish it in 1987 and obtain royalties by 1989. He agreed that this was based on nothing more than optimism and was nothing more than a guess on his part. He felt there was a market for the book as he was a botanist, was aware of what was being sold and what was successful. He admitted that out of the 20,000 photographs taken only 250 would be used in the finished product. He also agreed that he had not done a cost comparison as to the use of photographs he had taken or photographs that he could purchase from stock agents. He had no idea as to the cost of the 250 photographs if purchased, but he said he would have to buy them beforehand and pay for them. Further he indicated that all the photographs he required might not be available and ultimately he might not use all those that were purchased.

The appellant was asked as to whether he consulted a publisher to consider the cost of the book and what revenues would be expected, and he said he had not but doubted that a publisher could give him those answers in any event.

It was suggested to the appellant that he had claimed $102,000 of expenses since 1984 in his writing venture and this was not denied. He did say that he now has a stock of photographs that can be used over and over again and earn him income for the rest of his life but he had no estimate as to the amounts of potential income from them.

The appellant was questioned in detail about the salary paid to his assistant, such things as the terms of employment, the hours of work, the hourly rate and the amount of work performed for the pay. He and his assistant were married on June 1, 1985. He was closely questioned about automobile expenses, repairs, travel expenses, food crop purchases, property rentals in various places, office expenses, society and subscription dues, cassette purchases, and cost of meals and was asked to explain why he felt these expenses were claimable in the years in question.

The appellant said that 80 per cent of the expenses claimed in the years in question related to the "Food Crops" book and that he expected royalties of $50,000 from it. When it was suggested that he had expenses of over $100,000, and only expected $50,000 in royalties and was therefore asked to explain how he could reasonably expect a profit, he answered that the expenses related to all his business as a writer over the period in question and not just to the" Food Crops” book.

The respondent called Mr. Lester Brown who was a field auditor for Revenue Canada in 1986 and 1987 and who performed the audit on the appellants file. He said the reason for the audit was because there was a large amount of expenses claimed and a small amount of reported revenue. He referred to his working papers prepared by himself in the course of his audit. He introduced Exhibit R-4 and compared the totals of expenses as claimed by the taxpayer with the totals shown by the exhibit receipts. He also pointed out amounts he did not allow in the audit as he felt they did not relate to the alleged business of the taxpayer. He referred to certain notes affixed to the receipts which could only have been put there by the taxpayer. He said there were no log books in support of the automobile expense claim and there were no documents to support a claim of 75 per cent of expenses for the automobile.

Mr. Brown was cross-examined by the appellants solicitor and said that he allowed certain amounts where he felt they directly related to the taxpayer's alleged business. He disallowed, among other things, an expense claim of $409.46 for produce purchases because after questioning the taxpayer he said that he did not believe the goods were used directly in the project. Further, he said he felt there was a possibility of some income from the writing project and allowed direct expenses, others he felt were unreasonable. He advised the Court that he did an extensive examination of the books presented to him, what income the taxpayer expected to earn from the books, referred to slides, talked extensively with the taxpayer about his business affairs and the conclusions he reached were based upon all of those factors, and in the end he calculated that approximately one half of the expenses claimed appeared to have been used directly in the business venture.

Appellant's position

It was the appellant's position in his opening remarks that editing and publishing were the taxpayer's business. This was not a hobby. His work was not done to enhance his academic position. He was there to earn money. The expenses were necessary and were incurred for the sole purpose of making a profit.

He referred to the leading case of Moldowan v. The Queen, [1977] 1 S.C.R. 480, [1977] C.T.C. 310, 77 D.T.C. 5213 and a decision of this Court in Paul Zolis v. M.N.R., [1987] 1 C.T.C. 2199, 87 D.T.C. 183, where Couture, C.J.T.C. found that expenses incurred by a high school mathematics teacher in writing a textbook in collaboration with three other colleagues were reasonable, attributable to those activities and there was a reasonable expectation of profit. The appellant emphasized the finding of the Court that "each situation must be assessed by the Court having regard essentially to its own particular facts, and only after a full analysis of these facts is the determination of the issue possible” (page 2201 (D.T.C. 184)). It was argued that the appellant was an expert in his field, that he was dedicated to this work, and I take his argument to be that this should guarantee a reasonable expectation of profit.

