Ace Salvage Alberta LTD v. Minister of National Revenue, [1985] 2 CTC 2277, 85 DTC 568

Taylor, TCJ: —This is an appeal heard in Calgary, Alberta on June 4, 1985, against income tax assessments for the years 1979, 1980, 1981 and 1982 in which the Minister of National Revenue allowed the taxpayer only the "restricted farm loss” deduction. The notice of appeal reads:

A. STATEMENT OF FACTS (from the appellant).

1. The Appellant is a corporation resident in Canada and was so resident throughout its 1979, 1980, 1981 and 1982 taxation years.

2. The Appellant’s head office is in the City of Calgary, in the Province of Alberta.

3. The Appellant carries on the scrap metal processing and sales business in the City of Calgary.

4. The Appellant owned during the years under assessment thoroughbred race horses (the “Horses”) which it raced under the name of Ace Stables:

Year	# of Horses	Value
1979	12	$20,000.00
1980	11	$23,000.00
1981	10	$27,950.00
1982	10	$40,950.00

5. During the years under assessment, the Appellant expensed the costs of maintaining and running the Horses, less winnings, against its income from the scrap metal processing and sales buisness.

6. By notices of assessment in respect of the Appellant’s 1979, 1980, 1981 and 1982 taxation years, each dated August 30, 1983 and issued from the Calgary District Office the Respondent reassessed the Appellant’s income for those years by limiting the amount of the expenses associated with the Horses which the Appellant could deduct:

	Expenses Claimed	Expenses	Expenses
Year	by Appellant	Disallowed	Allowed
1979	$ 9,616.00	$ 4,616.00	$5,000.00
1980	$21,468.00	$16,468.00	$5,000.00
1981	$31,340.00	$26,340.00	$5,000.00
1982	$41,914.00	$36,914.00	$5,000.00

7. The Respondent apparently has taken the position that the expenses associated with maintaining and racing the Horses which can be deducted by the Appellant is restricted by Section 31, of the Act.

8. The Appellant filed a Notice of Objection to each assessment but the Respondent confirmed each assessment on February 1, 1984.

B. STATUTORY PROVISIONS UPON WHICH THE APPELLANT RELIES AND THE REASONS IT INTENDS TO SUBMIT

1. Section 31 does not apply because Ace Salvage does not carry on a farming business.

2. The racing of Horses is the Appellant’s chief method of advertising its scrap metal processing and sales business and the expenses of maintaining and racing the Horses are fully deductible as ordinary business expenses pursuant to sections 9 and paragraphs 18(1)(a) and (b) of the Act.

3. The Appellant relies, inter alia, on the following cases: Olympia Tile Quebec Ltd v The Minister of National Revenue, [1970] CTC 99 (Ex Ct).

The reply to notice of appeal states: (for the respondent):

A. STATEMENT OF FACTS

1. He denies all allegations of fact as set forth in the Notice of Appeal, except as hereinafter expressly admitted.

2. Paragraphs 1, 2, 3, 4, 5, 6, 7 and 8 are admitted.

3. In assessing the Appellant, the Respondent assumed, inter alia, that

a. the Appellant carried on the business of farming as well as scrap metal processing and sales;

b. the Appellant’s chief source of “income” was neither farming nor a combination of farming and some other source of income.

B. STATUTORY PROVISIONS UPON WHICH THE APPELLANT RELIES AND THE REASONS WHICH HE INTENDS TO SUBMIT

4. The Respondent relies, inter alia, upon Sections 3, 4, 9 and 31 of the Income Tax Act, RSC 1952, c 148, as amended by SC 1970-71-72, c 63, s 1.

5. He submits that the Appellant carried on two separate businesses.

6. He further submits that he properly deemed the Appellant’s loss for the purposes of Section 3 to be $5,000.00 in each of the taxation years in issue, in accordance with Section 31 of the Act because the Appellant’s chief source of income was neither farming nor a combination of farming and some other source of income.

