Date: 19990317
Docket: 97-2118-IT-G
BETWEEN:
PIERRE-YVAN AUBÉ,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
Reasons for judgment
Archambault, J.T.C.C.
[1] Pierre-Yvan Aubé is appealing notices of
assessment for the 1993, 1994 and 1995 taxation years
(relevant years) issued under the Income Tax Act
(Act) by the Minister of National Revenue
(Minister). The Minister denied the deduction of losses
incurred by Mr. Aubé in the operation of a jewellery
business. The Minister contends that Mr. Aubé had no
reasonable expectation of earning a profit from the operation of
this business, and this is the only point at issue.
Facts
[2] Mr. Aubé is a high school English teacher at a
private institution in Drummondville. This activity occupies him
only approximately 25 hours a week.
[3] Mr. Aubé is a single man with ambition: he
wants to retire comfortably at the age of 50. With this objective
in mind, he decided to go into business and, in 1984, he and
Florence Castegan, became partners in acquiring a jewellery
business located in downtown Drummondville. The store's owner
wanted to sell because he wished to move to Valleyfield.
Mr. Aubé did not hire an expert to conduct a
profitability study with respect to this kind of business, but
formed his own idea by visiting a number of jewellers in the
region. In addition, the fact that Ms. Castegan had worked
in such a business for some 20 years with her husband, who
had since died, and that she appeared to be leading a prosperous
life also encouraged him to go into the business. By
Mr. Aubé's estimate, it was possible to make a
gross profit of 40 to 60 percent in this kind of
business.
[4] Although Ms. Castegan declared bankruptcy
two years later and left the business, Mr. Aubé
continued operating it alone. During the 1980s,
Mr. Aubé moved his jewellery store twice, first to
larger premises in the same neighbourhood, then, in 1987 or 1988,
to the Place Charpentier shopping centre in
St-Nicéphore, a municipality in the suburbs of
Drummondville. Mr. Aubé hoped that at this shopping
centre his business would be more visible and benefit from
greater traffic. His store would be located near an IGA.
Mr. Aubé also saw good potential in
St-Nicéphore since residential construction was
taking place around Place Charpentier.
[5] In addition to being a teacher and businessman,
Mr. Aubé became a municipal councillor for the city
of Drummondville in 1987 and held this position until 1995,
devoting between 10 and 12 hours a week thereto.
[6] All his free time was given over to operating the
jewellery store. He went there whenever he had some spare time.
Such periods of spare time could be as long as two full
days. Mr. Aubé worked at his store every Thursday and
Friday evening and on Saturdays. He also worked Sundays on
certain special occasions, in particular during exhibitions at
the shopping centre. He estimated that he devoted 20 or
30 hours a week to his business.
[7] For the operation of the jewellery business,
Mr. Aubé had three or four employees who worked
in turns over a period of 50 hours per week. Except during
the Christmas holidays, there was only one employee in the
store at any one time. Mr. Aubé helped the employee
during peak periods and also stood in for employees when they
were on vacation. Out of his two-month school vacation, he set
aside only two weeks to rest, but that still did not stop
him from visiting potential suppliers for his store. Lastly,
Mr. Aubé's parents helped him by picking up
merchandise in Montréal and delivering jewels and watches
that Mr. Aubé had had repaired by subcontractors. His
parents received no remuneration for this work.
[8] At the start of the relevant period, the business's
main assets were its inventory and fixed assets. The
inventory's book value at the time was $105,613. The book
value of the equipment was $23,648, and that of the leasehold
improvements, $17,398, for total fixed assets of $41,046. At the
end of the relevant period, the book value of inventory amounted
to $109,431, and that of the fixed assets, to $64,310.
