Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.
Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the Department.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle du ministère.
Principal Issues:
1. The impact that the recent court decisions in Michael Mastri et al. v. The Queen, The Attorney General of Canada v. Enno Tonn et al., R. Buvyer v. The Queen, and J. Walls v. The Queen has on the Agency's application of the reasonable expectation of profit test.
2. Whether profits are taxable where the Agency previously determined that an activity or undertaking had no reasonable expectation of profit, but in a subsequent taxation year the particular activity or undertaking earns a profit.
Position:
1. If there is no personal or non-business motivation behind the losses, the reasonable expectation of profit test will be applied less rigorously. (IT Technical News 16.)
2. It is our view that when an undertaking or activity results in receipts of revenue in excess of expenses, that fact is a strong indication that the undertaking or activity is a venture with an expectation of profit. Thus, the net income may be taxed as income from a business.
Reasons:
1. Interpretation of court decisions.
2. The fact that a taxpayer had or appeared to have no reasonable expectation of profit in previous years may be a factor in determining whether or not the taxpayer was carrying on a business. However, it is not conclusive evidence in itself that the taxpayer was not engaged in a business in that year. Other factors, in addition to the fact that the activity generated a profit, may support the conclusion that the taxpayer was in fact engaged in a business.
XXXXXXXXXX J. Gibbons
2000-000523
March 3, 2000
Dear XXXXXXXXXX:
We are replying to your letter of January 26, 2000, concerning the impact that the recent court decisions in Michael Mastri et al. v. The Queen, The Attorney General of Canada v. Enno Tonn et al., R. Buvyer v. The Queen, and J. Walls v. The Queen has on the Agency's application of the reasonable expectation of profit test.
You also wish to know what provisions in the Income Tax Act allow the Agency to tax future profits of a business where the Agency previously determined that the business had no reasonable expectation of profit. In this regard, you ask us to assume that the taxpayer did not change the manner in which the business was operated. Further, if the taxpayer sells such a business, you wish to know how the gains should be treated in the case where profits were earned in the business and in the case where profits were never earned. That is, you wish to know whether the property will be considered personal-use property.
As requested, we have considered your questions and have provided some comments below. However, we cannot confirm the tax implications of particular transactions unless the transactions are proposed and are the subject matter of an advance ruling request submitted in the manner set out in Information Circular 70-6R3. Thus, our comments are of a general nature only.
In Income Tax Technical News No. 16, we addressed the impact of the Courts' decisions in Mastri and Tonn, as well as the decisions in Zahid Mohammad v. The Queen and David Kaye v. The Queen. (The Income Tax Technical News is published by the Agency and can be found on our internet site at www.ccra-adrc.gc.ca.) The following is an excerpt of our comments in this issue related to the foregoing income tax cases:
Q. Will Revenue Canada continue to apply the reasonable expectation of profit test in its audits in addition to the requirements in paragraphs 18(1)(a) and (h) of the Income Tax Act?
A. Our auditors are encouraged to first determine whether a revenue-producing operation has commenced. They also look at specific expenses - the allocation between business and personal and capital versus income - to make sure the expenses claimed are not out of line.
Q. Will Revenue Canada "second guess" taxpayers' business decisions?
A. The Department recognizes that a start-up period often involves incurring extra costs in order to get a business up and running but taxpayers should not assume that two or three years of start-up costs will automatically be accepted. We will therefore examine taxpayers' business decisions. If there is no personal or non-business motivation behind the losses, the reasonable expectation of profit test will be applied less rigorously.
You also requested our views about the taxability of profits where the Agency previously determined that an activity or undertaking had no reasonable expectation of profit, but in a subsequent taxation year the particular activity or undertaking earns a profit. It is our view that when an undertaking or activity results in receipts of revenue in excess of expenses, that fact is a strong indication that the undertaking or activity is a venture with an expectation of profit. Thus, the net income may be taxed as income from a business. (See, for example, paragraph 11 of IT-334R2, "Miscellaneous Revenue," and paragraph 4 of IT-504R2, "Visual Artists and Writers.") If a taxpayer had or appeared to have no reasonable expectation of profit in previous years, we note that this may also be a factor in determining whether or not the taxpayer was carrying on a business. However, it is not conclusive evidence in itself that the taxpayer was not engaged in a business in that year. Other factors, in addition to the fact that the activity generated a profit, may support the conclusion that the taxpayer was in fact engaged in a business. (See, for example, paragraph 5 of IT-322R, "Farm Losses.")
In your letter, you also ask about the treatment of capital property used in the activity or undertaking described above, i.e., where there is some doubt as to whether a business was being carried on. If the taxpayer's activity or undertaking does not constitute the carrying on of a business, the disposition of capital property used for such an activity or undertaking would likely be considered the disposition of personal-use property, as defined in section 54 of the Income Tax Act.
We trust that our comments will be of assistance.
John Oulton
for Director
Business and Publications Division
Income Tax Rulings Directorate
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