Dedes v. R., [1998] 1 CTC 3247

Dussault T.C.J.:

These are appeals from assessments for the appellant’s 1991, 1992 and 1993 taxation years. By these assessments the Minister of National Revenue (the “Minister”) disallowed business losses claimed by the appellant in the amount of $25,204 for 1991, $25,144 for 1992 and $24,863 for 1993. In the notification of confirmation by the Minister, the stated reasons for doing so are that “it has not been demonstrated that there was any reasonable expectation of profit ... as the expenses have not been shown to have been incurred by the taxpayer for the purpose of gaining or producing income within the meaning of paragraph 18(1 )(a) of the [Income Tax] Act”.

In paragraph 9 of the Reply to the Notice of Appeal it is stated that in reassessing the appellant the Minister made the following assumptions of fact:

a. at all material times the Appellant was a full time employee;

b. in his income tax returns, the Appellant claimed business losses in the name of Montreal International Reg’d;

C. the Appellant had no reasonable expectation of profit from the “so- called” business mentioned in the preceding paragraph, in any of the 1991, 1992 and 1993 taxation years;

d. the expenses disallowed by the Minister were not incurred for the purpose of gaining or producing income from a business or property, but were personal or living expenses of the Appellant.

Counsel for the appellant took exception to the fact that the notification of confirmation does not refer to personal or living expenses while the Reply to the Notice of Appeal does. There are two comments I want to make in this respect. First, the assumption that the taxpayer “had no reasonable expectation of profit” has sometimes been viewed as an implied if not an express reference to the definition of “personal or living expenses” found in subsection 248(1) of the Act where such expenses are precisely defined as including:

(a) the expenses of properties maintained by any person for the use or benefit of the taxpayer or any person connected with the taxpayer by blood relationship, marriage or adoption, and not maintained in connection with a business carried on for profit or with a reasonable expectation of profit.

As we know, the deduction of personal or living expenses is prohibited by paragraph 18(l)(/i) of the Act. However, in Tonn! [1] Linden J. of the Federal Court of Appeal was of the view that the test of “reasonable expectation of profit” as propounded by Dickson J. in the Supreme Court of Canada decision in Moldowan? [2] was broader than that suggested by paragraph 18( 1 )(/i) [3] and that in fact, because of its objective nature, it “does not derive from any of the deductibility provisions in sections 9, 18 and 20” and thus “contemplates stricter application” than the “business intention tests of subsection 9(1) and paragraph 18(l)(a)”. [4]

Having said that, Linden J. adds a little further on:

I have dwelt upon the issue of the origin of the “reasonable expectation of profit” test because a proper understanding of it is necessary to the resolution of this application. As a common law formulation respecting the purposes of the Act, 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^. [5]

I think we are facing here precisely a situation “where a taxpayer is attempting to avoid tax liability by an inappropriate structuring of his .... affairs” in attempting to gain a tax refund by deducting personal expenses.

But before entering into the details of the present case, I would like to make my second comment, which has to do with the reasons given in support of an assessment. In Belle-Isle^, [6] Boisvert, Q.C. after referring to the texts of what are now section 166 and subsections 152(3) and (8) said:

Where the above texts are concerned, it matters little under what section of the Act an assessment is made. What does matter is whether tax is due. [7]

In Minden [8] the following was said by Thorson P.:

In considering an appeal from an income tax assessment the Court is concerned with the validity of the assessment, not the correctness of the reasons assigned by the Minister for making it. An assessment may be valid although the reason assigned by the Minister for making it may be erroneous. This has been abundantly established.^ [9]

These statements have been quoted with approval by the Federal Court of Appeal in Riendeau)®. [10] In any event, I make these remarks in the interest of accuracy only, as the point was raised, and not because I believe that the Minister was wrong in his reasons for assessing the appellant. As a last comment, I would add that, in my view, the assumptions are sufficiently pleaded in the Reply to the Notice of Appeal to cast upon the appellant the burden of demonstrating both that he had a “reasonable expectation of profit” with respect to his activities carried on under the name Montreal International Reg’d, and that the losses disallowed did not result from the deduction of personal or living expenses. [11]

The appellant started his wholesaling and retailing activities with respect to various types of goods in 1983. In 1984, he registered with the Superior Court of Quebec under the firm name “Montreal International” with a view to carrying-on the business of marketing gifts, novelties and services. From his testimony and that of his wife, Muzeyven Dedes, it would appear that they sold all types of clothing from underwear to jeans to ski suits, as well as cookware, kitchen utensils, pastry molds, etc. The merchandise was stated to have been bought from wholesalers and sold initially to family members, friends and acquaintances. Some goods, such as jeans and pastry molds, were allegedly exported to Turkey. As word got around, people came to know of these activities and the number of customers apparently grew although the level of activity seems to have remained relatively modest. As will be seen, the level of sales was more or less constant from 1988 to 1995. The appellant admitted that his activities did not generate any profit from 1983 to 1986. With regard to that, no records were submitted nor was I made aware of any figures. However, Mr. Jean-Guy Francoeur, an Appeals Officer for Revenue Canada, testified as to amounts reported by the appellant for his 1987 to 1990 taxation years. Computer printouts indicate that gross business income reported and net losses claimed for those years were as follows:

Notes:

{12} Exhibit R-1

From the financial statements filed with the income tax returns for the years in issue as well as from those returns, one can ascertain more detailed information on key features of the activities in question, as indicated below:

Notes:

{13} This is an error in the financial statements as this amount should have been ($25,335).

