Easton (R.) v. Canada, [1994] 1 CTC 2609

Hamlyn, J.T.C.C. (orally):—This is in the matter of Robert Easton, versus Her Majesty the Queen. It is an appeal with respect to the 1989, 1990, and 1991 taxation years. In computing income for the 1989, 1990, and 1991 taxation years, the appellant deducted, respectively, the amounts of $36,869.28, $22,854, and $15,618.98 as losses incurred in a yacht chartering operation. In assessing the appellant for the 1989, 1990, and 1991 taxation years, the Minister of National Revenue disallowed the deductions of the reported yacht charter losses.

The issue to be decided in this case is whether the losses incurred by the appellant in his 1989, 1990, and 1.991 taxation years are deductible in computing his income for tax purposes.

From the pleadings, the Minister's assumptions stated the following. The appellant contracted to purchase a yacht during 1987. The yacht was located in the Bahamas for approximately two years until it was transferred by the appellant to Canada. The appellant did not at any material time have a reasonable expectation of profit from the ownership of the yacht. The appellant incurred significant losses in respect of his yacht chartering endeavour.

With respect to those losses, the following table from paragraph 11(e) of the reply of the respondent has been accepted as factually correct by the appellant. Specifically, in the year 1987, the leasing revenue was nil; the expenses were $32,399; the excess of expenses over revenue before capital cost allowance was $32,399; capital cost allowance claimed was nil; total losses claim were $32,399.

In 1988, the leasing revenue was $1,192; the expenses were $17,393; the excess of expenses over revenue before capital cost allowance was $16,201; the capital cost allowance claimed was nil; the total losses claimed were $16,201.

In the year 1989, the first year under appeal, the leasing revenue was $5,137; the expenses were $31,659.59; the excess of expenses over revenue before capital cost allowance was $26,522.59; the capital cost allowance claimed was $10,346.69; the total losses claimed were $36,869.

In the year 1990, the second year under appeal, the leasing revenue was $8,904; the expenses were $22,052; the excess of expenses over revenue before capital cost allowance was $13,148; the capital cost allowance claimed was $9,706.38; and the total losses claimed were $22,854.

In the year 1991, the last year under appeal, the leasing revenue was $9,989.80; the expenses were $17,358.36; the excess of expenses over revenue before capital cost allowance was $7,368.56; the capital cost allowance claimed was $8,250.42; and the total losses claimed were $15,618.98.

The appellant's case

The appellant first became interested in the yacht charter business in the fall of 1987, after reading an article in a Canadian sailing magazine about a company called Barreterre Yacht Charters, which operated a yacht chartering business in the Bahamas. The appellant apparently satisfied himself with the financial viability of Barreterre's program, and in December 1987 entered into a contract with Barreterre for the purchase of a sail boat to be chartered in the Bahamas by Barreterre.

The appellant's boat went into the Barreterre fleet in Georgetown, Exumas, in the Bahamas in February 1988 and by July 1988, the appellant submits the second quarter statements showed a small operating profit to the appellant in U.S. dollars of $921.53. In accordance with his agreement with Barreterre, the appellant was to receive regular monthly payments until October 1988; however, the appellant’s cheques from Barreterre for November and December 1988 were returned from the bank non-sufficient funds, that is NSF. Thereafter, the appellant learned from one Alan Redfern of a Canadian yacht charter company known as Executive Sailing that Barreterre was in financial trouble and had been operating illegally, that is without licences, in the Bahamas. At that point, the appellant's boat, along with other boats, was impounded by the Bahamian authorities. The appellant was required to pay a penalty to obtain custody of his boat.

One other boat owner, one Mr. Fitzpatrick of Stephens Yachts of Florida, also had a boat in the Barreterre fleet and was making arrangements to retrieve that boat. The appellant retained Mr. Fitzpatrick to retrieve his boat and to bring it to Miami, Florida. After some further discussion, the appellant then decided to bring the boat to Canada and place it in the charter program in Toronto with Executive Sailing. Before the boat could be sailed from the Bahamas to Florida, the rudder required repairs and the navigation instruments had to be replaced as they had been stolen. Also stolen were the dinghy and other chattels including a T.V. and stereo. The appellant then instructed Mr. Fitzpatrick to repair the boat and replace the stolen instruments.

When the boat arrived in Miami it was boarded by the U.S. Coast Guard which apparently suspected that there might be drugs on board. In the process of the search, the forward cabin was destroyed. This further added to the appellant's rising cost base. Thereafter, the appellant made arrangements to truck the boat and bring it to Canada. A Canadian trucking company arrived at the marina to collect the boat. There the trucking company discovered that the boat had been stolen. After a few days the boat was found. However, by that time the trucking company had picked up another boat and returned to Canada and the appellant had to wait until June 1989 until another truck could carry the boat to Canada. In the meantime, once again, further costs accumulated. Once the boat arrived in Canada, more costs were incurred when Canadian customs duties had to be paid.

