John Carpenter v. Minister of National Revenue, [1987] 2 CTC 2007, 87 DTC 331

Brulé, T.C.J.: —This is an appeal from reassessments of income tax for the 1980 and 1981 taxation years. The reassessments were made on the basis that the taxpayer was not carrying on a business with a reasonable expectation of profit and therefore was not entitled to deduct the losses of his antique business operations from his other sources of income, which is the issue in this case.

Facts

The taxpayer first became interested in antiques in the early 19705. In April of 1975 he acquired a vendor's permit and became involved in the collecting, refinishing and selling of antiques under the name of "Wishes Come True Antiques". Business cards, letterhead, bank statements and municipal tax notices bearing the name of "Wishes Come True Antiques” were entered into evidence. In addition, the appellant provided numerous trade journals and and antique shop directories with advertisements announcing his operation.

During the years in question, and to the present time, Mr. Carpenter has maintained full-time employment as a teacher with the Simcoe County Board of Education. His employment earnings in the 1979 to 1982 taxation years were as follows:

The agent for the appellant stressed that the business losses amounting to $7,103 for 1980 and $5,234 for 1981 were not personal or living expenses within the meaning of paragraph 18(1)(h) and subsection 248(1) of the Income Tax Act. The appellant also contends that the losses arose from outlays and expenses that were incurred by the taxpayer for the purpose of gaining or producing income from business within the meaning of paragraph 18(1)(a) of the Act.

During the years in question investment in the business to the extent of $26,472 in 1980 and $17,834 in 1981 was made from the proprietor's personal income sources. Considerable business activity took place in 1980 and 1981, including purchasing, restoration, promotion and sales. Sales revenue was $11,661 in 1980 and $17,651 in 1981.

The appellant was well qualified to carry on this type of business. He developed a plan involving, among other considerations:

(i) initial concentration on specific antique items;

(ii) purchasing antique items over a wide geographic area at auction sales, flea markets and through private sources;

(iii) arrangements for professional restoration of each item;

(iv) sales arrangements involving use of home and flea markets;

(v) proposal to move to storefront location as volume and reputation build up;

(vi) building high profile in antique business through local involvement in antique events and displays in local stores.

It was stated that this type of business requires both time and capital to develop; the appellant had contributed both. An inventory was created, which takes time in the antique business, and the endeavour was more than a hobby. The period under question was a difficult one in that the country was somewhat in the economic doldrums. This changed and so did the appellant's business. His original plan envisaged a loss. His costs were rational and reasonable. It was argued that nowhere is a reasonable expectation of profit defined in terms of length of time and each endeavour must be considered separately. The antique business is one that takes time to develop and accordingly the appeal should be allowed.

Minister's Position

The Minister maintains the position that, inter alia:

(i) the appellant was not engaged in an activity carried on for profit or with a reasonable expectation of profit;

(ii) the expenses which created the losses were not incurred for the purpose of gaining or producing income;

(iii) the expenses which created the losses were personal or living expenses of the appellant, and therefore no amount of loss arising from the antique operations may be deducted from the computation of the appellant's income by virtue of paragraphs 18(1)(a) and 18(1)(h) of the Income Tax Act.

The evidence was reviewed for the Court and counsel maintained that based on the facts and the jurisprudence the appeal should be dismissed.

Analysis

The pertinent provisions of the Income Tax Act are found in paragraphs 18(1)(a) and (h):

18.(1) In computing the income of a taxpayer from a business or property no deduction shall be made in respect of

(a) an outlay or expense except to the extent that it was made or incurred by the taxpayer for the purpose of gaining or producing income from the business or property;

(h) personal or living expenses of the taxpayer except travelling expenses (including the entire amount expended for meals and lodging) incurred by the taxpayer while away from home in the course of carrying on his business;

The definition of “personal or living expenses" is provided in section 248(1) of the Act:

248.(1) In this Act,

"Personal or living expenses" includes

(a) the expenses of properties maintained by any person for the use or benefit of the taxpayer or any person connected with the taxpayer by blood relationship, marriage or adoption, and not maintained in connection with a business carried on for profit or with a reasonable expectation of profit,

(b) the expenses, premiums or other costs of a policy of insurance, annuity contract or other like contract if the proceeds of the policy or contract are payable to or for the benefit of the taxpayer or a person connected with him by blood relationship, marriage or adoption, and

(c) expenses of properties maintained by an estate or trust for the benefit of the taxpayer as one of the beneficiaries;

During most of the years of operation, the appellant's activities have been carried on from his home where the basement and garage have been converted to provide space for storage, refinishing, office and display. There is a separate entrance providing customers with access to these areas of the house. In earlier years the taxpayer frequently attended antique shows which accounted for a large percentage of his sales and where he also purchased antiques for resale. He testified, however, that transportation to these shows proved to be too expensive and he therefore decided to concentrate instead on improving sales in his home area.

The appellant testified that he has been looking for a number of years for an appropriate site to which he could relocate his business. Between 1981 and 1983 he rented space in a local mall, but found that the location did not attract sufficient business to warrant entering into an expensive long-term lease. Recently he found a suitable property and made arrangements for financing which included mortgaging his home but the plan fell through when he lost the bid to one slightly higher than his own. The appellant's agent argued that these actions evidence a commitment inconsistent with the respondent's assertions that the antique operations are merely a hobby of the appellant.