In his closing remark the appellant's solicitor argued that the evidence disclosed that the appellant was an author and writer who had written several works, one or two out of general interest and the remainder out of a moneymaking interest. He had the expertise to embark upon this type of venture. Because of his particular academic niche he correctly identified the area where he could make money. It is not enough for the Minister to argue in hindsight that there was no reasonable expectation of profit.

It was argued that writing is a front-ended business venture, the writer must put all his investment up front and then take a chance on its success. It was reasonable in 1984 and 1985 to expect a profit in the end even though his timetable may have been incorrect in respect to the specific length of time it would take to make a profit.

The appellant says that the expenses were all reasonable and were made to advance the project and were made in the sincere, honest belief that they were reasonable in light of his expected profit. He questions the auditors’ conclusion as to what were directly related to the project and what were not and points out that the auditor was not there when the expenses were incurred and each one made was in keeping with what every author everywhere does.

With respect to the auditor's attack on the expenses the appellant says that there was no satisfactory, fundamental attack per se, possibly a bit here and there but given the circumstances of the venture it was not unreasonable for him to proceed as he did.

The appellant referred to a "Revenue Canada Policy on the Taxation of Artists and Writers” dated June 27, 1984 and although this release is not law, but merely indicates some of the factors that Revenue Canada will take into account in their determination of when a writer or author has a reasonable expectation of profit, and are by no means exhaustive, it does refer to some of the factors that one should consider in a case such as that before me. The appellant argued that the application of the facts established in this case to these factors augurs well for the appellant.

It is pointed out that there was obviously a delay as to when the appellant could expect a profit but due to his move to Guam and the fact that the project had to be put on hold, this satisfactorily accounts for the delay.

In conclusion, the appellant submitted that the evidence was clear, that the expenses were not personal or living expenses and that there was nothing but innuendo to suggest otherwise. He submitted that the appeal should be allowed with costs.

Respondent's position

The respondent takes the position that the real issue here is not whether the Minister initially allowed some of the expenses. He says that there is no estoppel against the Crown, there is no issue as to the allowed expenses, they must stand, and further that the Minister was correct in disallowing the expenses in issue here.

The respondent argues that there was no reasonable expectation of profit from publishing and editing in 1984 and 1985, and therefore there was no source of income from which the expenses could be deducted. Secondly he says that the expenses were not incurred to earn income but rather were personal or living expenses, or if they were not they were unreasonable.

The respondent accepts as a fact that the appellant was a bona fide writer, that he had expertise, that he had published works, that he expected to make a profit, but the evidence points to the fact that there was no reasonable expectation of profit, in his opinion.

The respondent refers to Exhibit R-1 which was a letter sent to Revenue Canada by the appellant in 1986 seeking a tax exemption in which he predicted revenues from the work as early as 1989, but his evidence given in Court is clearly contradictory.

The respondent refers to Moldowan, supra, and argues that some of the prerequisites as set out therein are present here but not all. If you look at the profit and loss history you see that there was no profit between 1982 and 1988 except in the year 1988 when the appellant incorrectly claimed income from business of $6,000 which was really employment income. Further, he argues that the losses are increasing from $983.76 in 1982 to $37,274.54 in 1986. When you look at the revenue side between 1982 and 1987 and deduct an insurance recovery claim in 1985, the income averaged about $1,000 per year.

It was submitted that the appellant should have done a revenue forecast and it would have been clear that there was no reasonable expectation of profit, but this was not done, it was not run as a business and there was nothing to show where the appellant was going wrong. On the history of loss test he says there was no way it was going to show a profit in the reasonable future.

The respondent says that the case also fails on the future course of action test. As indicated, there were no reasonable projections done, it was not run as a business, it was run on conjecture. If you are going to spend $100,000 in expenses, a reasonable person would do a proper projection of profit and expense. He refers to the exhibit letter R-1 which predicted travel expenses of $2,000 for 1986 but the evidence disclosed that it was over $17,000 that was spent in that year on that item.