Both Mr Baxter, a chartered accountant with the firm of Touche Ross, and Mr Shulder, president of the appellant corporation, testified and provided details and information regarding the rationale for treating the “net” expenses incurred in the “horse-racing” operation as a deductible expense with regard to the “salvage” operations. Financial statements for the years in question were filed, and the precise fashion in which the situation was portrayed therein, was that in the section of the Statement of Income called “Other Income”, there appeared as “Ace Stables, net”, the amounts shown by the notice of appeal (supra) as “Expenses claimed by the appellant”. As explained to the Court, this “net” amount consisted of the total expenses for the purchase of horses, boarding, training and racing them, less winning purses and sales of horses. The purses and sales of horses (gross income) was increased from about $40,000 to about $85,000 for the years 1979 to 1982 inclusive. The expenses therefore always exceeded by considerable amounts any revenue from the horse racing operation. While he always hoped to win a big race, or raise an outstanding horse — and thereby some year (perhaps only as an exception) show a “profit”, Mr Shulder was sanguine about the operation and regarded it as not likely to produce such a profit. In fact he regarded the losses as advertising and business promotion for the salvage business, and consciously set out on that path. He claimed that a substantial portion of both his customers and suppliers were racetrack fans, and by these contacts his “salvage” business did receive the benefit from the expenses (losses) incurred. His evidence was that only very minimal other “advertising” was conducted by the company, but he believed his salvage business (Ace) was one of the most profitable, perhaps the most profitable in the area. He raced his horses under the name of “Ace Stables”, and felt that his clients, even the general public made a direct connection between “Ace Stables” and “Ace Salvage Alberta Ltd”.

In argument counsel for the appellant emphasized that there was no evidence or rationale for the Minister assessing the company on the basis that “Ace Stables” was a farming business separate and distinct from the salvage business. He rejected any implications that there was a “reasonable expectation of profit” from the operation — in effect reaffirming the appellant's basic position (notice of appeal (supra)) that “. . . Ace Salvage does not carry on a farming business”. Counsel however, did concede that if the Court found there was indeed a “business”, then the “farming loss”, should rightly be restricted to the “$5,000” limit, a secondary position which in itself might be in jeopardy in the event the appellant were to support its main assertion. Counsel’s position and argument did not take the view that this was a situation in which the appellant’s chief source of income was either farming or a combination of farming and some other source of income.

Counsel for the respondent made two basic points — first, that indeed the horse-racing operation was a “business”, since there were certain indications it had a reasonable expectation of profit (the number of horses, the increasing purses won, the general quality of the horses, etc); and second that in any event, if the proposition of the appellant was to be considered at all (advertising and promotion) that the horse-racing expenditures were just too remote from the salvage business to have any recognizable bearing on the profit of the appellant from that salvage business. According to counsel nothing had been brought out in evidence which would support any direct beneficial connection whatsoever. Counsel submitted considerable jurisprudence, as follows:

Moldowan v The Queen, [1977] CTC 310; 77 DTC 5213 (SCC).

Hall and Lane v MNR, [1983] CTC 2003; 83 DTC 8 (TRB).

Utah Co of the Americas v MNR, [1959] CTC 496; 59 DTC 1275 (Exch Ct).

Merchants Distributors v MNR, [1969] Tax ABC 1124; 69 DTC 803 (TAB).

Bio-Test Laboratory Inc v MNR, [1983] CTC 2348; 83 DTC 295 (TRB).

H J O'Connell Ltd v MNR, 42 Tax ABC 174; 66 DTC 714 (TRB).

Blair Supply Company Limited v MNR, [1984] CTC 2560; 84 DTC 1457 (TCC).

Basically, according to counsel for the respondent, Hall and Lane (supra) indicated that a “business” of horse-racing could exist when the relevant evidence was very slim — thereby providing a “source”; Utah Co of the Americas (supra) rejected any “interconnected” argument of the appellant; while H J O'Connell Ltd (supra) and Blair Supply Company Limited (supra) were in most ways identical to the instant situation and supported the Minister’s assessment.

I would agree with counsel for the respondent that, looked at quickly, this instant case is similar to that of Blair (supra), and that could lead to the Court dealing with it in the same manner — by dismissal. Certain specific quotations from Blair (supra) were highlighted by counsel for the respondent, and I would make reference to them:

Page 2563 (DTC 1459)

. . . In my view the real problem in the proposition of this taxpayer corporation is that it negates the “farming business” as a “source” of income.

The source of income to which the expenditures constituting the farming loss at issue in this appeal, while part of the overall business activity of the corporation is not the same source of income as the main building supply business of this corporation.

