Leung v. R., [1998] 1 CTC 3299

Christie A.C.J.T.C.:

These appeals are governed by the informal procedure provided for under section 18 and following sections of the Tax Court of Canada Act. The years under appeal are 1992, 1993, 1994. The: appellants are husband and wife and the appeals were heard together.

The Notice of Appeal filed by Jason Leung reads:

TAKE NOTICE THAT JASON PING LAU LEUNG appeals to the Court from reassessment of income tax returns under appeal. The date of reassessments is Aug. 26, 1996 and the taxation years are 1992, 1993 and 1994.

A. The reasons for the appeal are:

1. The original audit carried out in June, 1995 is totally biased and unfair with the auditor violating all four basic Taxpayer Rights as defined in the back page of the Federal and Provincial General Tax Guide and Returns. A Notice of Objection was filed to the Appeals Division with specific examples/questions on each of the complaint of the violations but none of these questions was answered. Appendix A is a copy of the objection sent to the Appeal Division.

2. The Appeal Division failed to perform their appeal functions to follow up with the complaints filed under the Notices of Objection. Instead, the Appeal Division carried ‘out a second audit and they demanded information way beyond the 3-year limit (audit period). The Appellant was told the onus is on the Appellant to provide all the information during an appeal. The appeal process was performed incorrectly by the Appeal Division because if the original audit is invalid, the Appeal Division should revert the auditor’s decisions. However, if the Appeal Division decided to perform the audit functions, which is inappropriate, they should not demand information which is prior to 1992. Also, with the Appeal Division performing the audit functions, the Appellant has been denied one level of appeal which should be available to all Taxpayers.

3. The Appellant provided all the required information and documentation during the appeal process. The Appeal Division agreed all the income tax information during the 1992, 1993 and 1994 were filed properly and the information are fully substantiated. However, the Appeal Division has arbitrarily made adjustments to the claims. None of the questions contesting the adjustments in the letter from the Appellant to the Appeal Division dated July 2, 1996 was answered. Appendix B is a copy of this letter to the Appeal Division.

B. Statement of relevant facts:

1. The adjustment made by the Appeal Division on splitting the business loss to %o between the Appellant and his spouse is incorrect because the Appellant has injected major capital to the business since the start of the partnership. The current partnership split ^/io between the Appellant and his spouse is based on capital investments.

2. The Appeal Division said the Appellant’s business ceased prior to 1994 even though there are full documentations such as rent payments, sales records to prove that the business continue to exist up to present. Using the information prior to 1992, the Appeal Division performed a detailed re-construction of funding disposition for the carrying charges. They agreed all the carrying charges were directly linked to the shares investments and the business expenditures. Therefore the disallowance of the majority of the carrying charges in 1994 and subsequent years is incorrect.

3. The Appeal Division adjusted the business portion of the vehicle to 20%. This adjustment is incorrect because the 70% business usage is based on the actual usage, i.e. distance travelled.

I elect to have the informal procedure apply to this appeal.

It is unnecessary for the purpose of these reasons to produce the appendices referred to in the Notice of Appeal.

The grounds relied on in the Notice of Appeal filed by Lina Leung are the same as those of her husband.

The opening statement and paragraphs 1 to 9 inclusive of the Reply to the Notice of Appeal in the case of Jason Leung read:

In reply to the Notice of Appeal for the 1992, 1993 and 1994 taxation years, the Deputy Attorney General of Canada says:

A. Statement of Facts

1. He admits that the documents marked as Appendix ‘A’ and ‘B’ are copies of letters that were sent by the Appellant to the Appeals Division.

2. He denies all other allegations of fact contained in the Notice of Appeal.

3. In computing income for the 1992, 1993 and 1994 taxation years, the Appellant reported business losses in the amounts of $19,921.98, $18,179.02 and $16,719.89 respectively, and claimed carrying charges and interest expenses in the amounts of $33,185.39, $19,655.47 and $18,581.54 respectively.

