Fazekas v. R., [1998] 1 CTC 2931, 98 DTC 1204

Archambault T.C.J.:

Mr. Fazekas is appealing income tax assessments for the 1991, 1992, and 1993 taxation years (relevant period). The Minister of National Revenue (Minister) disallowed the business losses claimed by Mr. Fazekas in respect of his activities carried on under the firm name of Zoosystems Enterprises (Zoosystems) because these activities did not constitute a business. The Minister contends that Mr. Fazekas did not have any reasonable expectation of profit from such activities during the relevant period.

The Minister also assessed Mr. Fazekas for failure to withhold taxes pursuant to paragraph 212(l)(a) of the Income Tax Act (Act) in respect of payments allegedly made for marketing and consulting services performed in Hungary by a Hungarian firm {Piac Studio).

Facts

Mr. Fazekas was born in 1936 in Szeged, Hungary, where he became a medical doctor. He moved to Canada in 1968 at the age of 32. In Montreal, he first worked as a research associate in the endocrinology laboratory of the Notre-Dame Hospital. He qualified to practise as a physician in Quebec in 1973 and started a private practice in 1976. He has published many scientific papers: 76 full papers and 28 abstracts. During the relevant period, he worked all day on Tuesdays and Thursdays, and in the afternoon on Mondays, Wednesdays and Fridays.

His gross and net medical incomes from 1991 to 1995 were as follows:

Mr. Fazekas has always been fascinated by Africa, its history and its culture. In 1983, he made his first trip to South Africa. He went back at least four more times: in 1985, 1986, 1991, and 1993. He usually spent three weeks there each time. With one exception, he was accompanied on these trips by his wife and his son. During the first trip he only toured the country; on all the subsequent trips, in addition to touring, he participated in hunting safaris and visited ethnic craft shops. The first three trips cost him about $50,000.

Hungary, according to Mr. Fazekas, has a long-standing hunting tradition, so it is not surprising that he developed a passion for hunting. He says that he has accumulated over the years 32 animal trophies. Mr. Fazekas’ trophies rank among the best 100 in seven different categories of animals in the 1990 Book of Records of the Safari Club International of Tucson, Arizona. His ranking varies from as high as 42nd to 97th.

On April 15, 1991, Mr. Fazekas filed in the Quebec Superior Court a declaration of “raison sociale” in which he stated that he was carrying on a business under the name of Zoosystems for the following purposes:

Promotion des aspects de commerce, business et conservation des animaux sauvages au niveau national et international comme consultation, recherche, ferme de gibier, importation et exportation des produits naturel [sic], zoologique [sic], etc.

Mr. Fazekas stated that he prepared, at about the same time, a business plan and financial projections. He said that he followed the guidelines of a book describing how to establish a small business. This book was not filed as an exhibit to corroborate his verbal testimony. The business plan is a three-page document in which, for instance, the “business products” are described as follows:

Business Products: a multifaceted company, interested in business related to wildlife and nature products and scientific research related to wildlife as listed below:

a. Safari Organizer and Promoter to Africa

Big Game hunting and photographic safaris in South Africa

b. Hunting in Hungary

Organizing hunting in Hungary for clients from North America and bringing hunters from Hungary to Canada

c). Hunting videos

Production of original African Hunting videos for sale and advertisement of our own hunting packages

d. Importation and sale of ethnic craft [sic] from Africa

Ethnic jewellery and other crafts, mainly from South Africa to be sold in Canada retail or to distributors

e. Book writing and publishing related to African Hunting

Write and publish books on hunting adventures and travel in South Africa in order to achieve recognition and profit

g. [sic] Scientific Research and Consultancy

Conduct and support scientific research at the highest level related to wildlife and renewable resources with the aim of discovering new procedures and creating novel products for profit.

This business plan also describes the “market and competition” and “management expertise” as follows:

Market and competition

— Hunting related services: huge market of wealthy hunters in U.S.A. and Canada. In Hungary market of 50,000 big game hunters, less wealthy. Competition: strong in North America virtually non existing in Hungary.

Scientific Research: worldwide market, competition little if any, if original.