I am aware that the decision in Blair (supra) is under appeal to the Federal Court, and while it is of assistance, the areas of distinction with the instant appeal should be noted before relying on it for the determination of this case. The major difference, as I see it is that in Blair (supra), the appellant did not specifically take the position that there was no business source (farming), although by implication this was the ultimate result of the “advertising or promotion” argument advanced. Counsel for the respondent in Blair (supra) was not called upon to support the basis of the Minister’s assessment — that the operation of farming had a “reasonable expectation of profit”, and I hasten to add for counsel for the respondent that may have been fortuitous for the Minister’s case since asserting the “reasonable expectation of profit” position in the face of the astounding farming losses cited would have been a formidable task indeed. In Blair (supra), counsel for the appellant did not attempt in the notice of appeal, to reconcile the assessment itself (restricted farm loss allowed) with his claim that the amount at issue was “promotion and advertising”. In the instant appeal counsel for the appellant soundly rejected the assertion that there could be any separate “farming” business, with qualities falling under the general parameters of “reasonable expectation of profit”. However, for the appellant, that is only the first of two steps he must take, the next is to establish that the amounts at issue (whether the “net amounts" as asserted by the appellant, or the gross expense amounts after making some alternate provision in the financial statements for the horse-racing revenue, as explained by counsel for the respondent) are properly deductible from the sole corporation source of income — that is the “salvage" operation. Therefore the simple nature of the expenditures must be examined in relation to that “salvage" income. It is perhaps useful to look at the situation, as it was detailed by counsel for the appellant, that is — pulling apart the “net" Ace Stables expense items, and substituting therefor (at least theoretically) the “Ace Stables horse-racing revenue" (for 1982 the figure was approximately $85,000) and the “Ace Stables horse-racing expenses" (for 1982 the figure would have been about $126,914 ($85,000 revenue + $41,914 “loss"). We will assume for the moment, that in the preparation of the financial statements the accountants had shown the revenue of $85,000 under corporation revenue, and shown the expenses, under the heading of expenses, such as “General promotion" $126,914, which is what is really being proposed to the Court. This method of looking at the problem, is not in any way meant to be a criticism of Mr Baxter's “net" method of showing the amounts, since he made no effort as was done in Blair (supra), to validate the situation simply by virtue of this “netting" procedure. It is clear that the purchase, training and racing of horses (from which the $126,914 expenses arose) of itself did not assure any revenue, let alone profit. Clearly Ace could do so for an entire year, and theoretically at least never earn one dollar either from “purses" or “sales". I would agree that situation would have exemplified exceedingly “bad luck", but that it could happen is quite evident from the frank testimony of Mr Shulder. And quite logically, while Mr Shulder would probably have made every effort to earn revenue, there was simply no assurance that any revenue (purses in particular) could be earned during any one year or during any period longer than a year. That in itself is not fatal, since there is no bar in the Income Tax Act to a person engaging in a high-risk business — but when he is challenged by Revenue Canada (as in the present case) he must accept that the difficulty of substantiating the situation as a “business" may be formidable indeed.

I agree with counsel for the appellant — and I believe the critical testimony of Mr Shulder would support a view that he held very little “expectation" of profit, let alone any “reasonable expectation" of profit from his horse-racing operation. To whatever degree it is significant, the evidence itself — which was presented at the hearing — does not support the assertion inherent in the assessment that the operation had a “‘reasonable expectation of profit", and therefore as I see it there was no “‘business of farming". It is quite possible that the appellant, possessed of a much greater knowledge of the facts and circumstances surrounding the expenditures, could demonstrate that there was a “reasonable expectation of profit" from the horse-racing activity, but not only was that effort not made, the corporation made every effort to demonstrate the obverse — that there was no reasonable expectation of profit. I am aware of the recent Tax Court decision in Gorjup v MNR, [1985] 2 CTC 2194; 85 DTC 530, but in my view the evidence presented here does not even meet the minimum standards noted therein. Accordingly to view properly the issue before the Court, one can simply ask the question — what is the proper designation and treatment (for tax purposes) of the expenditures incurred for purchasing, training, boarding and racing the horses, under this set of circumstances? The appellant corporation must have been prepared in a year when (and if) there was no revenue, to charge off all the horse-racing costs incurred against income earned from the salvage operations. The appellant’s position is that this was nothing different than normally expected (if somewhat unique) advertising and promotion expenses. In support of this proposition there are two main facts:

(1) The appellant corporation alleges that in other forms of advertising, very little was spent; and

(2) The opinion of Mr Shulder that salvage business resulted from the contacts he made at the race-track.

As opposed to these, there was no hard empirical evidence whatever that a connection existed between the horse-racing expenses and the salvage income; again, a situation which might not be completely fatal under certain circumstances, but is of serious proportions in this situation, because of the unusual nature of the proposition put forward by the appellant.

