James D. Troop v. Her Majesty the Queen (Informal Procedure), [1993] 2 CTC 2432

Margeson, T.C.C.J. (orally):— This matter for decision was heard under the informal procedure, Troop v. Her Majesty The Queen, 92-834(IT).

The respondent agreed at the beginning that there was no issue with the appellant regarding the years in question, 1987 and 1988, as to the expenses sought to be deducted, that is, in the sense that they were incurred. Neither was there any issue as to the amount of expenses that were incurred. The Minister was not arguing either that the expenses that were made were personal or living expenses.

The Minister is not admitting that the expenses were incurred by a“ "business". The only question before the Court is whether or not there was a reasonable expectation of profit in the years 1987 and 1988, by Mr. Troop from his Amway enterprise.

The respondent's position is set out in the reply to the notice of appeal paragraph 5.B, where counsel for the respondent says:

5. The issue is whether the expenditures claimed by the appellant in relation to his Amway activities during the 1987 and 1988 taxation years were expenditures made or incurred for the purpose of gaining or producing income [sic] from a business.

As well, the respondent is arguing that there is no reasonable expectation of profit.

The appellant introduced documentary evidence which was admitted into evidence by agreement, and he also gave viva voce evidence. The appellant’s position in his evidence was that he ran a business during the years in question out of his home.

Exhibit A-1, contained the tax returns, information and supporting documentation of the appellant for the years 1983 to 1990. In addition to this evidence and Schedule 1 and Schedule 2, which are attached to the reply to the notice of appeal, the appellant gave further testimony with respect to the years 1990 and 1991.

The appellant said that in 1990 there were gross sales of $132,150 showing a profit of $4,209, and in 1991 there were gross sales of $181,942 which would show a profit of $977. The appellant said in his evidence that whatever happened, what monies were earned were subject to volume. Volume was the important consideration.

His business, as the Court understands the evidence was a wholesale business. He went out and recruited other people. The more he recruited, I presume, the more they would sell. The better he recruited, the more they would sell, and therefore the more he would make. His income came from bonuses. It was a simple formula. Bonuses in minus bonuses out equalled income to the appellant.

The appellant said it was different from a regular business. Some of the things that make it different, there are no employers but themselves, there are no inventories, really. The goods are really pre-sold. "There are no accounts receivable. Our profit is dependent upon recruiting brokers", if you can call them that. "We do have expenses, however", and the expenses are ongoing, he said.

The expenses were clearly defined, although they go up and down in amount depending upon the volume of sales. It is clear that this enterprise, unlike a lot of Amway enterprises, was run in a pretty neat manner. The respondent has accepted that, by admitting as he did, that the expenses made were directed toward this enterprise and that they were not fraudulent and they were not personal living expenses.

The appellant himself said he kept a logbook of his miles travelled and there are no expenses claimed there that were personal. The appellant said he is retired now and is sticking at the business at hand full-time. They are building it for the future is what his evidence disclosed. He said he has no bank loans and what they have is theirs. The appellant says it can be seen that they are trying to create a business that is viable. The revenue is increasing and has increased substantially over the last number of years. We only have to look at the documentary evidence before the Court to establish that. The appellant said they are still in business, as far as he is concerned. He is continuing to try to develop it.

The appellant referred to a letter, Exhibit A-2, which is a reply from Revenue Canada which he says suggests that the Minister was satisfied that in the year referred to in the letter that the business had increased substantially. The Court takes his argument to be that there is evidence in itself that things were getting better. Exhibit A-3 was introduced, which was the covering letter to Exhibit A-2. The documents introduced show the efforts that were made by the appellant to make this business viable. Those were the efforts which were referred to the Minister when the question was raised as to how he intended to make a profit.