Management Expertise

The owner of the company has extensive experience in hunting and travel in South Africa. Has excellent contacts in the field and knows a lot about the country. He also knows Hungary very well, being born and raised there, speaks the language as[sic] has extensive contacts in the country.

Regarding scientific research Dr. Arpad Julius Fazekas, the owner, has a background of over 30 years in biomedical research and is the author of over one hundred publications. He is an internationally known expert in the area of comparative endocrinology, formerly a Professor in Experimental Surgery at McGill University.

Andrew S. Fazekas, B.Sc., our zoological consultant is a graduate of McGill University, a young scientist with international experience.

The company has access to scientific experts of the highest calibre through former personal contacts, both in Canada and other countries (South Africa, Hungary, U.S.A.).

The business plan also outlines business goals and financial needs.

Business cards were printed, a different telephone line was installed in Mr. Fazekas’ home, fax equipment was purchased, and a bank account under the name of Zoosystems was opened.

During the 1991 trip to South Africa, Mr. Fazekas took a $4,400 course in hunting and included that amount as an “advertising and promotion expense”. He negotiated agency contracts with at least two game ranchers, which entitled him to a commission of 15 percent of the daily cost for a visiting hunter. Mr. Fazekas stated that a hunter would normally spend about $300 to $400 per day for a minimum of six days and as many as ten days. However, the safaris that he advertised in trade papers were shown to cost between $230 and $240 per day. So this would entitle him to a minimum commission of $207 [$230 x 6 x 15%] and a maximum of $360 [$240 x 10 x 15%]. These results do not match the $1,000 commission per hunter that he alluded to in his testimony. From 1992 to 1996, he only succeeded in sending to these game ranchers about two or three hunters per year. Mr. Fazekas blamed this poor result on the political situation and the violence existing in South Africa. Mr. Fazekas also blamed a ban on importing animal trophies to Canada, which had been in force since 1987 and was only lifted in 1995.

In 1991, Mr. Fazekas hired Piac Studio to do a marketing survey of Hungarians to determine their interest in hunting in Africa, and in wildlife books and videos. Mr. Fazekas provided a summary of some of the results to the Minister, and this was filed as exhibit. Based on the statements of professional services filed in Court, the marketing and consulting services in Hungary were performed over a three-year period during the relevant period. The receipts for payments from Mr. Fazekas were signed by his sister-in-law on behalf of Piac Studio.

In December 1991, Mr. Fazekas signed a one-year lease with an unrelated landlady for a small office situated in his Hungarian home town, for which he paid an annual rent of about $8,000. He hired his father-in-law to do over $8,000 worth of renovation work. According to Mr. Fazekas, the purpose was to obtain an address and a telephone line in Hungary and a suitable place to receive potential clients.

Mr. Fazekas says that he went to Hungary in 1992 to visit some hunting clubs and he negotiated agency contracts so that he could earn commission income for sending hunters there. The agreed commission was smaller than the one agreed upon with South African ranchers. The number of clients that he was able to send to Hungary was likewise smaller than for South Africa.

During this trip to Hungary, he was accompanied by his wife and son. He also visited relatives, including his daughter and mother and his wife’s father and sister. [1] The following year, his wife returned to Hungary alone, and Mr. Fazekas claimed her full travelling expenses as business expenses in computing the income of Zoosystems. He stated that she took along with her some of the cash required to pay for the marketing services of her sister’s firm and she visited some craft boutiques and saw a well known artist about the narration of a future video.

In 1993, Mr. Fazekas and his son went back to South Africa. He implied that the purpose was to accompany a client bound on a safari. When I asked how much his commission was, he replied, “$2,000”. I asked him if it was the client who was paying for his trip (Dr. Fazekas) and he said “no”. His travelling expenses were over $15,000 and I showed him my surprise at that. The following day, Mr. Fazekas changed his version and put more emphasis on collecting antelope adrenal glands for a project of his son who was doing research for his post-graduate studies. I also got the impression that Mr. Fazekas hardly did any hunting during this trip. However, the summary of the English version of his book describing his 1993 trip to South Africa gives a different impression:

New hunts in Natal and the Cape Province in 1993. Three hunters travelling together. Joburg to Hluhluwe by car. Hunting Bonamanzi again. Adventures. About ticks in the bush. Everybody is successful. Bagging the red duiker. On to Rooipoort by car through Durban-Pietermaritzburg-Harrismith-Bloemfontein- Kimberley. New hunts on Rooipoort in the African winter. Sleeping in tents in the grand tradition. Adventures. I bag a really great kudu! Success to all! Back to Joburg. Visiting taxidermy shop. Return to Canada.

