Thomas W. Mulholland v. Her Majesty the Queen (Informal Procedure), [1994] 1 CTC 2435

Brulé, J.T.C.C.:—This appeal results from a disallowance of expenses claimed by the appellant in his 1990 taxation year and the appellant elected to proceed under the informal procedure provisions of the Tax Court of Canada Act, R.S.C. 1985, c. T-2. The sum of $8,819 was determined by the Minister of National Revenue ("Minister") not to have been incurred for the purpose of gaining or producing income from a business in accordance with the provisions 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").

Facts

The appellant was an employee of Imperial Oil Ltd. throughout 1990 during which time he accepted a retirement package to commence June 30, 1991. Since 1986 the appellant had been developing a software product which he believed would fill a need and which did not have a competitor in the marketplace.

On April 19, 1990 the appellant wrote to his employer stating his intention to start a proprietorship under his name and requesting their permission to install a version of the product he was developing. During September and October 1990 Imperial Oil Ltd. indicated they wanted to enter a license agreement with the appellant to use his product. He continued the development and took courses to update his computer language skills. No positive steps were taken to market or promote the product in 1990 but work continued on its development.

Issue

The sole issue is whether or not the expenses claimed in 1990 were incurred for the purpose of gaining or producing income from his alleged business.

Analysis

The appellant said that developing and marketing a software product for use by large corporations is a lengthy process and involves expense. Admittedly there was no marketable product in 1990 but evidence showed that large corporations do not purchase such a product without an evaluation or testing. This explains that after April 1990 in the appellant’s mind a business existed with start-up costs being necessary before a sale could take place.

On the other hand the position of the respondent was simply that there was no marketable product in 1990, no income was received, the appellant did not incorporate until July 1991 and accordingly did not commence a business in 1990. Reliance was placed for this opinion on the decisions in Rolland v. M.N.R., [1987] 2 C.T.C. 2001, 87 D.T.C. 341 (T.C.C.), and Bancroft v. M.N.R., [1989] 1 C.T.C. 2196, 89 D.T.C. 153 (T.C.C.).

The respondent's counsel cited cases to the Court including McLachlen v. M.N.R., [1974] C.T.C. 2003, 74 D.T.C. 1035 (T.C.C.), and McClure v. M.N.R., [1988] 2 C.T.C. 2140, 88 D.T.C. 1504 (T.C.C.). Both of these were decided in favour of the Minister on the basis that no reasonable expectation of profit existed during the period in question. While such is also true in the present case the appellant felt he was in business in 1990 and even though there was no expectation of profit there were legitimate start-up costs, not associated with capital expenses as was mentioned in McClure, supra,

A case where expense was disallowed is found in Hanlon v. M.N.R., [1984] C.T.C. 2131, 84 D.T.C. 1101 (T.C.C.). This involved an appeal from the 1976 and 1977 years and as of 1984 virtually no income had been produced thus landing to the conclusion that the appellant had no reasonable expectation of profit. In the present case, however, the appellant believed his business commenced in 1990 and within two years three large corporations (Imperial Oil Ltd., SHL System House Ltd. and TransAlta Utilities) had purchased the software and three other large corporations (TransCanada Pipelines Ltd., PetroCanada and Pembina Pipelines) were evaluating the product.

A discussion of start-up costs is found in M.P. Drilling Ltd. v. M.N.R., [1974] C.T.C. 426, 74 D.T.C. 6343 (F.C.T.D.). In that case a company was incorporated to market petroleum gases. Eventually the venture was abandoned and the company deducted their losses from this venture. The Court held that the losses were deductible. The Court rejected the argument by the Minister that the expenses were incurred in preparation for the start of a business and not as part of the carrying on of the business. The Court explicitly said that preparation expenses are business expenses, and set out at page 429 (D.T.C. 6345):

It is reasonable to assume that if the appellant had made a profit from its marketing plan, it would have been subject to income tax. It follows that since these expenditures were incurred for the purpose of producing income they were revenue expenses and deductible.

One point which the Court must consider is the matter of the records of the appellant. He admitted in cross-examination that he did not have such at hand but seemed to justify the amounts spent. This area was not pleaded in the respondent's reply to the notice of appeal, and while it is important to have records of the expenses the Minister’s counsel did not dwell on this and I am prepared to overlook this defect.

The appellant has been honest, straightforward and was in 1990 developing a product which not long after became saleable. As a result the appeal is allowed and the matter returned^ to the Minister for reconsideration and reassessment.

Appeal allowed.