The appellant referred to paragraph 4(g) of the reply to the notice of appeal and took issue with that, where the Minister was alleging that the expenses were not incurred for the purpose of earning income and, further, that the expenses were personal in nature. He said they were not. He gave figures setting out the difference in the bonuses paid out in the various years. The Court has a list of the figures and I will refer to those in my decision. The appellant did say further in his evidence, that the percentage of bonuses paid out to total sales was 23 per cent for the year 1990 and 40 per cent for the year 1991.

In cross-examination, the appellant admitted that he had no proof of the 1991 figures, but he did say they were submitted to Revenue Canada. They have been undisputed here, so that is the evidence that we have, that he submitted them to Revenue Canada.

The appellant said in 1983, his intention was to operate a viable business with profit. He said he saw security down the road, he had plans. He saw a chance to set it up for a profit. He did admit that there was no projection of sales. He did not sit down and project how many sales he would expect in each of the years in question. He went out and started the business and Exhibit A-4 shows the results between 1982 and 1990, and further he showed the results in 1991.

The appellant was asked what happened in 1990 to enable him to show a profit. He testified that he went to an early retirement seminar and he decided if he took early retirement, he was going to have to get another means of income, either put his wife out to work or get another job himself or make this enterprise work. “I could take the enterprise and put more time into it, get more business, get more volume, get more profit.” That was his intention. According to the questions asked about 1990, he answered: "I spent every evening at it.”

The appellant said he could not give the number of people that were recruited in 1987 and 1988. Exhibit A-2 was introduced. His evidence indicated that the business is a wholesale one. No accounts receivable, he said. Profits depend upon the amount of recruiting, the type of brokers that he gets and the volume of sales. Thee were low start-up fees, and any low income family apparently can get involved in the organization without too much capital up front. I presume that means from his point of view that it should be easier to recruit people, they do not need a large amount of investment at the beginning and therefore that assists him in developing the network that he needs.

The appellant was asked to explain why there was no profit in 1987 and 1988, the two years in question, plus of course the other years from 1982, when there was no profit, "Even though you say you had a reasonable expectation of profit". One of the answers the appellant gave was, "the volume was not there”. The Court will comment on that when it comes to making its decision.

In 1990, the appellant said he tried harder. He found people to do what he wanted to do. In other words, he found the proper people. He found people that were interested in doing this kind of work. The more they became interested, of course, the better off he was because the better agents they became.

The appellant was not going to make anything unless he got good agents and they sold. That is where his bonuses came from. Therefore, there were more people and better people to recruit, he said, more people who wanted to do the type of thing that he wanted them to do and what he wanted to do. He decided to put in more time. The appellant said that one of the reasons was that in 1990 there was a downturn in the economy and because of the economic situation better people became available, recruiting was better. It was different in 1990 than it was in 1987 and 1988.

In re-direct he merely said that, "We did what we thought we had a right to do”, and that is to deduct the expenditures. He did not regard it as a tax shelter and he did not think they did anything wrong. Whether he did anything wrong is not the issue before this Court. The issue before the Court is whether or not the expenditures were deductible against income.

In argument the respondent says the testimony given shows that there were no projections of income, which is just part of what a person that claims he is in business has to do. It is one of the things people who go into business do in order to show that there was a reasonable expectation of profit. The respondent says the appellant had no plans in 1983 when he started the business. He just started it up and watched it go and hoped that it would be profitable. There is no question that the appellant had the intention of it being profitable, but it is argued that he did not do anything more than that.

The respondent said that the evidence disclosed that there were no start-up fees, there were no mark-up costs, there were no employees, no inventory and that one needed little money to start up. From that, it is argued, if there was a chance to make money it should have come early, not as in many cases where the argument is "I didn't make a profit in the first number of years because I had all these start-up costs". The respondent says there were no start-up costs, a fortiori there should have been a profit.