The bottom line, whether he realized it or not, is that Mr Shulder was authorizing the expenditure of some part of the gross income earned from the salvage operations, for purposes for which the only support is his opinion, — that it was to gain or produce income from the salvage operation. Certainly Mr Shulder, as the president and major shareholder of Ace Salvage may authorize the use of funds of that company as he sees fit — but that of itself does not assure that such use of funds will be treated as a deduction from the salvage income of the company for income tax purposes. The expenditure of such funds may reduce the pool of funds available in the company, but that is not synonymous with acquiring the right to a deduction from income with respect to the earning of those funds. Otherwise, simply the authorization by the principal shareholder, president, board of directors, owner, or some other responsible body or person would be all that was needed to make an expenditure incurred a deductible expense. And that is the crux of the problem in this appeal. In effect, the Income Tax Act presupposes a tax on all business income, reduced only by the deductions scheduled and permitted. It must be demonstrated that the funds expended (and for simplicity of perspective we refer to 1982 estimated total of $124,916 in this instance) were so expended for the purpose of gaining or producing income for the salvage business. The Court recognizes that there is probably no more ethereal category than "advertising and promotion", and that indeed in general the interpretation of the tax laws by Revenue Canada has been flexible and generous in allowing the parameters around such a category to encompass a great range of tangential or obliquely related items. I do not doubt (and this was acknowledged in Blair (supra)), that some of the activity which surrounded the horseracing provided contacts, information, leads and help which were of benefit to the salvage business. But it could also easily be argued that Mr Shulder — (a highly personable and congenial man) going for a cup of coffee, mowing his lawn, or attending a wedding could have (and probably has) done the same thing, perhaps even to the same degree. But it could not be argued (except under possibly the most extreme circumstances that are not easily evident to me) that going for a cup of coffee, mowing the lawn, or attending the wedding was for the “purpose of gaining or producing income from the salvage business". (See paragraph 18(1)(a).) It might be argued that some small or modest part of the cost of doing so (coffee, lawn, wedding) which could be directly and clearly associated with the incomeproducing activities of the company might be the responsibility of the company — but no such limited and restricted effort was defined in this appeal. Any such proposal would be required in any event to meet the test of “reasonableness” under section 67 of the Act. Simply put, if the clear and primary purpose for an expenditure can be discerned, and that purpose, prima facie is markedly different than the normal business purpose of the payor entity, then the road to recognition that any subsidiary or ancillary benefit to the payor entity (from an income tax viewpoint) should be substituted for that reasonable, direct, and primary purpose for the expenditure is difficult indeed. Accordingly the purpose of the expenditures at issue in this matter was for purchasing, boarding, training and racing horses, not for purposes directly (perhaps not indirectly) associated with the salvage business purpose of the appellant.

The question of whether the expenditure in question, under the circumstances of this appeal (no demonstrated business purpose) was an appropriate or legitimate use of company funds by the president was only touched on rather than argued, and therefore will not be dealt with further by the Court. However, various provisions of the Income Tax Act do emphasize the risk for directors, shareholders or employees of the non-business utilization of corporate funds.

Before concluding this decision, I would note certain relevant comments from a recent judgment of this Court (Louis S Levy v MNR, [1985] 2 CTC 2107; 85 DTC 450 as follows:

The facts and the amounts are not disputed. The question of reasonable expectation of profit was not raised and the basic issue is whether the appellant was engaged in the business of farming. There can no longer be any doubt that maintaining horses for the purpose of racing comes within the definition of farming (subsection 248(1)). If it is found that the appellant was so engaged, then subsection 31(1) is applicable since there is agreement that the appellant's chief source of income was neither farming nor a combination of farming and some other source, within the meaning of subsection 31(1).

The appellant’s submissions are:

1) that his losses arose from his investments in the horse syndicates and as such were losses from property and not losses from a business;

2) if the losses can be regarded as losses from a business, they should be regarded as losses from the business of dealing in horses, not as losses from the business of farming;

3) the losses did not arise from a farming business carried on by the appellant.

The appellant contends that subsection 31(1) does not apply and that the full amount of the losses are deductible from his income from other sources by virtue of subsections 9(2) and 3(d) of the Act.

It appears clear from the Income Tax Act that Parliament, in adopting generally applicable taxing provisions with respect to the three principal sources of income: employment, business and property, considered the particular circumstances of certain sources of income such as fishing, mining, the lumber industry and farming and passed special provisions for each of these resources. Indeed, subsection 31(1) is one of the exceptional provisions with respect to farming. These exceptional provisions are not to be applied restrictively and are not interchangeable or applicable by way of analogy.

The question raised in Levy (supra), was not the same as in the instant case, but the effort to evade the restriction on deductible farm losses imposed under section 31 of the Act was similar. To some degree therefore, the adverse decision in Levy (supra), does align itself with the comments made in this case.

The funds at issue in this appeal were not expended by Ace Salvage Alberta Ltd for any demonstrated business purpose of the corporation and therefore are not deductible from income as such. Whatever that may mean for assessment purposes, is up to the Minister. This Court is only deciding that the amounts in issue noted as “expenses disallowed" in the notice of appeal (supra) are not deductible as “general promotion" expenses.

The appeal is dismissed.

Appeal dismissed.