John Friesen v. Minister of National Revenue, [1990] 1 CTC 2002, 89 DTC 682

Teskey, T.C.J.:—The appellant appeals his 1985 and 1986 reassessments wherein the respondent disallowed, in 1985 expenses totalling $5,669.85, and in 1986 expenses totalling $4,648.26.

During the trial the respondent's counsel consented to this Court allowing the appellant the sum of $341 as an additional expense for the 1985 year. The appellant, at the same time, abandoned $50 of his claimed expenses. This left in dispute for 1985 the sum of $5,278.85.

In order for a taxpayer to be able to deduct expense of any kind he must come within either section 18 (this section allows a taxpayer to deduct expenses that are incurred for the purpose of earning income) or section 20 (this section covers inter alia convention expenses, and a taxpayer is limited to two a year).

Overriding these two sections is section 67, under the heading general limitation re expenses, and it reads as follows:

In computing income no deduction shall be made in respect of an outlay or expense in respect of which any amount is otherwise deductible under this Act, except to the extent that the outlay or expense was reasonable in the circumstances.

Facts

The appellant’s primary money-earning business is in construction. In 1977 his wife was sponsored into Amway of Canada Limited (Amway) as a retail seller of products. In 1979 the appellant went to his wife’s sponsors and by letter to Amway joined the Amway network by becoming attached to her original distributorship.

The appellant's business was entirely different from his wife’s in that he started right out to form and build a network of Amway representatives that would be under him. The system works on sales and recruitment of new sales personnel. The more sales personnel the appellant brings into the network and the more sales these people produce, then the more income is accrued to the appellant.

The Amway people are always talking about their "up line” and their "down line". The "up line” of the appellant starts with him and goes to his sponsor, then onto his sponsor's sponsor, and on up to the very first person that was originally sponsored by Amway.

The appellant's "down line” starts with him and goes to the people he sponsors into the Amway system and down to all the people that they sponsor, on and on down from sponsored people to new sponsored people.

The appellant's "down line” is attached to his sponsor's "down line”. Although the appellant's sales volume is increasing substantially, no profit has been obtained after ten years. In all years, expense far exceed the income from Amway. In fact no concrete evidence was given as to when, if ever, a profit would be realized. The respondent, by his actions, is acknowledging that there is a reasonable expectation of profit as some expenses have been allowed.

Since the sales scheme of Amway is a combination of sales and recruitment, motivation becomes a very important part of its programs. The programs are not run by Amway but by their different classes or grades of distributors. These programs are for basically two purposes, namely:

1. to keep motivated those people that are already on their down line;

and

2. recruitment of new people to their down line.

Generally, employers are always attempting to motivate their sales force to go out and get more and more sales. The Court sees nothing wrong with meetings that are primarily directed to motivating sales personnel and the creation of what could be described as a “religious zeal". However, the up line meetings must be described as "conventions" which would fall in the ambit of section 20, the down line meetings for recruitment of new people, will fall within the ambit of section 18.

Analysis

The Court was referred to two cases of this Court released within 30 days of each other, and without knowledge of each other. The first in time is the unreported decision of King, T.C.J., in Tompkins v. M.N.R. dated September 27, 1988. The other being a decision of Taylor, T.C.J., in Michayluk v. M.N.R. found at [1988] 2 C.T.C. 2236, 88 D.T.C. 1564. The Michayluk decision was referred to favourably by Brulé, T.C.J. in Roche v. M.N.R., [1989] 1 C.T.C. 2199, 89 D.T.C. 156.

The facts of this case appear to be virtually identical to those in the Michayluk case. Judge Taylor described the Amway network in great detail. The major difference in this case is that there is evidence that shows that in ten years the appellant has not made a profit, and only a vague hope that he can in the future produce a profit.

The Court agrees with the reasoning of Taylor, T.C.J., in the Michayluk decision and without hesitation prefers the reasoning therein to those expressed in the Tompkins decision. It must be remembered that these cases will be determined on the individual facts brought out at trial.

As far as section 18 is concerned, the Court finds that the expenses for the attendance in Canada, as well as the attendance at Bismark, North Dakota, are proper expenses pursuant to this section. In regards to the other out of Canada trips, they are different in nature and should be considered as convention expenses under section 20. Geography does not play a part in this difference. If the conventions had been held in Regina, they still would have been classified as conventions.

Once the Court has classified the expenses as section 18 or section 20 expenses, this still is not the end of the matter. The Court still must apply section 67, referred to above. In this case, looking at the gross profit before expenses, the expenses appear to be unreasonably high. The respondent, in each year, has allowed the appellant to pay his wife $6,000 in wages and deduct the same. This Court cannot take this away from the appellant once given. It also does not believe it can take away the expenses in Canada and Bismark as unreasonable in the circumstances, and therefore will be awarded to the appellant.

After considering the profit and loss statements for the two years in question, and that profit was not achieved in 1987 and 1988 and all the facts before it, the Court is satisfied that the conventions (in this case they are all out of Canada) would not have been attended if there had not been income over and above the Amway income.

The Court realizes section 67 is a grey area which does not lend itself to strict objective criteria. Where a business has not been able to generate a profit, or at least show a reasonable expectation of profit in the near future, section 67 should seriously be considered.

Under the circumstances of this case, the Court does not feel that the convention expenses for 1985 and 1986 are reasonable, and are therefore disallowed to the extent that they have already been disallowed.

This Court is not prepared to allow convention expenses if a business has not shown a profit and paid tax thereon, or in very exceptional circumstances receives concrete evidence which showed that profit was imminent.

The appeal will be allowed, and the matter is referred back to the Minister for reconsideration and reassessment on the basis that the appellant be allowed additional expenses in 1985 of $1,457.85, and additional expenses in 1986 of $1,875.43.

As the results of this appeal are approximately equal, there will be no order as to costs.

Appeal allowed, in part.