4. The Minister of National Revenue (the ‘Minister’) assessed the Appellant for the 1992, 1993 and 1994 taxation years, Notices of Assessment thereof dated May 4, 1993, March 17, 1994 and March 16, 1995 respectively.

5. In reassessing the Appellant for the 1992, 1993 and 1994 taxation years, concurrent Notices of Reassessment thereof dated October 17, 1995 the Minister disallowed the deduction of the business losses in the amounts of $19,921.98, $18,179.02 and $16,719.89 respectively and reduced the claim for the deduction of the carrying charges and interest expenses to $ nil, $131.47 and $170.54 respectively.

6. On November 8, 1995, the Appellant filed Notice of Objection against the Notices of Reassessment dated October 17, 1995 for the 1992, 1993 and 1994 taxation years.

7. In further reassessing the Appellant for the 1992, 1993 and 1994 taxation years, concurrent Notices of Reassessment dated August 26, 1996 the Minister allowed the deduction of the business losses in the amounts of $8,683.00, $7,470.00 and nil respectively and allowed the claim for the deduction of the carrying charges and interest expenses in the amount of $28,326.00, $17,164.00 and $3,115.00 respectively.

8. In so reassessing the Appellant, the Minister made the following assumptions of fact:

(a) in 1988, the Appellant and his spouse started an oriental giftware business in equal ( %o) partnership under the name ‘Classic Arts & Collectibles’ (the ‘Business’);

(b) in 1988, the Appellant leased a store at 734 Queen Street, East, Toronto to operate the Business;

(c) the Appellant and his spouse reported gross income of $7,553.04, $3,724.73 and $1,328.34 and gross profit (excess of income over cost of goods sold) of $3,236.94, $1,510.97 and $371.23 in the 1992, 1993 and 1994 taxation years respectively, arising out of the Business carried on by them;

(d) the Appellant and his spouse reported expenses of $27,760.83, $21,709.88 and $18,948.88 in the 1992, 1993 and 1994 taxation years, resulting in business losses of $24,523.89, $20,198.91 and $18,577.65 in the 1992, 1993 and 1994 taxation years, of which the Appellant re- ported 81% or $19,921.98, 90% or $18,179.02 and 90% or $16,719.89 in the 1992, 1993 and 1994 taxation years respectively;

(e) in reassessing the Appellant for the 1992, 1993 and 1994 taxation years, the Minister reduced the net loss from the Business to the amounts of $17,366.00, $14,939.00 and nil respectively, and allocated 50% or $8,683.00, $7,469.50 and nil respectively to the Appellant and the remaining 50% of the loss from the Business to the Appellant’s spouse;

(f) at all material times, the Appellant was in full time employment with Ontario Hydro;

(g) the lease for the Queen Street store expired in November 1993 and the Appellant moved the inventory stock to the basement of his residence;

(h) after the expiry of the lease for the store, the Appellant did not operate the Business with a reasonable expectation of profit;

(i) the Appellant has failed to produce adequate receipts, invoices or other records to support the expenses incurred during the operation of the Business;

(j) the Appellant claimed his share of the Business losses in other years as follows:

YEAR	%	LOSSES
1988	50	$21,527.00
1989	50	$19,963.00
1990	50	$18,962.00
199]	50	$28,045.00
1995	50	$ 4,642.00

(k) expenses in excess of the amounts allowed by the Minister were not made or incurred for the purpose of gaining or producing income from a business or property;

(l) the disallowed expenses were personal or living expenses of the Appellant;

(m) the business expenses reported by the Appellant and his spouse for the 1992, 1993 and 1994 taxation years, included automobile expenses including capital cost allowance in the amounts of $6,692.71, $7,274.81 and $3,270.11, respectively;

(n) for the 1992 and 1993 taxation years, the Minister allowed 20% of the automobile expenses claimed including capital cost allowance in the amounts of $1,207.00 and $1,406.00 respectively;

(o) the balance of disallowed automobile expenses in the 1992, 1993 and 1994 taxation years represents the Appellant’s personal use portion;

(p) the Appellant did not maintain a proper log book in connection with the business use of the automobile.