The respondent says the appellant was a full-time employee during 1987 and 1988 and therefore he could not put the time into it that he needed in order to make it profitable and he could not do that until he retired. It was a new business in 1990, the year he showed a profit. This was a new business from what he had in 1987 and 1988. The appellant tried harder, he worked harder. He decided to make a business out of it. The respondent's position was that there was no reasonable expectation of profit in 1987 and 1988, or for the earlier years and thereafter, until 1990 and 1991 when there was a profit according to the evidence that we have before us.

The respondent says that it was nothing more than a hobby until he retired and then he started to make a go of it, he started to look at it in a business sense. The respondent refers to Moldowan v. The Queen, [1978] 1 S.C.R. 480, [1977] C.T.C. 310, 77 D.T.C. 5213, which is the leading case on reasonable expectation of profit. In essence, the Moldowan, supra, case says that in order for you to be entitled to deduct expenses, there must be a stream of income against which you can deduct the expenses. Further, it says, in order for there to be a business in the sense as it is referred to in the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the "Act"), there must be a reasonable expectation of profit from your enterprise, otherwise there is no business.

It is argued here that there is no reasonable expectation of profit and therefore the expenses are not deductible in the years in question.

The appellant for his part says that counsel for the respondent claims that he only started the business in 1990 and he had no business before that. His position was that he did not start in 1990. He just started to do things differently in 1990 but he was in business before that and he intended to make a profit. In 1990 he decided to develop a better plan, more personal retail sales, more volume, more profits. Further, he reiterated, there is no capital outlay but there are ongoing expenses." I had to make them, they were reasonable expenses to make and I should be allowed to deduct them."

That would normally be<he case. If they are reasonable expenses and they are not personal expenses, they can be deductible. But before you get to that point, it is obvious that there has to be a business against which you can deduct them, as I have already outlined in referring to Moldowan, supra. The appellant says that in 1991 his statements show that he had a business. He said in 1987 and 1988 he had a business. All you have to do is look at Schedule 2 of the reply to the notice of appeal which has been introduced and also Exhibit A-4 and you can surely see that he had a business.

The appellant referred to the cases cited and said they do not really mean very much, they are not relevant here, the factual situations are different. In his business, he said, you are always in the building stage. You cannot look at it from one point in time. You must look at it over a period of time.

The appellant did reasonably expect a profit. When you look at the letter of September 23, 1991, from the Minister, it is obvious that the Minister felt that things were getting better and things were improving. He asks that the appeal be allowed and that he be allowed to deduct the expenses against income. He says if he is not entitled to the expenses, then he will have to go back and consider whether he stays in it, he may have to go back to work.

Those are the facts as disclosed by the viva voce evidence and also by the documents that are before this Court.

As the Court indicated at the outset, the only issue is whether or not in the years in question, 1987 and 1988, there was a reasonable expectation of profit. In making that decision I must look at all of the evidence, the documentary evidence and the viva voce evidence and draw any reasonable inferences which the Court is entitled to draw from those facts.

It is necessary to look at the whole financial picture, that is, sales, bonuses, cost of sales as set out in Schedule 1 and Schedule 2 and Exhibit A-4, they all must be considered. Further, it is necessary to take into account the letter referred to from the Minister which indicated that things were getting better, take into account the evidence given by the appellant regarding what he was attempting to do to make things better, to improve, and refer to Schedule 1 and Schedule 2 in the reply to the notice of appeal. As referred to in Moldowan, supra, all the facts must be looked at objectively. What we must do is look at the years in question, 1987 and 1988, and decide whether or not there was a reasonable expectation of profit during those years. We must use all the information that is before us, not necessarily only to look at 1987 and 1988. But what we really must do is look at 1987 and 1988 in light of all the information available to us from 1982 to 1991, which is really what we have before us, and then look at it objectively and make a decision as to whether or not there was a reasonable expectation of profit in the years in question.