[9] Despite Mr. Aubé's efforts, there were
only two years in which the jewellery business made a profit
during the period from 1986 to 1997. Mr. Aubé's
financial statements and the work sheets of the Minister's
auditor provide the following figures for that period with
respect to turnover, gross profit, profit (loss), rental expenses
and advertising expenses:
Year Turnover Gross profit
Profit Rent Advertising
(loss)
1986 n/a n/a $ 687 n/a n/a
1987 $50,795 $24,438 ($ 2,130) n/a n/a
1988 $46,003 $21,453 ($14,892) $ 5,975 $2,177
1989 $68,057 $32,210 ($11,400)[1] $ 6,350 $1,133
1990 $58,558 $26,947 ($20,107) $ 7,500 $1,609
1991 $63,397 $25,506 ($12,641) $ 7,778 $1,605
1992 $57,851 $25,162 ($19,692) $ 9,539 $ 916
1993 $69,015 $30,456 ($21,743)[2] $10,154 $ 909
1994 $64,454 $29,835 ($24,599)2 $10,986 $5,052
1995 $70,780[3]
$34,692 ($15,077)2, $10,683 $1,660
1996 $71,7823 $36,475 ($ 4,231) $ 7,662 $ 752
1997 $62,113 $31,470 $ 888 $ 2,194 $ 985
[10] Mr. Aubé explained the lower turnover in 1990
and 1991 relative to 1989 by saying that the roadwork done on
St-Joseph Boulevard, where the shopping centre was located,
required customers living a kilometer away from the shopping
centre to make an eight- or nine-kilometer detour.
[11] Mr. Aubé tried by various means to make his
jewellery business profitable. He implemented a strategy to
increase his turnover, adopting, for example, certain techniques
for developing customer loyalty. In January 1992, he gave his
customers membership cards providing them with certain benefits,
in particular 15 percent discounts on the regular price of
merchandise and free wrapping. He also introduced contests
enabling his customers to win prizes, including a child's
wagon. For the 1994 fiscal year he increased his advertising
budget from $900 to $5,000.
[12] Mr. Aubé also attempted to find new sources
of supply for lower-cost products. During trips to Florida and
the eastern United States, he located suppliers who would supply
him with products at lower prices than he was paying.
[13] In addition to his efforts to increase his turnover and
gross margin, Mr. Aubé tried to reduce some of his
fixed costs, in particular his hydro expenses: he reduced the
number of light fixtures while enhancing the effectiveness of
those that remained. He tried to reduce his long distance
telephone expenses by acquiring a 1-800 line and making
greater use of the facsimile machine to order his merchandise. In
1996, Mr. Aubé secured a six-month reduction of his
rent from $890 to $500 a month. He even went as far as to close
the store on Mondays to reduce salary expenses during the last
two years of operation.
[14] Despite all his efforts, Mr. Aubé was unable
to make his jewellery business profitable and had to resign
himself to selling it. Steps were taken to this end in April
1996, but without success. In September 1997,
Mr. Aubé made another attempt, giving Trans-Action
Centre du Québec an exclusive mandate for three and a half
months. If nothing materialized by the end of this period,
Mr. Aubé would simply close his jewellery store,
which is in fact what he was obliged to do on May 31,
1998.
[15] Mr. Aubé explained his jewellery store's
failure in part by saying that the economic situation in the
1990s did considerable harm to this type of business. According
to Mr. Aubé, there were some 27 jewellery stores
in the greater Drummondville area between 1986 and 1989, of which
only seven or eight are still in business today. In addition, the
number of stores at the Place Charpentier shopping centre has
fallen from 38 to six or seven. This decline may be explained in
part by the fact that the IGA occupies more space and the
shopping centre is increasingly leasing its premises to
professional people rather than merchants.
Analysis
[16] As the Supreme Court of Canada held in Moldowan v. The
Queen, [1978] 1 S.C.R. 480, it is essential that
there be a source of income in order for a taxpayer to be able to
deduct business losses. For the purposes of determining whether
there is a source of income, a business exists only if an
activity is profitable or is carried on with a reasonable
expectation of profit.
[17] Some of the analytical factors used in making an
objective determination as to whether a taxpayer has a reasonable
expectation of profit are stated in a number of decisions,
including Moldowan, supra, and Landry v. The
Queen, 94 DTC 6624. In Moldowan, Dickson J.
described these factors as follows at page 486:
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. The list is not intended to
be exhaustive. The factors will differ with the nature and extent
of the undertaking: The Queen v. Matthews [(1974),
74 DTC 6193].
[My emphasis.]