B. Issues to be Decided

9. The issues are:

(i) whether the Appellant is entitled to deduct his share of the loss from the Business in the 1992 and 1993 taxation years in excess of the 50% allowed by the Minister;

(ii) whether the Appellant is entitled to deduct automobile expenses in the 1992, 1993 and 1994 taxation years in excess of the amounts allowed by the Minister;

(iii) whether the Appellant had a reasonable expectation of profit from the Business in the 1994 taxation year; and

(iv) in the alternative, whether the expenses were reasonable in the circumstances.

While this will involve some duplication I think it more convenient to reproduce in full the opening statement and paragraphs 1 to 10 inclusive of the Reply to the Notice of Appeal in the case of Lina Leung:

In reply to the Notice of Appeal for the 1992, 1993 and 1994 taxation years, the Deputy Attorney General of Canada says:

A. Statement of Facts

1. He admits that the documents marked as Appendix ‘A’ and ‘B’ are copies of letters that were sent by the Appellant to the Appeals Division.

2. He denies all other allegations of fact contained in the Notice of Appeal.

3. In computing income for the 1992 and 1993 taxation years, the Appellant reported business losses in the amounts of $4,601.91 and $2,019.89 respectively.

4. In computing income for the 1994 taxation year, the Appellant reported other income in the amount of $10,000.00 and business loss in the amount of $1,857.77.

5. The Minister of National Revenue (the ‘Minister’) assessed the Appellant for the 1992, 1993 and 1994 taxation years, Notices of Assessment thereof dated May 4, 1993, April 25, 1994 and March 16, 1995, respectively.

6. In reassessing the Appellant for the 1992, 1993 and 1994 taxation years, concurrent Notices of Reassessment thereof dated October 2, 1995 the Minister disallowed the deduction of the business losses in the amounts of $4,601.91, $2,019.89 and $1,857.77 respectively and reduced the other income reported in 1994 to nil.

7. On November 8, 1995, the Appellant filed Notice of Objection against the Notices of Reassessment dated October 2, 1995 for the 1992, 1993 and 1994 taxation years.

8. In further reassessing the Appellant for the 1992 and 1993 taxation years, concurrent Notices of Reassessment dated August 26, 1996 the Minister allowed the deduction of the business losses in the amounts of $8,683.00 and $7,470.00 respectively.

9. In so reassessing the Appellant, the Minister made the following assumptions of fact:

(a) in 1988, the Appellant and her spouse started an oriental giftware business in equal ( %o) partnership under the name ‘Classic Arts & Collectibles’ (the ‘Business’);

(b) in 1988, the Appellant leased a store at 734 Queen Street, East, Toronto to operate the Business;

(c) the Appellant and her spouse reported gross income of $7,553.04, $3,724.73 and $1,328.34 and gross profit (excess of income over cost of goods sold) of $3,236.94, $1,510.97 and $371.23 in the 1992, 1993 and 1994 taxation years respectively, arising out of the Business carried on by them;

(d) the Appellant and her spouse reported expenses of $27,760.83, $21,709.88 and $18,948.88 in the 1992, 1993 and 1994 taxation years, resulting in business losses of $24,523.89, $20,198.91 and $18,577.65 in the 1992, 1993 and 1994 taxation years, of which the Appellant reported 19% or $4,601.91, 10% or $2,019.89 and 10% or $1,857.77 in the 1992, 1993 and 1994 taxation years respectively;

(e) in reassessing the Appellant for the 1992, 1993 and 1994 taxation years, the Minister reduced the net loss from the Business to the amounts of $17,366.00, $14,939.00 and nil respectively, and allocated 50% or $8,683.00, $7,469.50 and nil respectively to the Appellant and the remaining 50% of the loss from the Business to the Appellant’s spouse;

(f) the lease for the Queen Street store expired in November 1993 and the Appellant moved the inventory stock to the basement of her residence;

(g) after the expiry of the lease for the store, the Appellant did not operate the Business with a reasonable expectation of profit.

