Macdonald v. R., [1997] 1 CTC 2501

Hamlyn J.T.C.C.: - These are appeals for the 1990, 1991, 1992 and 1993 taxation years.

In computing his income for the 1990, 1991, 1992 and 1993 taxation years, the Appellant sought to deduct business losses in the amounts of $38,972, $35,268, $35,968 and $31,108 respectively.

By Notices of Reassessment dated July 28, 1994, the Minister of National Revenue (the “Minister”) disallowed the deduction of the said business losses.

In reassessing the Appellant for 1990, 1991, 1992 and 1993 taxation years, the Minister made the following findings or assumptions of fact that were admitted by the Appellant at the hearing: at all material times the Appellant worked full-time as a locomotive engineer for CP Rail; between 1982 and 1989, the Appellant purchased land, buildings, and various equipment in relation to a proposed sawmill operation.

Since 1985, the Appellant claimed business losses in respect of the sawmill operation. Those losses were set forth in a schedule annexed to the Reply.

The following assumptions of the Minister were not admitted by the Appellant at the hearing: during the taxation years in issue, the sawmill was not operational as the Appellant could not obtain the necessary financing to sufficiently capitalize the operation; at no time did the sawmill operation commence to be a business; and a further assumption that really was not significant in these appeals was that there was no reasonable expectation of profit from the sawmill operation during the years 1991, 1992, and 1993.

From the Appellant’s appeal document we have the following: prior to 1987 the Appellant, concerned with difficulties in economy, found it uncertain to rely exclusively on his income from the Canadian Pacific Railway (“CPR”), where he worked as a locomotive engineer. He believed that eventually he would face lay-off, as had been the case with a number of railway workers. For this reason he thought of establishing a small sawmill business, which he expected to be operational in early 1990. His plan was to develop the sawmill business gradually. In the early years the sawmill would supplement his CPR income, and as the business grew, the sawmill would turn into the chief or exclusive source of his income.

To implement his plan, he intended to use his savings and financing from the Royal Bank of Canada, from which he had received verbal authorization for a loan in the sum of $250,000. When it was time to draw on the loan proceeds, the Royal Bank refused to make the loan because of the changes in the economic condition. He obtained, however, $100,000 from First City Trust. As a result of the reduced financing, the sawmill did not become fully operational as planned in 1990.

Over the years, and prior to 1987, the Appellant purchased the 20 acre land site on which the sawmill was located, some sawmill equipment and a tractor-trailer. He also built an access road from Roger Stevenson Road to the sawmill building which he constructed in preparation for operating the business. He invested approximately $300,000 since 1987, excluding his labour during the period. Though the mill was operational at the time of the filing of the Notice of Objection, he required further pieces of equipment, at a cost of approximately $50,000, to make the mill operational at 100% capacity.

ISSUE

The issue to be decided in this case is whether the expenses claimed were expenses incurred prior to the commencement of a business. For that we have to look at the meaning of business.

THE MEANING OF “BUSINESS”

The Income Tax Act does not define “business” but states that “business” includes profession, calling, trade, manufacture or undertaking of any kind whatever. Generally speaking, “business” refers to some form of industrial, commercial or financial endeavour or activity.

If a business is not being conducted at all, it cannot be said to be a business. It must “involve more than passive holding of a property as an investment”.

The word “business” implies the presence of some economic activity. Economic activity by itself is not enough to prove the presence of a business: to constitute a “business”, the activity must be for the purpose or with the expectation of realizing a profit.

The taxpayer’s income for a taxation year from a business or property is the 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. They must be for the purpose of producing income and must not be prohibited by statute.

In terms of what are the expenses of a business, there is a distinction between capital expenditures and revenue expenditures. In Canada Starch Co. v. Minister of National Revenue, [1968] C.T.C. 466, 68 D.T.C. 5320, the Exchequer Court of Canada found at pages 471-72 (D.T.C. 5323):

The distinction between expenditure and outgoings on revenue account and on capital account corresponds with the distinction between the business entity, structure, or organization set up or established for the earning of profit and the process by which such an organization operates to obtain regular returns by means of regular outlay, the difference between the outlay and returns representing profit or loss.