The respondent suggests that the reason for the large losses was the travelling expenses which were basically used for taking photographs when they could have been purchased. There was no analysis as to whether it would be cheaper to buy them instead of taking them. There was no rhyme nor reason as to why a person would take 20,000 photographs and travel such distances without projecting whether or not it would be cheaper to buy them. It is argued that there is no objective evidence that there would be a profit and we have only the appellants word on that.

The respondent referred to Fleming v. M.N.R., [1987] 2 C.T.C. 2113, 87 D.T.C. 425, for the proposition that the primary purpose must be that of turning the writing into a money-making operation and not for personal considerations. As in Corrigan v. M.N.R., [1984] C.T.C. 2904, 84 D.T.C. 1764, the respondent argued that it is not just the time and effort spent on the work, nor the quality of the work that is important, nor only his educational background, but to what extent such factors were likely to generate profits. See also Michael Issacharoff v. M.N.R., [1988] 1 C.T.C. 2006, 87 D.T.C. 673 (T.C.C.). The respondent argues that the duty is on the appellant to show that the expenses incurred were not personal and he says the evidence discloses that some of them definitely were and that there is insufficient evidence before us to prove that the others were not. Here he refers to Symes v. Canada, [1991] 2 C.T.C. 1, 91 D.T.C. 5397 (F.C.A.) and argues that in order for the expenses to be deductible there must be a reasonable proximity of the expenses to the profit. Thus, he says, many of the expenses claimed by the appellant such as meals are improper because there was no good evidence as to how the expense related to the expected profit. He says the appellant was never able to explain why the expenses were incurred.

The case of McGugan v. M.N.R., [1982] C.T.C. 2458, 82 D.T.C. 1459 (T.R.B.) is offered by the respondent as containing a similar factual situation as here and in support of his contention that there was insufficient evidence presented to show that the appellant was operating a business, and that onus is on the appellant.

Finally the respondent referred to the case of Gabco Ltd. v. M.N.R., [1968] 2 Ex C.R. 511, [1968] C.T.C. 313, 68 D.T.C. 5210 in support of his proposition that if the appellant was not considering a personal use factor when he made some of the expenditures he would not have made such expenditures, because no reasonable businessman would have done so. The respondent asks that the appeal be dismissed.

Analysis and decision

The relevant portions of the Income Tax Act in this appeal are sections 3 and 37, subsections 8(2) and 248(1) and subparagraphs 18(1)(a) and 18(1)(h). In the notice of appeal reference was made to the applicability of subsection 37(1) but the Minister in his reply argued that it was not applicable. There was no evidence before me which would allow me to conclude that the deductions in question here are deductible as having been made on scientific research and experimental development, it was not argued by either party at the conclusion of the trial and I find that subsection 37(1) is of no avail to the taxpayer here.

It was conceded by the respondent at the beginning of the case that there is no issue about the expenses that the Minister allowed, whether this decision was correct or not. It was also submitted that because the Minister allowed certain expenses that does not mean that he is bound to conclude that there must have been an "active business” as defined by subsection 248(1) and there can be no estoppel against the Crown. This matter was not actively pursued by the appellant but after a thorough consideration of the relevant authorities, [1] I agree with the respondent's submission on it.

I have no difficulty in finding that the appellant was a bona fide writer, that he had a rather extensive list of published works, that he had considerable expertise and experience, that he had a desire to make money out of this venture and I accept his evidence that he did not consider it to be a hobby any longer.

One of the real issues here is whether or not all of the appellant's best intentions, combined with his actions as evidenced by the facts proven before me, were sufficient for him to have a reasonable expectation of profit, thus a source of income against which he could deduct the expenses in question. To put it another way, was there a business in existence here?

The taxation years in question are 1984 and 1985 but it is necessary to look beyond these years in order to answer the first question posed here. The evidence presented has disclosed a rather extensive history of the appellant with specific financial information available for six years and other relevant viva voce evidence given with respect to the venture up to the year 1996.