In connection with this visit to the taxidermy shop, Mr. Fazekas included a fee of $2,000 paid to the taxidermist for one of his animal trophies and claimed it as an “advertising expense”.

During each of the three years of the relevant period, Mr. Fazekas’ whole family went to Florida, and he claimed one half of the travelling expenses for tax purposes. He stated that during these trips he would visit craft shops, search for land for a game ranch and talk to lawyers. He never actually bought any such ranch.

During his numerous trips, Mr. Fazekas would normally buy a few hundred dollars’ worth of jewellery to test the market in Canada. He hired five salesladies who, operating like Avon salespersons, succeeded in selling them. Some of the purchasers included some of his acquaintances and patients. Mr. Fazekas stated that he made a profit; however, I do not know which expenses he took into account in coming to this conclusion. After realizing that Mexican jewellery was selling at a much cheaper price, he decided not to pursue this activity due to a low profit margin.

He hired his son to do surveys of wildlife breeding programs and to carry out other studies in 1991 and 1992, for which he paid total fees of $16,662. He thought that he could, in this fashion, acquire the necessary know-how to earn potentially millions of dollars. He thought, for example, that the antelope meat could be used for human consumption, that the studies could elucidate some of the mystery of a disease called “capture myopathy”. However, the fee paid in 1991 is shown as an “advertising and promotion” expense.

In 1992, Mr. Fazekas began writing a book on travelling and hunting in South Africa and on the history of that country. For this endeavour, he bought many books. For 1993 alone, he claimed expenses of $9,794 in this regard. He also claimed $1,415 for hunting clothes and equipment, and $2,520 for video equipment. He finished his book in 1996, publishing it in the Hungarian language. This decision was made on the basis that Hungarian was his mother tongue.

Mr. Fazekas had 1,000 numbered copies printed and decided to sell them himself to increase his profit margin. According to him, distributors usually take between 40 and 60 percent of the selling price. He claimed that his cost per book was $13 and that selling each copy at $50 would generate a profit of $37 per copy. He now intends to publish the English version of this book and has an offer from Quebecor to print 1,020 books for $13,000. He is confident that he can sell a lot of them and make a big profit.

Here are the amounts of gross revenue, profit and losses, and expenses earned or incurred by Zoosystems (Mr. Fazekas) from 1991 to 1996: Analysis

Reasonable expectation of profit

The Minister in assessing Mr. Fazekas has assumed that all the expenses claimed by him constitute personal expenses and that Mr. Fazekas did not have a reasonable expectation of profit. Mr. Fazekas had the burden of showing that the facts assumed by the Minister were wrong. Unfortunately for Mr. Fazekas, he did not succeed in discharging this burden.

I would like to start by stating that contrary to popular belief, the fact that a person gets business cards, registers a “Déclaration de raison sociale” saying that he now carries on a business under a certain name and prepares a business plan and financial projections does not necessarily mean that this person is carrying on a business.

The approach that must be followed to make such a determination has been described many times in the case law. For the present purposes, I will only mention three key decisions: Moldowan v. R., (1977), [1978] 1 S.C.R. 480 (S.C.C.), Landry v. R., (1994), 94 D.T.C. 6499 (Eng.) (Fed. C.A.) and Tonn v. R. (1995), [1996] 1 C.T.C. 205, 96 D.T.C. 6001 (Fed. C.A.).

In Moldowan, Mr. Justice Dickson of the Supreme Court of Canada stated at page 485:

Although originally disputed, it is now accepted that in order to have a “source of income” the taxpayer must have a profit or a reasonable expectation of profit. Source of income, thus, is an equivalent term to business...