In his testimony the appellant maintained that he was by then trying to improve his business every way he could. Lack of knowledge of the business and of the local market, inappropriate choices in the type, quantity and quality of goods purchased, ignorance of the French language as well as the fact that he was new in the business and not very well known were all mentioned as reasons for the failure to make a profit in earlier years.

Both the appellant and his wife said that to straighten things out during the years in issue they took French courses. Moreover, in 1990, the appellant bought a van and started to make some modifications to it so that he could more easily carry the displays, tables and merchandise to flea markets where he would go with his wife on Saturdays, Sundays and holidays to put up a Stall. He also bought a trailer in 1991 and again modified it so as to make it easier to carry the necessary equipment to flea markets. Both the van and the trailer were registered for commercial purposes and were insured accordingly.

The appellant was also operating from his home where he kept goods for sale in the basement. He had a commercial phone line and a fax machine in the den. As he was employed full-time as an inspector with Air Canada, his wife would answer the phone during the day and would take orders from customers. Sales were also made by visiting customers at their residence. Purchasing was done by both the appellant and his wife from wholesalers in the St-Lawrence Street and Chabanel Street area in Montréal as well as at flea markets. Mrs. Dedes received no salary for her work.

I might add that during the years in issue the appellant was registered for provincial sales tax purposes. He only became a GST registrant in 1995.

In addition to the reasons already given, additional expenses for the van and trailer as well as years of recession were presented as having contributed to the lack of profit during the period in issue. I will only comment here that no explanation whatsoever was given as to how the appellant could have incurred losses of the magnitude indicated, a point to which I will come back later.

In his testimony, Mr. Francoeur from Revenue Canada also said that the appellant’s returns for the 1994 and 1995 taxation years indicated the following:

According to him, the 1995 tax return was filed April 30, 1996, which was after he had started, in January 1996, the office audit for the years in issue.

To complete the picture, financial statements for the year 1996 were also submitted in evidence by the appellant. They indicate the following:

Returning to the years in issue and looking at the expense side of things, the following is indicated in the financial statements filed with the taxpayer’s tax return for the 1991 taxation year:

To this amount, $482 was added as capital cost allowance for 30% use of the car for business activities. Total expenses claimed were $26,979 resulting in a loss of $25,204.

In the financial statements filed for the 1992 and 1993 taxation years, expenses are presented under the same headings and are comparable.

All the expenses and losses claimed were disallowed at the conclusion of the audit for the reasons already stated. At the objection stage, the appellant’s accountant filed with Revenue Canada new schedules reducing the expenses claimed by the appellant in relation to his activities for the 1991 to 1993 taxation years. [12] The following schedule presented for 1991 is typical and figures presented for 1992 and 1993 are comparable:

Expenses

	Rent Flea Market	550
	Telephone - long distance	150
	Office supplies	85
	Promotion	125
	total expenses (before car)	890
Net income		885
Auto expense (per schedule)		4847
Use of residence (per schedule)		0
Net Loss
		3962
Use of home expenses		0 {16}
Net Loss
		3962
Notes:
{16}	In the document, this line is crossed out.

Although a separate schedule indicates expenses for the use of the residence no amount is claimed for that item. Many expenses originally presented have also disappeared or have been considerably reduced.

I would simply add here that in the financial statements prepared for the 1996 taxation year an amount of $1,358 is presented as being rent for the use of the residence.

Counsel for the appellant made representations on the issue of the reasonable expectation of profit for the years in issue, emphasizing the fact that the appellant after investing and restructuring his business has now reached the point where he can show a profit. According to counsel, if it has taken 12 years to reach that result, it is not for the Court to second-guess the business decisions of the appellant who, despite his initial lack of experience, has adapted constantly over the years while facing difficult economic conditions. According to him the situation here does not involve hobby activities and should not be governed by the test enunciated in the Moldowan case (supra). In support of his arguments, counsel relied on the decisions in Tonn (supra) and Bélec J [13]

However, on the question of expenses, counsel for the appellant indicated that he was limiting the appeals to the reduced amounts of expenses and losses as presented by the appellant’s accountant at the objection stage, that is $3,962 for 1991, $4,919 for 1992 and $4,506 for 1993.