I accept the position that it is necessary to look at all of the writing activity of the appellant during those years and not just at the activity relative to the" Food Crops" book even though 80 per cent of the expenses in question related to that project. As pointed out in Zolis, supra, the particular facts of each case must be considered and analyzed objectively and in light of the criteria set out in Moldowan, supra, and other criteria as well.

The appellant emphasized the fact that he was an expert in his field, that he was dedicated to his work, that he had a burning ambition to make a profit, that he had correctly identified the area where he felt he could make money and that all these factors taken together should have guaranteed a reasonable expectation of profit. However, if one looks at the history of the operation from an income and expense point of view alone there is no way that there could have been a reasonable expectation of profit during the years in question.

It is necessary however, to consider other factors, such as the delay in bringing the work to fruition as pointed out by the appellant, the fact that writing cannot be looked at in exactly the same way as any other business, that there is a certain amount of investment that has to be made up front and that one cannot expect that the return will be immediate. In light of the dismal financial picture between 1982 and 1987, in light of the increasing losses between 1982 and 1987 and the size of such losses, one must ask if there was any reasonable explanation for such losses, and was there any evidence that the losses would not continue and that a profit would be forthcoming in the reasonable future?

In this case the appellant offered as an explanation, the necessity of the upfront expenses, the delay in bringing the book to market and the inaccuracy of his timetable, but he offered no concrete plan or future course of action which indicated that there would be a turnaround, nor are there any reasonable projections for profit. Indeed, if you accept the appellants own evidence about future income there will be a shortfall of approximately $50,000 taking into account only the expenses incurred to date. It is true that the projected income of $50,000 over five years relates only to income on the "food crops project" and that there are other possible sources of income from the writing project, but there is insufficient evidence before me to conclude that all of the income from all of those sources will produce a profit in the foreseeable future.

It is clear that the losses were incurred to a large extent because of the cost of the photographs and the extensive travelling relative thereto. When one looks at this and considers the near absence of credible evidence to explain why such expenses were incurred without preparing some form of cost analysis, I can only conclude that it was poor planning or one did not want to know.

The appellant was adamant that he could reasonably expect a profit from his writing but we have only his word on that and I am satisfied that the evidence points unavoidably to the opposite conclusion.

Considerable effort was expended by the appellant in detailing the extent and nature of his writings and his educational background and these elements are important, but it was not shown as "to what extent such factors were likely to generate profits" as referred to in Corrigan, supra.

The respondent has also argued that the expenses were not deductible because the appellant has failed to show that they were not "personal expenses or living expenses". It should have been within the power of the appellant to show what each and every expense was for and there should have been clear evidence given to support these claims. Basically we have only the evidence of the appellant saying that each and every one was for business purposes and was directly and closely linked to the project but there is no objective evidence to support that argument.

The cross-examination disclosed that many of the expenses claimed were personal or at least partly personal and oftentimes too remote from the project itself to be claimable. When questioned about the trip to Jamaica the appellant said he prorated the trip but there was no attempt to specify how this was done and the explanation was incomplete. Again when he was questioned in detail about such things as automobile expenses, food crop purchases, cost of meals and other claimed expenses, the answers were vague and unconvincing as was his response to the questions asked relative to the assistant's employment.

Out of the many cases cited, that of Fleming, supra, seems most similar to the factual situation here. Brulé, J. at page 2115 (D.T.C. 426) said:

The manner in which the appellants chose to carry on their undertaking does not satisfy the Court that their primary intention was that of turning their writing into a money-making operation.

Further, on the next page he concluded:

The manner in which the appellants chose to carry on their research leads to the conclusion that personal consideration may have been more important in the operation of their undertaking than the search for profits.

I believe the final point raised by the respondent in his argument is significant. If there was not a personal use factor involved in many of the expenditures the appellant would not have made them because after considering all the evidence available, I do not think that a reasonable businessman would have made them.

It is also clear from the appellants own records and notes that personal expenses were claimed and no attempt was made to clarify or to explain this relatively damaging disclosure.

I am satisfied that the respondent has met any burden cast upon him as a result of the different positions taken on the appeal from that assumed at the time of the assessment.

The appeals are dismissed.

Appeals dismissed.