In other words, as I understand it, generally speaking,

(a) on the one hand, an expenditure for the acquisition or creation of a business entity, structure or organization, for the earning of profit, or for an addition to such an entity, structure or organization, is an expenditure on account of capital, and

(b) on the other hand, an expenditure in the process of operation of a profit-making entity, structure or organization is an expenditure on revenue account.

The next point is when does a business commence? In Gartry v. R., (sub nom. Gartry v. Canada) [1994] 2 C.T.C. 2021, 94 D.T.C. 1947 (T.C.C.), Judge Bowman of this Court examines the question of when a business has begun. This decision has also been examined by other judges of this Court, for example, Judge Dussault in Samson & Frères Ltée v. R. (1 novembre, 1995), no. 92-607(IT)G (T.C.C.).

In Gartry (supra) the Appellant had agreed to buy a ship which was out of service from the American navy, to modify it and then to use it in a commercial fishing business. The Appellant had ordered the necessary modifications, had paid for them, but the ship sunk before the transfer of title and the delivery of the ship to the Appellant. In finding that the business had commenced, Bowman J. stated in his reasons, at page 2025 (D.T.C. 1949):

In determining when a business has commenced, it is not realistic to fix the time either at the moment when money starts being earned from the trading or manufacturing operation or the provision of services or, at the other extreme, when the intention to start the business is first formed. Each case turns on its own facts, but where a taxpayer has taken significant and essential steps that are necessary to the carrying on of the business it is fair to conclude that the business has started.

From this case, in essence, I have concluded that one must look at the intention, and once the intention is established, the Court must examine what essential steps are left to be taken to make the business operational. What is the time interval involved? What is the continuing action of the Appellant? What significant activity is undertaken that is a regular part of the income-earning process or is essential preliminary to normal operations?

SIGNIFICANT EVIDENCE

The Appellant has worked in or has been about the sawmill, woodcutting, pulp and general logging industries for most of his life. In an effort to find alternative employment as a railway employee, the Appellant decided to go into the sawmill business. He surveyed the local area as to market supply of logs and surveyed a broader area as to market demand for sawmill products. He satisfied himself that both were to his advantage. His employment with the railway was sufficient to give him time to devote to his sawmill. He then commenced the project from the point of acquiring the mill site, to the building of a road, to the acquisition of a mill, and eventually to the construction of a building to house the mill. He also acquired the appropriate licenses. As indicated from the pleadings and from the Appellant’s evidence, financing became a problem and the project thereafter has inched along to the present.

The time-frame spans a period from 1985 to the present over a ten year period, and as I indicated, the tax years in question are 1990 through to 1993. The business losses from 1985 to 1993 are in excess of $238,000, and the sawmill has yet to become fully operational or to earn any income.

ANALYSIS

The lack of financing was the cause preventing the operational implementation of the sawmill. Even today the sawmill cannot be implemented until there has been further site development, including a road upgrade, yard equipment, and from the evidence I conclude that 20 to 25% further expenditure of funds is required before the project is fully operational. Also, there is further additional equipment needs. For example, a forklift is necessary to run the operation.

Moreover, an essential ingredient to the operation of the sawmill is the employment of four to six persons, four employees or four persons being the bare minimum to run the mill.

The Appellant has yet to arrange for this manpower. Thus, the extra but necessary steps to the implementation of the Appellant’s business plan include more time, more money, and people to do the millwork. I conclude the project has been from the 1990’s in slow development or, from time to time, in a hold pattern pending the Appellant resolving his financial problems. These financial problems have yet to be sorted out, as indicated by the Appellant’s evidence that his proposed lender still does not know the full extent of his possible financial difficulties.

CONCLUSION

I find the Appellant had the intention to earn income from a business but that several significant factors, including the length of time involved, the lack of meaningful activity during much of this time, the undercapitalization of the project and the failure to complete the essential steps to the making of a sawmill product lead to a conclusion that the business had not yet commenced in 1990, 1991, 1992, and 1993. In fact, the business has yet to commence. The business has yet to go through that very important threshold of carrying on business.

DECISION

The expenses incurred by the Appellant in the establishment of a sawmill for the taxation years in question were prior to the commencement of the business of a sawmill. These expenses incurred were on capital account. With this conclusion, the appeals are therefore dismissed.

The Respondent is entitled to her costs.

Appeal dismissed.