Later on, he added:

...If the taxpayer in operating his farm is merely indulging in a hobby, with no reasonable expectation of profit, he is disentitled to claim any deduction at all in respect of expenses incurred.

There is a vast case literature on what reasonable expectation of profit means and it is by no means entirely consistent. In my view, whether a taxpayer has a reasonable expectation of profit is an objective determination to be made from all of the facts. The following criteria should be considered: the profit and loss experience in past years, the taxpayer’s training, the taxpayer’s intended course of action, the capability of the venture as capitalized to show a profit after charging capital cost allowance. The list is not intended to be exhaustive. The factors will differ with the nature and extent of the undertaking: The Queen v. Matthews.

[Footnotes omitted.]

In Landry, supra, at page 6500, Mr. Justice Décary stated:

Outre les critères énumérés par le juge Dickson, ceux dont la jurisprudence a tenu compte, a ce jour, pour déterminer s’il y avait espoir raisonnable de profit,

comprennent les suivants: le temps requis pour rentabiliser une activité de ce genre, la présence des ingrédients nécessaires à la réalisation éventuelle de profits, l’état des profits et pertes pour les années postérieures aux années en litige, le nombre d’années consécutives pendant lesquelles des pertes ont été enregistrées, l’accroissement des dépenses et la diminution des revenus au cours des périodes pertinentes, la persistance des facteurs qui causent les pertes, l’absence de planification, et le défaut d’ajustement. Par ailleurs, il ressort de ces mêmes arrêts que la bonne foi et la réputation du contribuable, la qualité du résultat obtenu, le temps et l’énergie consacrés, ne suffisent pas, en eux-mêmes, à transformer en entreprise l’exercice d’une activité.

[Footnote omitted.]

In Tonn, supra, at page 6009, Mr. Justice Linden made the following statement [2] :

the Moldowan test is ideally suited to situations where a taxpayer is attempting to avoid tax liability by an inappropriate structuring of his or her affairs. One such situation is the attempted deduction of an expense incurred to gain a tax refund. Another is an attempt by a taxpayer to deduct personal housing expenses under the guise of a free-lance typing business operated by his wife. These cases are merely instances where an inappropriate use of the Act is attempted, and where the Moldowan test has rightly denied deductibility on the basis that the Act’s purposes would otherwise be violated.

[Footnotes omitted.]

Mr. Justice Linden, at the same page in Tonn, provided the following description of the type of case that is very well suited to the application of the Moldowan test:

. One group is comprised of the cases where the impugned activity has a strong personal element. These are the personal benefit and hobby type cases where a taxpayer has invested money into an activity from which that taxpayer derives personal satisfaction or psychological benefit. Such activities have included horse farms, Hawaii and Florida condominium rentals, ski chalet rentals, yacht operations, dog kennel operations, and so forth. Though these activities may in some ways be operated as businesses, the cases have generally found the main goal to be personal. Any desire for profit in such contexts is no more than a “pious wish” or “fanciful dream”. It is only a secondary motive for having set out on the venture. What is really going on here is that the taxpayer is seeking a tax subsidy by deducting the cost of what, in reality, is a personal expenditure.

[Footnotes omitted. ]

Let’s apply this approach to the facts of this case. First, with respect to the business plan, I have some serious doubts that it was prepared in 1991, at the beginning of his endeavours, as claimed by Mr. Fazekas. Indeed, the plan states that the firm draws on the expertise of a zoological consultant who is a graduate of McGill University. In 1991, his son was still an undergraduate enrolled in a B.Sc. program with a major in zoology. He started his master’s degree in the fall of 1993 when his father “gifted” $5,000 per semester for two years starting in the fall of 1993. So either the business plan inflates the professional credentials of Zoosystems’ “zoological consultant”, or it is a correct description and the business plan was prepared two years after the commencement of the alleged business operations.

Even if we consider the business plan at face value, it is far from being a serious attempt to establish a bona fide business operation. Mr. Fazekas seems to be going in many directions: organizing safaris and hunting trips, producing and selling videos, writing and selling books, importing and selling ethnic crafts and doing scientific research and consulting work on wildlife. There is no serious attempt to describe how Mr. Fazekas is to succeed in these many endeavours.