[18] In Landry, Décary J.A. proposed the
following factors at page 6626:
Apart from the tests set out by Mr. Justice Dickson,
the tests that have been applied in the case law to date in order
to determine whether there was a reasonable expectation of profit
include the following: the time required to make an activity of
this nature profitable, the presence of the necessary ingredients
for profits ultimately to be earned, the profit and loss
situation for the years subsequent to the years in issue, the
number of consecutive years during which losses were incurred,
the increase in expenses and decrease in income in the course of
the relevant periods, the persistence of the factors causing the
losses, the absence of planning, and failure to adjust. Moreover,
it is apparent from these decisions that the taxpayer's good
faith and reputation, the quality of the results obtained and the
time and energy devoted are not in themselves sufficient to turn
the activity carried on into a business.
[19] In Tonn v. Canada, [1996] 2 F.C. 73, at
page 105, Linden J.A., like Dickson J. in
Moldowan, notes that this list is not exhaustive:
These quotations suggest that the list of relevant factors is
growing and that it may continue to grow. What this indicates is
that a detailed look at the business in the context of its
operations is what is required, and that reasonableness is to be
assessed on the basis of all the relevant factors, both the
already listed ones and any new ones that may be helpful.
[20] In assessing these factors, it is important that the
courts use common sense and that taxpayers not be penalized
retroactively when their business proves to be less profitable
than expected. Linden J.A. stated the following in
Tonn at pages 95 and 96:
The tax system has every interest in investigating the bona
fides of a taxpayer's dealings in certain situations, but
it should not discourage, or penalize, honest but erroneous
business decisions. The tax system does not tax on the basis of a
taxpayer's business acumen, with deductions extended to the
wise and withheld from the foolish. Rather, the Act taxes on the
basis of the economic situation of the taxpayer—as it is in
fact, and not as it should be, subject to what is said below.
. . .
Consequently, when the circumstances do not admit of any
suspicion that a business loss was made for a personal or
non-business motive, the test should be applied sparingly and
with a latitude favouring the taxpayer, whose business judgment
may have been less than competent.
[My emphasis.]
[21] In Mastri v. Canada (Attorney General), [1998]
1 F.C. 66, the Federal Court of Appeal had an
opportunity to clarify its thinking on this approach, at
page 75:
In other words, the term "sparingly" was meant to
convey the understanding that in cases, for example, where there
is no personal element the judge should apply the reasonable
expectation of profit test less assiduously than he or she
might do if such a factor were present. It is in this sense that
the Court in Tonn cautioned against
"second-guessing" the business decisions of
taxpayers.
[My emphasis.]
[22] The case law is full of examples in which activities
carried on by taxpayers represent a source of personal benefit.
This is the case, for example, with the city dweller who loves
horseback riding and purchases a farm to engage in horse
breeding. Being able to deduct certain farming expenses might
enable him to finance a secondary residence and the indulgence in
an enjoyable sport at least in part out of tax savings.
Similarly, there is a source of personal benefit when a taxpayer
purchases a building and leases a portion of it to members of his
family at a below-market rent.
[23] Applying the aforementioned approach to the facts of the
instant case, I must note, as Linden J.A. did in Tonn
at page 105, that the most important factor is the nature of
the activity in respect of which the losses were deducted. The
activity in this case is a purely commercial one. The evidence
does not show that this activity entailed a personal benefit for
Mr. Aubé or for members of his family. On the
contrary, it is apparent from the evidence that his parents
provided him with services without receiving any
remuneration.
[24] Furthermore, the scope of the activity, the number of
persons who took part in it and the context in which it was
carried on are also important factors to consider in this case.
This was not a store set up in the basement of
Mr. Aubé's home and operated by him in his spare
time. The pleasantly appointed store was located in a shopping
centre; four employees unrelated to Mr. Aubé
worked there; and the store had a large inventory.
[25] Mr. Aubé's sole motivation was to earn a
profit from the business. He hoped to save enough money to be
able to retire in comfort. He worked hard at operating the
business successfully, but in vain. The financial difficulties
moreover appear to have started when he moved his jewellery
business from downtown Drummondville to
St-Nicéphore. The fact that, over the years, the
Place Charpentier shopping centre became more an office building
than a shopping centre confirms that the new location was not the
ideal place to operate a jewellery store. The IGA's expansion
and the moving of its entrance also had a negative impact on
custom at Mr. Aubé's jewellery store. In addition,
traffic at the shopping centre was disrupted by roadwork in 1991.
To all this must be added other factors beyond
Mr. Aubé's control, such as the difficult
economic situation in the 1990s.