When the Court does that, and we look at the income and the expenses between 1982 and 1991, there were continuous losses between 1983 and 1989. Only in 1990 and 1991 was there a profit. The losses vary as much as $3,000 and $4,000, the highest one being in 1985 where there is a $9,222 loss and in 1988 $8,100. Then they go down to a low of $3,027 in the first year. Looking at that alone, one would say, "How can there be any reasonable expectation of profit?"

Well, that is not the end of the issue though. We then ask: What does the appellant say? Can he explain the losses between 1982 and 1989?

The appellant was given the opportunity to explain those losses, as to whether or not there were any extraordinary events, was there anything such as start-up costs, extra expenses, calamities, disasters, which would account for the apparent lack of profit. He was given an opportunity to explain why in those years he would have had a reasonable expectation of profit or why the Court should decide he had a reasonable expectation of profit in spite of those losses. Basically, he was not able to come up with any explanation because there was nothing there which he could show. There were losses in fact, between 1983 and 1989 contrary to his avowed intention that there was a reasonable expectation of profit.

There was clear evidence given, that in 1990 and 1991 there was a complete change in the way that he did business. The changes were that in 1990 and 1991, in which years he showed a profit, the appellant spent more time on his enterprise because he had more time, he recruited better people, he recruited more people, he knew that he had to have a greater network if he was going to make more bonuses and sell more product. The appellant even said that in 1990 and 1991 there was a change in the economy, the economic outlook changed so that there was the availability of a greater array of people who were interested in doing the kind of thing that he was going to do and they were interested in making money and could help him make money.

There is no doubt in my mind that there was an overt change in the way the appellant conducted this enterprise in 1990 and 1991 and the conditions existent then were not indications of those existent in 1987 and 1988. The Court has no hesitation in coming to the conclusion that there was no reasonable expectation of profit from a business in 1987 and 1988.

The appellant has referred to some of the cases that are mentioned by the respondent. The Court need not refer further to Moldowan, supra, because it is clear from that case that unless there is a reasonable expectation of profit there is no business against which to offset your income and therefore the deductions are not allowable. He does not fit within Moldowan, supra, on that point. Regarding Craddock v. M.N.R., [1986] 1 C.T.C. 2006, 86 D.T.C. 1014 (T.C.C.), it is true that the factual situation is not similar as here, but it was cited by the Crown only to show that even in that case where there might have been an argument about start-up costs, in this case at bar there were no start-up costs and the appellant cannot even rely upon that. Consequently, there is no explanation as to why he showed a loss in the years between 1983 and 1989.

Regarding Chequer v. The Queen, [1988] 1 C.T.C. 257, 88 D.T.C. 6169 (F.C.T.D.), again the factual situation is not the same as here. That was a charter business. It was only cited by the Minister, as far as the Court is concerned, to show that the appellant failed to objectively show that there was a reasonable expectation of profit. That is the same duty that is imposed upon the appellant here.

The duty of the appellant is to satisfy the Court on the balance of probabilities, looking at it objectively, that there was a reasonable expectation of profit from the business. In that case he was unable to do so and in this case the Court is satisfied that the appellant has not done so.

Coupland v. The Queen, [1988] 1 C.T.C. 414, 88 D.T.C. 6252 (F.C.T.D.), was also cited by the Minister. Again, the factual situation in Coupland, supra, is not the same. This was a business that was attempted to be operated as a campground. The Court again found that there was no reasonable expectation of profit, in spite of the fact that the taxpayer had considerable experience to run a campground, but the evidence showed that he was not on the property much of the time, there was no evidence of any concerted advertising campaign to create enough business to make a profit, and it was clear the enterprise from the start was undercapitalized.

Capitalization does not come into the picture in the appellant's case because there was not much capital required. I think one of the facts, though, was that in the beginning, in between 1983 and 1989, the appellant did not spend the time on it that was necessary. It is quite obvious in 1990 and 1991, when he did spend the time on it, that he turned the corner and showed a profit.

The Court dismisses the appeal and confirms the assessment of the Minister.

Appeal dismissed.