All the Zoosystems business projects required a considerable input of time and much capital; both labour and capital had to be put in place and organized in an efficient way in order to produce a profit. Mr. Fazekas’ time and energy were taken up by his medical practice. He is a successful medical doctor who earns a gross income at the $180,000 level. He recognized during the hearing that his medical practice was his priority and that it was the main source of his livelihood.

When could he have implemented such a “multifaceted” business operation? Who would then have provided the labour to establish and operate all these different businesses? His son? He was at school, studying to become a zoologist; he would not obtain his master’s degree until 1996. His wife? We do not know what she was doing. From Mr. Fazekas’ testimony, she seems to have been involved only when they were travelling on vacation in South Africa, Hungary and Florida. I did not hear that she was involved to any significant degree in the selling of the ethnic crafts. I also note that she did not testify to corroborate her husband’s testimony, nor to describe her involvement in Zoosystems.

Were the expected flow of income and the capital of Mr. Fazekas sufficient to support the hiring of the personnel required for such endeavours? The financial projections do not reveal any serious attempt to forecast what was involved in carrying on these multifaceted endeavours. They are silent on the costs involved in procuring the products that Mr. Fazekas was contemplating selling, such as labour costs, inventory costs and accommodation costs. Furthermore, there is no serious basis for the level of sales assumed in the financial projections.

The best illustration of this lack of seriousness is the projections of income from the sale of videos and ethnic crafts. There are no projections of the costs involved in producing the videos. In fact nothing was done to produce a video except for the taking of the raw footage by Mr. Fazekas’ son during the hunting safaris. The videos were never produced because it requires sophisticated equipment and the work of professionals to produce them, and this is expensive. A lot more than the shooting of the video itself is required. So it is not surprising that no video was ever completed.

With respect to the marketing of ethnic crafts, it is easy, while travelling, to buy a few hundred dollars’ worth of jewellery and artefacts and bring them back to Canada. But it requires a lot more to retail them. Five travelling salesladies offering their products after the fashion of Avon salespersons might barely be just sufficient to test the market but certainly not enough for the carrying on of a viable business. Mr. Fazekas acknowledged that a boutique was what he had in mind for the marketing of these products. But who was to manage it? People in this kind of business work very long hours to be successful, not only to offer good products at the right price but also to make sure that their employees are doing things properly and are not keeping money that does not belong to them. It is thus not surprising that Mr. Fazekas decided not to start up such an operation. In my view, the business of importing and selling ethnic crafts never got off the ground.

Neither the business plan, nor Mr. Fazekas in his testimony for that matter, explains how a profit can be made by offering such a very limited product as hunting trips to South Africa and Hungary for North Americans and to Canada for Hungarians. I think it is quite obvious that this kind of expeditions does not appeal to a broad public. This does not mean that there is not on the North American continent a large number of game hunters like Mr. Fazekas who would be interested; but how do you reach them if you do not advertise in trade papers? Mr. Fazekas acknowledged that he only advertised for the first two years and stopped thereafter. Mr. Fazekas realized that a lot of people responding to his adds inquire but do not buy: it takes time to reply to these inquiries, and he is a full-time medical practitioner. In addition, it should be stated that he only incurred $900 in expenses for advertising in trade papers in 1991.

Afterward, Mrs. Fazekas said that he only relied on word of mouth for his advertising. How can one expect to build up volume this way so as to recover one’s “front end” expenses? Mr. Fazekas himself admitted that he does not like to go through an intermediary like himself to book his hunting trips because he can get much better prices when he deals directly with the game ranchers. One would expect that the very specialized and experienced hunters in North America would do the same. So this makes it difficult for an entrepreneur to start a safari agency business and to expect to make a profit at it.

I also note that the survey Mr. Fazekas showed to the Minister did not reveal the level of disposable income for personal consumption in Hungary. Are there enough Hungarians with enough disposable income to visit South Africa for hunting safaris? We do not know. One would expect that if a person invests $32,700 in marketing surveys, this would be among the first questions asked. Furthermore, the surveys do not seem to define what constitutes a reasonable price for videos and safaris. What is a reasonable price in Hungary for videos and books on wildlife hunting and on touring in a country such as South Africa?