(h) the Appellant has failed to produce adequate receipts, invoices or other records to support the expenses incurred during the operation of the Business;

(i) the Appellant claimed her share of the Business losses in other years as follows:

YEAR	%	LOSSES
1988	50	$21,527.00
1989	50	$19,963.00
1990	50	$18,962.00
1991	22	$ 7,681.00
1995	10	$	515.00

(j) expenses in excess of the amounts allowed by the Minister were not made or incurred for the purpose of gaining or producing income from a business or property;

(k) the disallowed expenses were personal or living expenses of the Appellant;

(l) the business expenses reported by the Appellant and her spouse for the 1992, 1993 and 1994 taxation years, included automobile expenses including capital cost allowance in the amounts of $6,692.71, $7,274.81 and $3,270.11, respectively;

(m) for the 1992 and 1993 taxation years, the Minister allowed 20% of the automobile expenses claimed including capital cost allowance in the amounts of $1,207.00 and $1,406.00 respectively;

(n) the balance of disallowed automobile expenses in the 1992, 1993 and 1994 taxation years represents the Appellant’s personal use portion;

(o) the Appellant did not maintain a proper log book in connection with the business use of the automobile.

B. Issues to be Decided

10. The issues are:

(i) whether the Minister correctly allocated 50% of the loss from the Business to the Appellant in the 1992, 1993 and 1994 taxation years;

(ii) whether the Appellant is entitled to deduct automobile expenses in the 1992, 1993 and 1994 taxation years in excess of the amounts allowed by the Minister;

(iii) whether the Appellant had a reasonable expectation of profit from the Business in the 1994 taxation year; and

(iv) in the alternative, whether the expenses were reasonable in the circumstances.

The onus is on the appellants to show that the reassessments are in error. This can be established on a balance of probabilities. Where the onus lies has been settled by numerous authorities binding on this Court. It is sufficient to refer to two judgments of the Supreme Court of Canada in this regard: R. v. Anderson Logging Co., [1925] S.C.R. 45 (S.C.C.) and Johnston v. Minister of National Revenue, [1948] S.C.R. 486 (S.C.C.).

In Joudrey v. R. (February 5, 1997), Doc. 96-3622(IT)I (T.C.C.) the appellant sought to deduct business losses of $4,815.00, $38,996.00 and $13,850.00 respectively in computing his income for 1991, 1992, 1993. The alleged business was trucking. From 1978 onward the appellant had full time employment with Maritime Tel & Tel. Paragraph 9(e) of the Reply to the Notice of Appeal, the correctness of which was confirmed by counsel, stated that the following losses were reported by the appellant in relation to the trucking activity:

The reasons for judgment read in part as follows:

In order for business losses to exist they must arise out of profit motivated commercial activity that can be regarded as a source of income. A source of income exists when there is a reasonable expectation of profit and the existence thereof is to be determined by objective testing. In Moldowan Dickson J. also said at page 5215:

Although originally disputed, it is now accepted that in order to have a “source of income’’ the taxpayer must have a profit or a reasonable expectation of profit. Source of income, thus, is an equivalent term to business: Dorfman v. M.N.R. [72 DTC 6131]

In Tonn et al. v. The Queen, 96 DTC 6001 (F.C.A.) Linden J.A. said at page 6012:

The primary use of Moldowan as an objective test, therefore, is the prevention of inappropriate reductions in tax; it is not intended as a vehicle for the wholesale judicial second-guessing of business judgments. A note of caution must be sounded for instances where the test is applied to commercial operations. Errors in business judgment, unless the Act stipulates otherwise, do not prohibit one from claiming deductions for losses arising from those errors.

