James D Pike v. Minister of National Revenue, [1981] CTC 2628, 81 DTC 546

D E Taylor:—This is an appeal heard in Halifax, Nova Scotia, on July 30, 1981 against income tax assessments for the years 1977 and 1978 in which the Minister of National Revenue disallowed losses incurred in race car operations. The notice of appeal read as follows:

During the taxation years of 1977/78, expenses incurred by me as a direct result of racing were necessary in order to attain a breakeven situation in 1980. With more than 80% of my operating expenses being paid by sponsors in 1981, not only will I break even but with prize money from the Atlantic Formula Ford Challenge Series, I will show a taxable profit.

Prior to the 1977 season I raced for eight years on a strictly amateur basis and did not claim any of the more than $10,000 in expenses. It wasn’t until the years in question, after deciding to enter professional races, that I made these claims.

I would like to bring to your attention a case cited in the Canadian Master Tax Guide of Huband v The Tax Review Board in 1974. In this instance a decision was made in favour of a race driver, who was a full time employee of the Government, on the basis of the percentage of his personal income spent over the years on racing. My investment as a percentage of my personal income exceeds that of Huband in the years 1977 to 1979.

To say there is no reasonable expectation of showing a profit from motor racing is simply not factual. Canadian race driver Gilles Villeneuve, who in fact started in a Formula Ford like mine and raced at Atlantic Motorsport Park here in Nova Scotia, earned $900,000 in 1980 solely through racing.

I, therefore, must and will, stand by my position that money paid to me by Revenue Canada in 1977-78 was a legitimate return on claimed expenses for the purpose of motor racing, which I had honestly intended to pursue until showing a profit.

The position of the respondent was set out in the reply to notice of appeal:

(a) At all material times the appellant was employed full time by the Department of National Defence as a tool maker and his total earnings from that source were $16,209.96 in 1977 and $17,134.47 in 1978;

(b) In 1977 and 1978 the appellant entered amateur car races with points being awarded toward a regional championship;

(c) In 1977 the appellant’s income from car racing was nil.

(d) In 1978 the appellant entered seven races winning $95 and receiving $1,200 in sponsorship partly in cash and partly in kind;

(e) In 1977 and 1978 the appellant claimed expenses in the amount of $5,047 and $6,726 respectively in respect of his car racing activity;

(f) The appellant had no reasonable expectation of earning a profit from car racing;

(g) The activity of car racing was not a business but an expensive hobby of the appellant and any expenses incurred by him were personal or living expenses.

The appellant reviewed his record in racing, and indicated that in 1981 he anticipated his expenses would not exceed $2,100, and that he expected to earn more than that in prize money. During the period 1977 to 1980, he had invested some $37,000 in the operation (including the cost of cars) and believed this should meet the criteria outlined in Ken Huband v MNR, [1974] CTC 2001; 74 DTC 1039. The fact that the appellant in the instant case had a reasonable expectation of profit in 1981 disproved the reason for which the Minister had disallowed the amounts in 1977 and 1978, according to the appellant. The appellant regarded the Minister’s disallowance as implying that there was no prospect of making racing into a profitable business. It was explained to him by counsel for the respondent that this was not the proper interpretation. According to counsel, there was a possibility of profit, even an expectation of profit by the appellant, but there was no such reasonable expectation of profit and certainly none that could be realized in the years 1977 or 1978.

With regard to the case of Huband (supra), counsel for the Minister referred to the more recent cases of Hugh Bingley Cree v MNR [1978] CTC 2472; 78 DTC 1352, and F W Beyer v MNR, [1978] CTC 2026, 78 DTC 1066, which cases were dismissed by the Board. In Cree, at 2474 and 1354 respectively, the following comment is made:

There is no doubt that Mr Cree is a better driver than Mr. Huband, but with the evidence adduced, it is difficult to convince the Board that the appellant’s autodriving activities can be done with a reasonable expectation of profit. As his own witness said, it was a “lousy proposition” and he could not understand why they do it. He also said that they all have to work because they cannot make a living from racing. The other witness, Mr. Clayton, said that one of the best Canadian drivers won $40,000 within two years and this was just enough to cover his expenses. I am certain that my colleague who has rendered a decision in Huband did not have such strong statements against the auto-racing activities in Canada. In the course of the hearing, when the witnesses had to refer to the auto-racing activity, they all used the expression “sport” and no one used the word “business”. According to the evidence adduced, it appears that many years would elapse before this activity of auto racing in Canada becomes a business.

I would agree with that statement from Cree (supra) since the case shows that knowledgeable witnesses gave evidence with regard to the operation. There is nothing in the instant appeal which would distinguish it from Cree (supra) and it must be dismissed.

Before ending, I should like to amplify some of the comments made by counsel for the respondent regarding the misinterpretation by the appellant of the requirement of the Income Tax Act as to the characteristics of and deduction processes related to a business. Mr Pike was under the impression that merely showing that a profit could be made from an operation in some year — (in fact that a profit was possible) — legitimitized all prior expenditures of the operation as deductible against other income in the years in which they were incurred. It represents a restatement of the “start-up costs” etc argument sometimes placed before the Board. In my mind that general proposition — the alleged immediate deductibility of operation losses from other income — is the genesis of the difficulty encountered by this taxpayer. The appellant puts forward the argument that the expenditures were incurred “for the purpose of gaining or producing income”, albeit at some time in the future. While I do not eliminate the prospect that under specific circumstances losses may be deductible in one year where there is clearly no reasonable expectation of profit in that same year. I do suggest that the onus on the taxpayer to put himself within the narrow parameters permitting such deductibility is a difficult task. Without attempting to define with precision those parameters, the appellant might be expected to show that he had pre-determined a clear, established pattern which allowed for those losses, and followed it; that he had provided the financing of such losses during the early years; and that the record of similar ventures almost assured him the ultimate realization of profit.

Sustained losses for a period of five years or more — even if a portion of that time is admitted to have been as a hobby — could also militate against the appellant. The Income Tax Act does not inhibit a taxpayer from reporting expenses incurred which he considers arose from a business venture and produced a “loss”. The Act only becomes difficult and restrictive when that loss is used to reduce the tax impact on other income, rather than the loss remaining available to be carried forward and applied against the profits which, by implication, the taxpayer is claiming will surely arise in the future. Such a process (retaining the losses for purposes of carrying forward against profits from the same operation rather than deducting them immediately from other income) is understandably not one which commends itself greatly to taxpayers. Nevertheless, in not so retaining the losses, the taxpayer does expose himself to the detailed examination of the profit prospects for the operation, as can be seen in this appeal.

As I see it, a taxpayer’s primary responsibility in a matter of this kind is to demonstrate that he did have a reasonable expectation of profit in the individual taxation year under review, and that his expectation was not realized for specific and documented reasons. Failing to demonstrate that in the year under review such a reasonable expectation of profit existed, leaves him with the substantial task of proving that the loss was part of an organized and systematic process of business development (not merely capital investment or accumulation) through which it was virtually inevitable that profit would accrue in time. Failing to do that may leave the taxpayer with the option of actually producing the profit and refiling the appropriate tax return to claim the earlier losses.

Decision

The appeal is dismissed.

Appeal dismissed.