Finally, how can one expect to generate any amount of business out of Hungary when one does not live in that country and one’s office there is not staffed? Mr. Fazekas paid over $28,000 for rent and renovations with respect to his office his home town, [3] and this is exclusive of the cost of furniture and supplies, and without any personnel having been hired. How useful is such an office when nobody is there to sell products or hunting packages? It should be noted that at the time there were no books or videos available for sale. Piac Studio only provided “marketing and consultant services”. I do not give much credence to an agreement written in 1995 referring to “marketing and promotional services and commercial activities” of Piac Studio and stated to be retroactive to 1991.

With respect to the scientific research and consultancy business, how can one seriously expect to carry on such a business in the zoological field when your only expert is still an undergraduate student? I have read the papers commissioned by Mr. Fazekas in 1991 and 1992 and for which he paid $16,600. These are the work of a student who might have prepared such papers in the course of a B.Sc. program. They might be very useful for a student learning his future profession but do not represent the kind of research that a bona fide business would pay for. These expenses are far removed from the earning process of a business. They do not have the required business connection.

Furthermore, Mr. Fazekas was not a veterinary who, as such, could become an expert on antelope, although I recognize that his expertise in endocrinology might be useful in helping his son in his research on those animals. I can foresee that his son could well become a recognized expert in this field: the fact that he obtained a job in his chosen field in a California zoo supports this opinion. However, that would be for his own benefit and not for his father’s. This is what happened when Mr. Fazekas’ son, an amateur astronomer, started a “sky tour” venture in 1996 on behalf of Zoosystems with the help of his father, who actually bought a computer: all the income that was deposited with Zoosystems (i.e. Mr. Fazekas) was fully repaid to his son. Where then was the profit for Zoosystems?

What about the book venture? This is the endeavour which, to me, makes the most sense among all the endeavours of Zoosystems. Mr. Fazekas has written extensively, although mostly in the scientific field. However, although a person might have a lot of talent, that does not mean that such person may necessarily expect to make a profit in publishing a book. In this case, in order to write the book in question, Mr. Fazekas had to make five trips to South Africa at a total cost of close to $80,000. He only claimed the last two of these trips, representing approximately $30,000.

The printing cost for 1,000 books is about $13,000. However, we do not know the distribution costs for the book. What is known is that if you go through a distributor, he may charge between 40 to 60 percent of the selling price. If you decide to handle the distribution yourself, you have to rely on your own advertising, on cocktail parties, on word of mouth, but then you are more likely to have lower sales, especially if you do not invest very much in the marketing campaign. There is no escaping: either you sell many books at a small profit or a few at a larger profit. Mr. Fazekas felt the latter course would be better.

By September 21, 1997, he had sold 356 out of 1,000 numbered books, 180 in Hungary at an average price of $15 and 176 in North America at an average price of $50 for a total average price of $32. To sell books in Hungary, when you live in Montreal, entails greater distribution costs.

Mr. Fazekas’ total accumulated losses for the period from 1991 to 1996 are close to $228,000. Without taking into account the printing costs for additional books and the expenses incurred to sell them, at this average price he would have to sell more than 7,000 books just to recover his initial expenses, and before making a profit. Obviously, to make a profit after incurring additional printing costs and additional selling costs, a lot more books would have to be sold.

It is true that one should not decide whether there is an expectation of profit by using hindsight. The test is: was there a reasonable expectation of profit when Mr. Fazekas started Zoosystems and during the three relevant taxation years? Mr. Fazekas did not provide any objective evidence to support his contention that such an expectation of profit existed. I only have his own subjective personal belief that there was such an expectation.

The courts have recognized that such a determination must be made objectively. Otherwise, the only thing required of a taxpayer would be to come before the Court and swear that he or she truly believes that he or she expected to make a profit. Obviously, this is not sufficient nor is it acceptable. Here I am using only the data collected for the period from 1991 to 1996 to test the belief of Mr. Fazekas; they are the only objective data available to me, No independent testimony corroborated Mr. Fazekas’ belief that he could make a profit from any of the multifaceted endeavours or from all of them together.