Counsel for the respondent submitted that the activities of the appellant were merely a hobby or an undertaking intended to generate a tax refund, that he had no business plan and did nothing significant to make the venture profitable. Referring to the Supreme Court of Canada decision in Moldowan (supra) she insisted that the Court should analyze the facts from an objective viewpoint. According to her, working only on weekends to generate a very small amount of gross sales while claiming to have a reasonable expectation of profit amounts to nothing more than a “fanciful dream”. She also pointed to the size of the losses incurred over the years and the significant reduction of expenses in the document submitted by the appellant’s accountant at the objection stage. In her view, the expenses claimed, although reduced, are still nothing but personal or living expenses. In support of her position, counsel for the respondent relied on the decisions in Tonn (supra), [14] Sipley,^Landry,Engler^ [16] and Dumont.\? [17]

No doubt, the evidence presented here invites close scrutiny of the situation, as it seems obvious that the appellant has, not only for the years in issue but for the seven previous years as well, that is, from 1983 to 1990, claimed expenses far in excess of what could reasonably be connected with his sales activities. To put it bluntly, I think he was simply claiming personal or living expenses, a great part of which were related to the maintenance of the family residence. Others were probably significantly exaggerated if incurred at all. In this respect, the comparison between the expenses originally presented in the financial statements and those presented later by the appellant’s accountant is revealing. The facts and figures speak for themselves. One would not be very hard pressed to conclude from them that the main reason for setting up the sales activities was essentially the deduction of expenses that were primarily and for the most part personal or living expenses of the appellant and his family. In so doing the appellant reduced his employment income subject to tax thereby generating for several years a generous tax refund. The level of activity revealed by gross sales figures obtained for the years from 1987 to 1990 and up until 1993 and even 1994 and 1995, and the gross margin figures recorded for the years in issue do not support a finding that the appellant had in those years any reasonable expectation of profit. This is so irrespective of the level of expenses. From 1988 to 1995, gross sales never increased significantly. For the three years in issue, the gross margin decreased year by year from $1,775 to $1,595 to $1,058. Moreover, with such figures on the income side, how could anyone seriously claim to have a reasonable expectation of profit while at the same time claiming expenses in the magnitude of $25,000 year after year. I do not think I need go much further in order to conclude that the appellant was, in the years in issue, maintaining his activities primarily for the unavowed purpose of obtaining an unwarranted tax benefit.

Even without resorting to the reasonable expectation of profit test enunciated in Moldowan (supra) the appellant’s expenses should be disallowed on the basis that he has failed to demonstrate, on the balance of probabilities, that they were not personal or living expenses, an assumption pleaded by the respondent. Paragraph 18(1)(h) prohibits the deductibility of such expenses as defined in subsection 248(1) of the Act.

Counsel for the appellant urges me to see things from a different perspective by limiting the appeals to the reduced amount of expenses and losses as presented by the appellant’s accountant. As we have seen, for the 1991, 1992 and 1993 taxation years the losses of $25,204, $25,144 and $24,863 would thus be reduced to $3,962, $4,919 and $4,506 respectively.

Unfortunately for the appellant this revised presentation of his affairs does not change my earlier conclusions. Even if with proper evidence as to the real nature of the remaining expenses I might perhaps have been prompted to view the whole matter differently, I must nevertheless note that no attempt was made to provide me with such evidence. I am thus left with the impression that amongst those expenses there are still some, and I do not know to what extent this might be so, that could be considered personal or that are exaggerated. Two examples will suffice to illustrate the point. The first relates to an expense of $550 still claimed for 1991 for rent at the flea market. According to a document filed by Mrs. Dedes in which all the transactions for that year are recorded, [18] there were only two occasions on which they had a stall at a flea market during the year. However, in her testimony she said that the rent paid was either $18 for a Saturday or $28 for a Sunday. Thus the figures simply do not add up.

The second example relates to the use of the van in connection with the sales activities. From the appellant’s and Mrs. Dedes’ testimony, I was left with the impression that the van was bought and used exclusively for the purposes of those activities. The financial statements submitted with the returns also lead to that conclusion. Moreover, additional capital cost allowance was also claimed for 30% use of a car for business purposes. In the documents submitted by the appellant’s accountant to Revenue Canada, personal usage of the van is acknowledged for 5,200 km per year out of a total of 16,000 km for each of the three years in issue. One is therefore left wondering whether this revised proportion of use conforms with reality. Again, no evidence at all was presented on that point.

The audit conducted by Revenue Canada in January 1996 certainly had the effect of straightening things out for 1995 and 1996. However, for the years in issue the appellant has failed to bring sufficient evidence to convince me, on the balance of probabilities, that he was conducting sales activities with a reasonable expectation of profit during those years and also that the expenses claimed were not personal or living expenses.

The appeals are dismissed.

Appeals dismissed.