Macdonald v. R., [1997] 1 CTC 2173, 96 DTC 3270 (Informal Procedure)

Hamlyn J.T.C.C.: — These are appeals for the 1990 and 1991 taxation years.

In computing income for the 1990 and 1991 taxation years, the Appellant deducted the amounts of $32,376.82 and $21,591.13, respectively as business losses from a purported business known as MacDonald’s Marketing & Researching (the “Activity”).

The Minister of National Revenue (the “Minister”) assessed the Appellant for the 1990 taxation year, notice thereof mailed July 15, 1992, as filed.

The Minister reassessed the Appellant for the 1990 taxation year and assessed the Appellant for the 1991 taxation year, notices thereof mailed July 26, 1993 and September 15, 1993, respectively to disallow the business losses.

Admitted Facts from the Pleadings

In the 1990 and 1991 taxation years, the Appellant assisted Bruce Barthorpe and his company, The North American Stable Feeder Inc. (“North”) in researching the company’s invention, an aluminum alloy feeder to be used in farm stables called the Stable Feeder.

In the 1990 and 1991 taxation years, the Appellant reported on the income statement expenditures as resulting in the alleged business losses from the Activity as follows:

In the 1990 and 1991 taxation years, the Appellant was not paid by the company for the expenditures she incurred.

Evidence Tendered at Trial

Three witnesses were called on behalf of the Appellant, the tax return preparer and advisor to the Appellant (Donna Shepherd), the Appellant’s fiancé and agent in these proceedings (Bruce Barthorpe) and the Appellant. Little documentary evidence was filed to support the Appellant’s contention save her income tax returns.

The Appellant was involved with Bruce Barthorpe in his capacity as sole shareholder of North. The apparent arrangement between the Appellant and North was oral wherein the Appellant was to do marketing research for North by attending fairs and horse shows to determine if there was a market for North’s yet to be financed or manufactured stable feeders. The arrangement which was never clearly explained to the Court as to remuneration or contract expectation seemed to operate, in part, as follows: the Appellant would take the prototype equipment of North to horse shows and fairs and while there the Appellant would poll the attendees as to a potential market and future customers for North’s wares. The Appellant prior to this did not have marketing training or experience. The Appellant incurred substantial costs in the activities of North to the point her tax return preparer (Ms. Shepherd) told her she should declare her activity on her tax return thereby seeking tax relief from the Activity. The tax preparer’s position was the Appellant’s object was to run a marketing business and collect income potentially from the sale of stable feeders. She also referred to a business plan prepared for North. North had paid for or caused to be paid for a business plan to demonstrate the feasibility of North’s project. (It is to be noted the business plan was prepared after the tax years in issue in these appeals.) To the present date the project is yet to be financed and the stable feeders have yet to be manufactured. To the present date North still does not appear to have established a source of income. The tax return preparer and advisor, the Appellant’s agent, and the Appellant all stated they had initially high expectations that North’s business would grow.

The Appellant expended considerable personal funds and time, used her own premises as an office, used her own vehicle and used Mr. Barthorpe’s vehicles in conducting her activity. All this activity was performed outside the Appellant’s regular job.

The most important evidence in the hearing came from the Appellant. She stated throughout, her position was that she was to be repaid her expenses. However, after several leading and suggestive questions she said that she was to get more than her expenses. In terms of a definitive conclusion on this point, I am not satisfied, considering all the evidence and the suggestive leading questions, that remuneration in excess of expenses was indeed the arrangement.

Jurisprudence

A taxpayer’s income for a taxation year from a business or property is her profit therefrom for the year. Profit means net profit i.e. revenues minus expenses incurred for the purpose of earning income. The expenses sought to be deducted must be reasonable, not artificial, not personal must be for the purpose of producing income and must not be prohibited by the statute.

A reasonable expectation of profit is an objective test and not just a fanciful dream. The objective test includes an examination of profit and loss experience in past years. The test also examines of the operational plan and the background to the implementation of the operational plan including the planned course of business action. The test further includes an examination of the time spent in the activity as well as the background of the taxpayer and the education and experience of the taxpayer. Other criteria include the time required to establish the intended business, the presence or absence of ingredients leading to profits, the record of profits and the record of losses, the cause of losses and the flexibility and actions of the taxpayer to make adjustments in the face of losses.

The financial data should not be contrived and should allow for the computation of all matters normally found in the financial records of a business carried on for profit, including the computation of capital cost allowance.

The purpose of an expectation of profit determines whether income from a particular source is income from a business. The expectation of profit is central to the concept of a business and distinguishes it from the pursuit of a hobby. The determination of a reasonable expectation of profit is a finding of fact.

When there has been no actual profit it would appear that fact alone is a presumption against a finding of a reasonable expectation of profit that presumption however may be rebutted by the evidence submitted on behalf of the taxpayer.

Reasonable expectation of profit has recently been explored by the Federal Court of Appeal in Tonn v. R., [1996] 1 C.T.C. 205, 96 D.T.C. 6001. Generally, Linden J.A. is critical of the courts for applying the test too strictly and for substituting the judge’s business judgement for that of the taxpayer. On this subject he states, at pages 219-20 (D.T.C. 6009) that:

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.

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.

Later, at page 224 (D.T.C. 6012), he states:

The primary use of Moldowan as an objective test, therefore is the prevention of inappropriate reductions of tax; it is not intended as a vehicle for the wholesale judicial second-guessing of business judgments.

And at page 225 (D.T.C. 6013):

[W]here circumstances suggest that a personal or other-than-business motivation existed, or where the expectation of profit was so unreasonable as to raise a suspicion, the taxpayer will be called upon to justify objectively that the operation was in fact a business. Suspicious circumstances, therefore, will more often lead to closer scrutiny than those that are in no way suspect.

Analysis

The Appellant only after being involved with North for some time decided to declare her purported business activity. The losses when declared were large and the remuneration was virtually non existent. The whole context of the arrangement was framed in significant personal elements. The Appellant has a personal relationship with Mr. Barthorpe. The Appellant’s house was used as an office. One vehicle was owned and used by the Appellant. The other vehicles in 1991 owned by Mr. Barthorpe were declared by the Appellant as her vehicles and capital cost allowance on Mr. Barthorpe’s vehicles was so claimed by the Appellant.

From the expense sheets filed in the tax returns, the Appellant on behalf of North paid several debts including large telephone bills and gas bills.

The magnitude of losses claimed for the two years in question was over $53,000 while the declared income was only $300. More particularly, none of the witnesses could explain definitively from what or where was the income derived. The lack of other documentation to support the Appellant’s position is a serious omission.

Conclusion

There was obviously some arrangement between the Appellant and Mr. Barthorpe on behalf of North. From the expenses filed, the Appellant helped finance the activities of North and, from the evidence, the Appellant devoted time to North. Moreover, from this investment of time and money by the Appellant in North, there may yet be an accounting between the Appellant and North that may have some future fiscal consequences.

The relationship as structured however does not lead to a business conclusion on behalf of the Appellant. The Appellant in her evidence was more concerned about indemnification of expenses than she was about any profit from her activities on behalf of North. There was no identifiable contract that would lead to a conclusion a profit was contemplated. The business concept seems to be more of the tax preparer and the Appellant’s agent than that of the Appellant. While it is clear she wanted North to succeed, as stated, the thrust of her evidence seemed more directed to receiving indemnification for her outlays than the operating of a business for profit. The conclusion is the preponderant purpose of the Appellant’s assistance to North was a motivation to assist Mr. Barthorpe’s business (1.e. North) for her own personal and investment purposes but not as a person in business for herself.

Decision

The appeals are dismissed.

Appeal dismissed.