The objective facts are that Mr. Fazekas is a medical doctor with some experience in writing scientific papers, not books on travelling in South Africa. He is not a recognized expert in this field. If we look at his track record for the subsequent years, from 1994 to 1996, it shows a very small profit aggregating less than $2,000, still leaving huge accumulated net losses. It should also be noted that the disappearance of his business losses for the period immediately following the relevant period is due more to the significant reduction of his expenses, from the $87,000 range to somewhere in the area of $14,000, than to an increase in gross income, which seems to have plateaued at the $14,000 level.

This change in the pattern of expenses may also be due, at least in part, to the visit of the tax auditor in the fall of 1993. Among the expenses which have either disappeared or have been significantly reduced are the travelling expenses, Should Mr. Fazekas feel that more travelling in South Africa is required in order to write about the joy of new adventures in that country, the expenses would have to increase significantly again and therefore would make it more difficult to recuperate the initial costs. Mr. Fazekas has great hopes that his new English version of the book will deliver huge revenues. However, based on his previous projections which have been proven wrong, and on the overall circumstances of this case, there is little basis for hope that these revenues will materialize.

In addition to the factors that I have already alluded to, there is one more that comforts me in my decision that Mr. Fazekas did not have a reasonable expectation of profit. It appears to me that this is a case where inappropriate use is made of the tax system in order to subsidize personal endeavours. This case falls in the group of cases that Justice Linden has described in Tonn as mentioned above.

Here, Mr. Fazekas has, in his testimony, cleverly related to a business purposes all the expenses that he has claimed in computing his losses from Zoosystems’ activities. However, there is also another way of interpreting the same facts. The expenses can all be related to personal endeavours. The most important ones are those claimed as travelling expenses for trips to South Africa, Hungary and Florida. All these trips have a very strong personal element about them. Mr. Fazekas enjoys hunting very much, he derives great satisfaction from and takes much pride in his achievements, and he is entitled to do so. The fact that he owns 32 trophies speaks for itself. However, hunting for one’s own enjoyment is a personal endeavour which does not entitle a taxpayer to deduct from his taxable income expenses relating to that activity.

Vacation trips for one’s wife and child also constitute personal expenses. The same can be said of taking a $4,400 course to learn to hunt antelope in Africa and of buying books. Paying fees of $16,600 to his son for doing research in his field of study, which research could easily be used for the purpose of his son’s university studies, appears to me to be one way of helping that son to pay for those studies. Under the Civil Code of Quebec, parents have an obligation towards their children to assist them in their education. In this context, it is not important that Mr. Fazekas’ son’s reports be particularly useful in advancing his father’s business endeavours. Finally, I am convinced that Mr. Fazekas would not have paid the same fees for similar reports to a student unrelated to him who was working towards a B.Sc. with a major in zoology.

The fact that Mr. Fazekas was able to structure a $20,000 gift to McGill University for which he received a charitable gift receipt and for which he claimed a tax credit shows that Mr. Fazekas was using the tax system to fund the post-graduate studies of his son. [4]

Similar comments can be made with respect to the payment of the renovation fees to his father-in-law and even regarding the marketing studies carried out by his sister-in-law’s firm. He acknowledged that his father-in- law was retired in Hungary on only $100 pension per month, and it is quite possible that Mr. Fazekas was motivated more by compassion than profit. Renting and renovating this office in his home town in Hungary does not make any sense at all to me. Over a 22-month period he spent more than $28,000 on an office which was not staffed. His sister-in-law did not have an office outside her apartment, and apparently access to a telephone was difficult. It is possible that the office was more for her own use: this would make more sense than Mr. Fazekas’ own explanations.

I am also convinced that he would not have paid $32,700 to his sister-in- law’s firm had she not been a member of this firm. The most natural market for Mr. Fazekas’ alleged business was in North America and he never incurred any such costs on this continent. I should add that, with the possible exception of his accountant and lawyer, the only persons to whom Mr. Fazekas paid significant fees for consulting services during the relevant period were all related to him.