The taxpayer's methods of acquiring inventory were brought into question by the Minister. The appellant testified that he makes his acquisitions through estate sales, auctions, private sales and by purchasing through other dealers. The respondent particularly questioned the latter method's ability to generate a profit. Apparently sales between dealers is a commonly used method which antique dealers find to be particularly useful in the case of slow-moving inventory. Items which have been in inventory for a period of time are sold at a discount to other dealers who may find the item to be more readily marketable in their area. I cannot accept the Minister's assertion that such a practice precludes the possibility of generating a profit.

Sales and net profits/losses for the operations were as follows:

The appellant testified that a profit was made in 1986 and that he expects 1987 to be profitable as well. As counsel for the Minister pointed out, the business incurred ten straight years of losses from 1975 to 1984. She also argued that if expenses had not been understated in 1985, there would have been a loss in that year as well. In particular, she noted that capital cost allowance had not been claimed since 1982, and the apportionment of expenses between office and personal expenses had been substantially reduced.

While sales have remained fairly constant, the gross profit margin has fluctuated substantially over the years:

1979	1980	1981	1982	1983	1984	1985
47%	19%	21%	16%	8%	3%	27%

Counsel for the Minister submitted that these fluctuations were another factor in favour of the conclusion that the taxpayer had no reasonable expectation of profit.

Another point made by counsel was that the appellant's advertisements and business cards indicated that the hours of operation were "by chance or appointment" and submitted that this was inappropriate for a viable business. While this may be a factor in determining whether or not a business is carried on with a reasonable expectation of profit it cannot be considered conclusive by itself. Many successful businesses are operated in this manner, including antique businesses.

The appellant gave evidence that he was available to work in his antique business on evenings and weekends during the winter and full-time for at least two months during the summer. His evidence also indicated that these were the busiest times for sales, particularly during summer tourist season. The volume of sales from the operation would appear to indicate that the appellant's hours of operation are not hindering his ability to attract customers.

In the case of William Moldowan v. The Queen, [1977] C.T.C. 310; 77 D.T.C. 5213, the Supreme Court of Canada concluded that the determination of whether a taxpayer has a reasonable expectation of profit is an objective determination to be based on all the facts. The following criteria were suggested as a guideline in making such a determination, but the list is not exhaustive and the importance of a particular factor will vary according to the nature and extent of the undertaking:

(i) profit and loss experience in past years;

(ii) the taxpayer's training;

(iii) the taxpayer's intended course of action;

(iv) the capability of the venture as capitalized to show a profit after deducting capital cost allowance.

The operations of the appellant have until recently shown only losses. Generally, where a loss has been incurred in a particular year it is viewed as a rebuttable inference that there was no reasonable expectation of profit. Regard must be had, however, to the type of operation under consideration. The business in question was started by the appellant. His testimony was that in this type of business it takes time to locate sources of antiques, to refinish the product, to build up inventory and to establish a reputation as an antique dealer. While he had anticipated that it would take time to achieve profitability, he had expected that operations would become profitable prior to 1985. He had not, however, anticipated profits in the years under review.

The question of deductibility of losses in a year where the taxpayer anticipates future profits but has no expectation of profit in that year was considered by Mr. D. E. Taylor, Member of the Tax Review Board, (as he then was) in the case of James D. Pike v. M.N.R., [1981] C.T.C. 2628 at 2630; 81 D.T.C. 546 at 547:

While I do not eliminate the prospect that under specific circumstances losses may be deductible in one year where there is clearly no reasonable expectation of profit in that same year, I do suggest that the onus on the taxpayer to put himself within the narrow parameters permitting such deductibility is a difficult task. Without attempting to define with precision those parameters, the appellant might be expected to show that he had pre-determined a clear, established pattern which allowed for those losses, and followed it, that he had provided the financing of such losses during the early years, and that the record of similar ventures almost assured him the ultimate realization of profit.

In my view the appellant has established that he had a reasonable expectation of profit in 1980 and 1981. He has presented evidence of a comprehensive plan for the establishment of a profitable business and has invested considerable time and capital in these operations. Although he had not previously engaged in this type of business, he testified that he took steps to educate himself through reading and talking to other dealers both prior to and after commencement of the business.

The nature of the antique business is not that of a typical retail store. Connections and contacts are essential to ensure a steady supply of inventory. The dealer must establish a reputation with his customers and this takes time. He must also learn to read his market to determine which items will sell and what price his market will bear. The appellant's course of action in establishing his business has shown a dedication to the business which denies that it is merely a hobby. Although it has taken longer than anticipated to achieve profitability, I find that on the basis of all the evidence the appellant had a reasonable expectation of profit in the years under review.

The case of Wesley H. Warden v. M.N.R., [1981] C.T.C. 2379; 81 D.T.C. 322, which was cited at trial, concerned an operation of a much smaller scale than that of the appellant's. I find no parallel between the two cases except that both relate to antique operations.

In the case of Charles Gerald Dumont v. M.N.R. (1987, as yet unreported) Cardin, T.C.J. said:

There is no longer any question that a full-time employee can, under proper conditions, carry out a bona fide business enterprise and his business expenses, including start-up costs, are deductible.

In my opinion the appellant had a reasonable expectation of profit in the 1980 and 1981 taxation years, albeit not in the immediate future but this I do not consider mandatory in the type of enterprise undertaken by him. The evidence disclosed a profit in 1985 and one was indicated for 1986.

The result then is that the appeal is allowed and the matter referred back to the respondent for reconsideration and reassessment. The appellant is entitled to costs on a party and party basis.

Appeal allowed.