In Brill et al. v. The Queen, 96 DTC 6572 (F.C.A.) Linden J.A. said at page 6577:

The other case relied on by the taxpayer was Tonn v. The Queen where deductions for interest inter alia were allowed on loans taken out to buy residential units for the purpose of gaining rental income. When the hoped [sic] for profit did not materialize, the Minister had sought to disallow the deductions on the basis of Moldowan to the effect that there was no reasonable expectation of profit during the years in question. This Court, reversing the Tax Court Judge, held that the deductions were properly allowed and suggested that Moldowan be used sparingly in cases where there was no personal element or suspicious circumstances. It stated also that Moldowan not be used to second guess good faith business judgments that were flawed.

He went on at page 6578:

In applying Moldowan, it is not whether profit is earned, but whether it could reasonably be earned. As long as the business has a reasonable chance of earning profit in the year or in the near future, the interest is deductible, whether or not there actually was a profit earned in a given taxation year. That is the lesson of the Tonn case, which only seeks to restate and clarify the application of the principle of Moldowan. Thus, where as here, if no profit is possible in the year or in the near future, no deduction can be allowed (at least as long as Moldowan continues to govern cases such as these).

The solid wall of losses incurred by the appellant recited in paragraph 9(e) of the Reply to the Notice of Appeal speaks for itself. Adapting the language of Linden J.A. in Brill, the inference to be drawn from the evidence is that no profit was possible in the years under review or in the near future. Consequently the deductions cannot be allowed.

The reasons for judgment in Joudrey are dated February 5, 1997. On une 27, 1997 the reasons for judgment of the Federal Court of Appeal in Mastri v. R. (June 27, 1997), Doc. A-650-96, A-651-96 (Fed. C.A.) were handed down. These were applications for judicial review under section 28 of the Federal Court Act. Robertson J.A., speaking for the Court, carefully reviewed the reasons for judgment of the Federal Court of Appeal in Tonn v. R. (1995), 96 D.T.C. 6001 (Fed. C.A.) and their relationship to the reasons of the Supreme Court of Canada in Moldowan v. R. (1977), 77 D.T.C. 5213 (S.C.C.). He said at para 12:

In summary, the decision of this Court in Tonn does not purport to alter the law as stated in Moldowan. Tonn simply affirms the common-sense understanding that it is not the place of the courts to second-guess the business acumen of a taxpayer whose commercial venture turns out to be less profitable than anticipated. Accordingly, the Tax Court Judge erred in his understanding and application of Tonn. The same holds true in regard to the following Tax Court cases which reveal a misunderstanding of the true import of Tonn: Howard v. Canada, [1997] T.C.J. No. 69 (QL); and Rossi v. Canada, [1996] T.C.J. No. 1632. By comparison, other Tax Court cases confirm my opinion as to what was decided in Tonn: see Joudrey v. Canada, [1997] T.C.J. No. 74 (QL); Stacey v. Canada, [1997] T.C.J. No. 117 (QL); Riddell v. Canada, 97 DTC 51; Schimmens v. Canada, [1996] T.C.J. No. 539 (QL); Urquhart v. Canada, [1996] T.C.J. No. 208 (QL); and Wallace v. Canada, [1996] T.C.J. No. 583 (QL). (Emphasis supplied)

The issues in these appeals are set out in paragraph 9 of the Reply to the Notice of Appeal regarding Jason Leung and in paragraph 10 of the Reply to the Notice of Appeal regarding Lina Leung.

I will deal first with the question whether the appellants had a reasonable expectation of profit from Classic Arts & Collectibles in 1994. As will be seen from the Replies to the Notices of Appeal, and these amounts were not challenged at trial, the appellant Jason Leung claimed business losses based upon the partnership percentage indicated as follows:

When asked about what was reported in respect of 1996 Mr. Leung replied that he could not remember. He said it may have been $2,000.00 or $3,000.00

The appellant Lina Leung claimed business losses based upon the partnership percentage indicated as follows:

Bearing in mind what was said by the Supreme Court of Canada in Moldowan as expounded upon by the Federal Court of Appeal in Tonn, Brill and Mastri, I am of the view that, on the whole of the evidence, objectively regarded, neither of the appellants had a reasonable expectation of profit in 1994. As was done in Joudrey, I place special emphasis on the uninterrupted string of losses from 1988 forward.