[26] Mr. Aubé originally got involved in this
business with a partner who had experience in the field. He also
performed a cursory market analysis by consulting a number of
jewellers in the area. When he decided to move the jewellery
store to the shopping centre, it was not unthinkable that he
might thereby improve its profitability. It is easy to see with
hindsight that Mr. Aubé's hopes were unjustified
and that he was unable to break even in the new premises.
[27] In support of his claim that Mr. Aubé had no
reasonable expectation of profit during the relevant years,
counsel for the Minister argued mainly that Mr. Aubé
had incurred losses in 10 consecutive years. In my opinion,
to determine whether there was reasonable expectation of profit,
the situation must be considered at the start of each of the
relevant years. At the start of 1993, Mr. Aubé had
been suffering losses for six years, not 10.
[28] If a taxpayer accumulates losses year after year and has
tried everything in order to correct the situation, but without
success, there definitely comes a time when he must realize the
obvious and recognize that the business cannot be made profitable
and that there has ceased to be a reasonable expectation of
profit. However, the Act contains no rule stating that business
losses are no longer allowable in computing a taxpayer's
income after three, six or nine consecutive years of losses. That
determination is up to the court, which must assess all the
circumstances to determine whether any expectation of profit has
evaporated. The number of consecutive years in which losses have
been incurred is merely one of the factors that must be
considered.
[29] Mr. Aubé took corrective measures to make his
business profitable, adopting in 1992 techniques to develop
customer loyalty and substantially increasing his advertising
budget in 1994. He also attempted to reduce his costs. In view of
the type of business he operated during the relevant years, there
was a likelihood that he could increase its sales and make a
sufficient gross profit to cover all the expenses of the
business. What was involved here was not a residential rental
property subject to the control of a rent control board.
[30] Lastly, it is important to note that, even though
Mr. Aubé was able to deduct his losses in computing
his income, that represented a tax saving equal to approximately
50 percent of those losses.[4] That means that in a way Canadian taxpayers
financed half of the losses. However, Mr. Aubé had to
finance the other half out of his savings.
[31] What did Mr. Aubé stand to gain by paying
$0.50 out of each dollar of losses during the relevant years? In
some instances, there are other tax benefits that would explain
such a situation. For example, in the rental property field, a
taxpayer can deduct, year after year, rental losses which are
100 percent deductible, while hoping one day to resell the
property and realize a capital gain, only 75 percent of
which is taxable. From 1972 to 1987, only 50 percent of such
gains were taxable. I am not aware that such a practice existed
for businesses such as jewellery stores.
[32] Another example is that of certain seasonal businesses
which are operated at a loss year after year in order to create
jobs for family members, thus enabling them to be eligible for
employment insurance benefits for a number of months. In the
instant case, no member of Mr. Aubé's family was
remunerated.
[33] Why would Mr. Aubé have persisted in spending
$0.50 for each dollar of losses he incurred except for the
ultimate purpose of making his business profitable and generating
a profit. This is clearly a case in which the courts must act, in
the words of Linden J.A. in Tonn, "sparingly and
with a latitude favouring the taxpayer". The words of my
colleague Bowman J. in Bélec v. Canada,
[1995] C.T.C. 2809, 95 DTC 121, are also very
apposite in the instant case. It would be most unfair for the tax
authorities to want to participate in a taxpayer's profits
but refuse to share his losses.
[34] Mr. Aubé ultimately realized that he could
not earn a profit from the operation of his business. He first
attempted to dispose of it, but was unsuccessful. He thus had to
resolve to close it in 1998.
[35] I believe that the course of conduct Mr. Aubé
adopted in operating his jewellery business was entirely
reasonable and consistent with the conduct of business people.
Consequently, I conclude that Mr. Aubé operated his
jewellery business with a reasonable expectation of profit during
the relevant years.
[36] For these reasons, these appeals are allowed and the
assessments are referred back to the Minister of National Revenue
for reconsideration and
reassessment on the basis that Mr. Aubé is
entitled to the deduction of his business losses, the whole with
costs.
Signed at Ottawa, Canada, this 17th day of March 1999.
"Pierre Archambault"
J.T.C.C.
[OFFICIAL ENGLISH TRANSLATION]
Translation certified true on this 18th day of January
2000.
Erich Klein, Revisor
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