His safari-organizing activities did not, and I think could not generate a profit for Mr. Fazekas, given the structure put in place by him and his limited advertising, which was done only in the first two years. However, there is evidence that he could obtain free hunting safaris for himself after having found five clients for the ranchers in South Africa. Therefore, these activities could be seen more as a way of reducing the cost of his personal hunting pursuits than an attempt to make a business out of them.

The withholding tax issue

In her Reply to the Notice of Appeal, the Respondent did not state sufficiently the facts on which the Minister relied in assessing Mr. Fazekas for failure to withhold taxes pursuant to paragraph 212(1)(a) of the Act. The scope of the expression “management or administration fee or charge” used in this paragraph is determined by subsection 212(4) of the Act. A “management or administration fee or charge” does not include a payment for a service that is performed in the ordinary course of a business of a non-resident payee if the Canadian payer and the non-resident payee were dealing with each other at arm’s length. Here the Respondent did not state that the Minister assumed that Mr. Fazekas and Piac Studio were not dealing at arm’s length, nor did she state that the marketing services were not performed in the ordinary course of Piac Studio’s business.

Mr. Fazekas testified that Piac Studio belonged equally to his sister-in- law and to another person who was not married to her at the relevant time. He testified that this firm had other clients but was unable to provide more information. The Respondent did not introduce any evidence except on the cross-examination of Mr. Fazekas. In my view, the burden was on the Respondent to establish that Mr. Fazekas and Piac Studio were not dealing at arm’s length and that the services were not performed in the ordinary course of business of this Hungarian firm.

I should point out that this was not a central issue for either party. Almost all of the debate concentrated on the issue of expectation of profit. Counsel for the Respondent argued that Piac Studio was a partnership and that Mr. Fazekas was not dealing at arm’s length with it. No cases were cited to support this contention. I allowed an extra day and a half to give both parties an opportunity to provide such precedents but none was forthcoming. My own research did not identify any case dealing with this particular issue except for Chutka v. R., [1997] 2 C.T.C. 2838 (T.C.C.) where the issue was raised on a motion for the determination of a question of law. But the Court turned down that request on procedural grounds. I have however come across Interpretation Bulletin IT-419R dealing with the meaning of arm’s length. The Minister has adopted therein the following approach, in paragraphs 20 and 21:

Partnerships

20. In situations when one partner is in a position to control a partnership, either through ownership of a controlling interest or through a mandate vested in the partner by his partners, that partner is not considered to be dealing at arm’s length with that partnership. However, when a partner is not in a position to control a partnership in which the partner has an interest, and that partner has little or no say in directing the operations of the partnership, it is generally recognized that the partner is dealing at arm’s length with the partnership.

21. As a general rule, it is presumed that partners deal with each other on an arm’s-length basis in transactions outside of their partnership activity, although their partnership in business would be a factor to be considered in any other transaction between them.

At first glance, it appears reasonable to adopt this approach, and I do adopt it for the purposes of this appeal. Given that I did not have the benefit of a full discussion on this issue and that the relevant facts surrounding the negotiation of the contract in question and those relating to the running of the Hungarian firm were not put in evidence, I do not feel that it is appropriate to say more at this time. Here there is no evidence that Mr. Fazekas’ sister-in-law was controlling the firm of Piac Studio. There is also the fact that her partner had retired from a food-canning business and that this firm was his only source of income whereas the sister-in-law was a university professor.

I acknowledge that this point may not be either relevant or significant; however, it does raise an issue as to who really benefited from the fees. One can speculate that it should have been Mr. Fazekas’ sister-in-law. In any event, for the purposes of the withholding tax issue, I have not been convinced on the balance of probabilities that an arm’s length relationship existed. I should add also that I have serious doubts as to whether the full amount paid to Piac Studio truly constituted fees for services. In these circumstances, it might make more sense to conclude that the amount so paid represents rather more a sort of benevolent assistance to a relative in Hungary, and no withholding tax applies with respect to gifts to a relative.

Therefore, the assessments pursuant to subsections 215(6) and 227(8) of the Act should be annulled. For all these reasons, the appeals against the assessments for failure to withhold are allowed, and these assessments are annulled. The other appeals concerning the deduction of business losses are dismissed with costs in favour of the Minister.

Appeal allowed in part.