Once in Canada, the boat was taken to Executive Sailing marina in Toronto. At that point the appellant determined that a number of further repairs and replacements would be necessary before the boat would be fit again. All of the accumulated additional expense resulted in the appellant refinancing and increasing the Original loan from approximately $78,000 to $100,000.

After the refit the boat was placed in Executive Sailing’s charter program in Toronto and the charter income for the shortened 1989 season amounted to $5,137. For the 1990 season the boat was moved to Executive Sailing's location on Georgian Bay where more charter business could be expected for a boat of its size. The charter income for 1990 was $8,904. For the next year, 1991, the boat remained at Georgian Bay and the charter income for the 1991 season was $9,989.80.

The appellant's submission

In relation to the yacht charter expenses, at all material times the appellant submits that the losses and expenditures incurred by the appellant in connection with the yacht chartering operation were made or incurred for the purpose of gaining or producing income from a business or property within the meaning of paragraph 18(1 )(a) of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the "Act").

From the outset of this venture, the appellant states that he had a reasonable expectation of profit from the operation and he further submits by way of his pleadings that in a letter of June 13, 1991, a Revenue Canada auditor who investigated the appellant's yacht chartering operation acknowledged that "with respect to the yacht rental business we are in agreement that there was an expectation of profit under the original Barreterre Yacht Partnership.” It further goes on to state the failure of the yacht rental operation to achieve a profit is as a result of a number of unfortunate circumstances which were not foreseeable by the appellant.

Jurisprudence

In terms of jurisprudence, both counsel have submitted to the Court their jurisprudence briefs and I have reviewed them carefully. I believe one case is worthy of review at this time and that is DesChênes v. Canada, [1993] 2 C.T.C. 107, 93 D.T.C. 5234 (F.C.T.D.). That case was before Mr. Justice Pinard. In reassessing the taxpayers for their 1983, 1984, and 1985 taxation years, the Minister disallowed the losses and capital cost allowance which they had claimed for those years in respect of their yacht chartering business. The taxpayers appealed to the Federal Court-Trial Division. At page 111 (D.T.C. 5238), Mr. Justice Pinard states:

Moldowan v. The Queen, [1978] 1 S.C.R. 480, [1977] C.T.C. 310, 77 D.T.C. 5213. . .is the leading case as to what constitutes the operation of a business and whether or not a taxpayer can be said to have had a reasonable expectation of profit. The Court sets out the following test of “reasonable expectation of profit" at pages 485-86 (C.T.C. 313-14, D.T.C. 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.”

And further on Mr. Justice Pinard states from the Moldowan case, supra:

There is a vast case literature on what reasonable expectation of profit means and it is by no means entirely consistent. In my view, whether a taxpayer has a reasonable expectation of profit is an objective determination to be made from all of the facts. The following criteria should be considered: the profit and loss experience in past years, the taxpayer's training, the taxpayer's intended course of action, the capability of the venture as Capitalized to show a profit after charging capital cost allowance.

Further on at page 112 (D.T.C. 5239), Mr. Justice Pinard finds:

In Chequer v. The Queen, [1988] 1 C.T.C. 257, 88 D.T.C. 6169 (F.C.T.D.), at page 259 (D.T.C. 6170), my colleague Addy, J. stated the following:

There exists a burden of proof on every taxpayer who claims a deduction of net losses resulting from a business adventure, to establish that there was, at the time he engaged in and carried on with the business, a reasonable expectation of profit. The reasonableness of the expectation must be viewed objectively and cannot merely consist of an expectation which the taxpayer in good faith entertains to the effect that a profit will be eventually realized.

Thus, in summary, I find on the question of reasonable expectation of profit that a taxpayer’s income for a taxation year from a business or property is his profit therefrom for that year. Profit means net profit, that is revenue minus expenses incurred for the purpose of earning income. The expenses sought to be deducted must be reasonable. A reasonable expectation of profit is an objective test, not a fanciful dream. The objective test includes an examination of profit and loss experience inpast years, also the examination of the operational plan and the background to the implementation of the operational plan including the planned course of action. The test further includes an examination of the time spent in the activity as well as the background of the taxpayer and the educational experience of the taxpayer. The determination of a reasonable expectation of profit is a finding of fact. Where there has been no actual profit, it would appear that that fact alone is presumption against a finding of reasonable expectation of profit. That presumption, however, may be rebutted by the evidence submitted on behalf of the taxpayer.