With respect to the allocation of the losses reference is made to subsection 103(1.1) of the Income Tax Act (the “Act’’). It provides:

103(1.1) Where two or more members of a partnership who are not dealing with each other at arm’s length agree to share any income or loss of the partnership or any other amount in respect of any activity of the partnership that is relevant to the computation of the income or taxable income of those members and the share of any such member of that income, loss or other amount is not reasonable in the circumstances having regard to the capital invested in or work performed for the partnership by the members thereof or such other factors as may be rele- vant, that share shall, notwithstanding any agreement, be deemed to be the amount that is reasonable in the circumstances.

The appellants being husband and wife they are deemed not to deal with each other at arm’s length. Paragraph 251 ( 1 )(«) of the Act provides that for the purposes of the Act related persons shall be deemed not to deal with each other at arm’s length. Subsection 251(2) states that for the purposes of the Act “related persons” include individuals who are connected by marriage.

There is no evidence before the Court which establishes that the allocation made by the Minister is other than reasonable in the circumstances.

Finally there is the matter of automobile expenses. The finding that there was no reasonable expectation of profit in 1994 disposes of this expense in that year. Regarding 1992 and 1993 there is again nothing to show that the amount allowed by the Minister for automobile expenses is not the proper amount. With regard to the keeping of records of business expenses this is said in Kay v. R. (1994), 95 D.T.C. 1 (T.C.C.), at pp. 2-3:

It may be appropriate to say something about taxpayers keeping records and books of account. Under subsection 230(1) of the Income Tax Act every person carrying on business and every person who is required to pay taxes shall keep records and books of account in such form and containing such information as will enable the taxes payable under the Act to be determined. Failure to comply with the subsection will not, of itself, result in the dismissal of an appeal against a reassessment of liability to income tax. But it could interfere with an appellant’s ability to discharge the burden of proof on him of showing that, on a balance of probability, the reassessment is in error. This was recently dealt with by the Federal Court of Appeal in Sidhu v. M.N.R., 93 DTC 5453. Mahoney J.A. in delivering the judgment of the Court said at page 5454-5:

The requirement of s. 230(1) may fairly be characterized as absolute but the consequence of not complying is liability to conviction of an offence under s. 238(2), not necessarily a conclusion that transactions which ought to have been recorded did not occur. The failure to record transactions will inevitably handicap a taxpayer seeking to discharge the burden of proving that they took place but the responsibility of the trial judge in such circumstances is to decide, on a balance of probabilities having regard to all the evidence and its credibility, whether any, all or none took place. The proper approach was demonstrated by Strayer J. in Schwartz v. Her Majesty the Queen, 87 DTC 5274 at 5275.

The law places the onus on the taxpayer in such cases to prove wrong the Minister’s reassessment on the basis that the taxpayer is in a better position to prove what actually happened, if he chooses and is able to do so. Unfortunately, the plaintiff has not been willing or able to particularize in any way the purchases made by him. He has confirmed on many occasions that the figures provided by his accountant as to his total purchases were correct. If he had made any effort to corroborate this and his oral evidence had seemed forthcoming and credible, it might have been possible to find in his favour even in the absence of any vouchers, receipts or other written records. Unfortunately neither of these requirements were met.

To the foregoing I might add that if on an appeal to this Court the circumstances are such that because of failure to keep records of business transactions or to keep reasonably comprehensible records the onus on the appellant cannot be discharged then, I think, the appellant can only be regarded as the author of his own misfortune.

The appeals are dismissed.

Appeal dismissed.