Significant evidence

The loss experience throughout was simply continuous losses in the face of rising expenses and a debt load for the asset, that is the boat. The revenue experience was marginal in relation to the expense level. The taxpayer had undertaken training in the handling of boats including power squadron courses and at the same time was looking for a semi-retirement business. He read an article on the Bahamas charter yacht proposal. He asked for their further material and he asked for income figures for one other boat that was apparently in the same fleet. That statement plus the charter company Barreterre’s pro forma projection documentation plus some other consultation was enough for the appellant. He borrowed heavily in relation to the projected charter. He put in some of his own personal equity. He bought the boat and embarked on the enterprise.

The Bahamas charter operation lasted a very few months and produced very little. However, the appellant maintained that a profit was shown in the second quarter of the 1988 year. Upon examination, it would appear that profit for the quarter was a small operating surplus without consideration of the appellant’s continuing and ongoing costs. Moreover, the subsequent evidence of the NSF cheques, the lack of proper licences, the non-payment of Bahamian duties, and the disappearance of the CEO of Barreterre Yacht Charters puts this alleged profit into disrepute. While the appellant said he researched the first part of the operation, that is the Bahamas operation, the evidence shows he primarily relied on the submissions of the Barreterre Yacht Charters. After several misfortunes, the appellant sought to take his asset to Miami and to regroup and rethink his venture. Throughout, his costs rose inordinately and eventually after several other problems he placed his boat in the hands of Executive Sailing in Toronto for what was then a very short 1989 sailing season. From there the boat travels to Georgian Bay, still with Executive Sailing, in an attempt to increase income.

For the Executive Sailing operation, the taxpayer referred to what he called a reconstructed projection compiled from the existing documentation and matters within his knowledge wherein he projected his income from the yacht charter proposal from anticipated boat rental revenue against his fixed expenses and his operating expenses. These projections showed a profit by 1993. It is of note, this reconstructed projection was prepared the day before the hearing of this appeal. Factually, however, as I have noted earlier, losses continued throughout the whole process and further factually, after the 1992 season the appellant ceased his boat charter operation.

Analysis

The appellant argues from the outset he had a reasonable expectation of profit and that expectation continued from the Bahamas to the operation in Canada at Toronto and then on to Georgian Bay. The reality from the evidence is from the beginning in 1988 to the end of 1992 this charter operation did not show a profit. For the Canadian operation, the evidence from the appellant was that the yacht could be expected to be chartered 70 or 70 plus days in the season. With this expectation and the level of daily rental fees as stated on the evidence, this Court concludes that it would have been very difficult indeed to achieve a profit, let alone achieve a profit after charging capital cost allowance. The operating expenses and the level of fixed debt, that is interest, expense was far beyond the level of actual gross revenue. I conclude further that it was beyond the projected gross revenue. On the financial facts before the Court, the operation could not have shown a profit with or without charging capital cost allowance.

The taxpayer's intended course of action was clearly stated to lead him to a semi-retirement boat charter business but this was clearly frustrated by the Bahamas experience and he was left then with a choice to abandon the charter business enterprise or seek alternative action. His eventual alternative action to place his boat in Canada was done without, I conclude, any real projected analysis but more of a hope based on the submission of Mr. Alan Redfern of Executive Sailing that they could rent his boat out and produce income, that is maximize revenue.

Executive Sailing in this salvage action did their best; however, the expected revenues did not result and the costs continued to raise. The revenue failure was attributed to the tired-out condition of the boat and the economic recession that prevailed for the taxation years in question. On this point the appellant places great emphasis on the unforeseen disasters: theft of the equipment, damage from drug searches, theft of the boat, unpaid duties, and the recession, to bolster his argument that recorded losses are clearly explainable and do not detract from the ongoing reasonable expectation of profit.

It must be remembered, however, business does not operate in a vacuum. Unforeseen circumstances certainly must be taken into account in any analysis. In this case a lot of what happened lay at the feet of the appellant by his not examining at the outset the stability and reliability of the Barreterre Yacht Charters and by not considering the problems of international transactions including the problems of licensing and the problems of duties, and latterly by not realizing the potential problems of bringing a boat from one country to another, that is from the Bahamas to the U.S.A. to Canada, and in particular in the U.S.A. to the City of Miami. Moreover, the factors of economic fluctuations and declining markets as well as unexpected repairs are part and parcel of all business and are by necessity part of business planning. The appellant in the circumstances described to the Court should not have been blind to all these potential risks, problems, and fluctuations in his expectation.

Conclusion

On the facts before this Court, I cannot conclude at the time the taxpayer engaged in the boat charter operation that he had a reasonable expectation of profit in the Bahamas nor in Canada after he changed locations.

Decision

The appeal is dismissed. The costs are to be on a party-and-party basis to the respondent if demanded. Thank you.

Appeal dismissed.