Rai v. R., [1999] 3 CTC 2348, 99 DTC 562

Bowman T.C.J.:

These appeals are from assessments for the appellant’s 1993, 1994 and 1995 taxation years. The issue is whether the appellant is entitled to deduct losses claimed by him in those years from maintaining and racing horses under the name of J. Rai Stables. His principal occupation in the years in question was as a sawmill operator with Coast Mountain Hardwood.

The respondent’s position is that there was no business within the meaning of section 9 of the Income Tax Act because there was no reasonable expectation of profit, that the expenses were not laid out for the purposes of gaining or producing income from a business or property within the meaning of paragraph 18( 1 )(«) and that in any event the expenses claimed were unreasonable within the meaning of section 67.

In 1986, Mr. Rai started going to the racetrack and betting on horses. In 1988 he, together with a partner, purchased his first horse. Apart from whatever he may have learned from betting on horses in 1986 to 1987 he had no experience with racehorses.

The evidence is somewhat unsatisfactory but the following appear to be the horses that he purchased:

By 1996, he had stopped the horse racing activity that he had carried on over the period 1988 to 1995, and had disposed of his horses, either because they had broken down, or did not perform.

He mentioned having sold at least three horses for $500 each. However in a questionnaire signed by him, he stated that he sold one horse in 1993 for $2,500 and another in 1995 for $2,500. For some reason these sales seem not to have been reported in his return of income.

From 1988 to 1995, he reported losses from the activity as follows:

evidence, but those for the years in question, 1993, 1994 and 1995, show expenses as follows:

1994 $20,382

1995 $27,422

A very substantial portion of the expenses related to the truck or car that he operated:

The gross income in 1995 was $1,200.

I do not question that Mr. Rai hoped to make money from racehorses. Most people who engage in inherently risky enterprises do. Subjective intention is, however, not the only criterion. As I observed in Kaye v. R., [1998] 3 C.T.C. 2248 (T.C.C.) at pages 2249 and 2250:

I do not find the ritual repetition of the phrase [reasonable expectation of profit] particularly helpful in cases of this type, and 1 prefer to put the matter on the basis “Is there or is there not truly a business?” This is a broader but, I believe, a more meaningful question and one that, for me at least, leads to a more fruitful line of enquiry. No doubt it subsumes the question of the objective reasonableness of the taxpayer’s expectation of profit, but there is more to it than that. How can it be said that a driller of wildcat oil wells has a reasonable expectation of profit and is therefore conducting a business given the extremely low success rate? Yet no one questions that such companies are carrying on a business. It is the inherent commerciality of the enterprise, revealed in its organization, that makes it a business. Subjective intention to make money, while a factor, is not determinative, although its absence may militate against the assertion that an activity is a business

One cannot view the reasonableness of the expectation of profit in isolation. One must ask “Would a reasonable person, looking at a particular activity and applying ordinary standards of commercial common sense, say ‘yes, this is a business’?” In answering this question the hypothetical reasonable person would look at such things as capitalization, knowledge of the participant and time spent. He or she would also consider whether the person claiming to be in busi- ness has gone about it in an orderly, businesslike way and in the way that a business person would normally be expected to do.

This leads to a further consideration — that of reasonableness. The reasonableness of expenditures is dealt with specifically in section 67 of the Income Tax Act, but it does not exist in a watertight compartment. Section 67 operates within the context of a business and assumes the existence of a business. It is also a component in the question whether a particular activity is a business. For example, it cannot be said, in the absence of compelling reasons, that a person would spend $1,000,000 if all that could reasonably be expected to be earned was $1,000.

Ultimately, it boils down to a common sense appreciation of all of the factors, in which each is assigned its appropriate weight in the overall context. One must of course not discount entrepreneurial vision and imagination, but they are hard to evaluate at the outset. Simply put, if you want to be treated as carrying on a business, you should act like a businessman.

Does this activity have sufficient of the indicia of inherent commercial- ity, revealed in its organization, to make it a business? Would a reasonable person, looking at the activity and applying ordinary standards of commercial common sense, say “yes, this is a business”.

I think the answer to both questions is in the negative. The activity did not have the indicia of commerciality. Rather, it seems to have developed as an extension of the appellant’s two years of betting on horses. As the appellant is alleged to have stated in the memorandum signed by him whether he makes a profit is a gamble and is dependent on luck. I place little weight on this memorandum. It was filled out by an income tax assessor at an interview with the appellant and seems to have been a paraphrase of what the assessor thought the appellant said to the assessor. It seems unlikely that the assessor understood the appellant or vice versa. Such a document is wholly unsatisfactory, either as evidence in court or as a basis for assessing. Nonetheless, the observation remains true that this enterprise seems not to have been operated in a businesslike way. Record keeping was haphazard and the expenses were not substantiated with even a modicum of precision. It is unclear just how such large expenses were claimed or even arrived at, or indeed what the sources of income were — whether they were solely racetrack winnings or whether they included proceeds from the sale of horses.

For these reasons, then, I have concluded that there was no business:

(a) the lack of any business organization and the haphazard method of keeping records;

(b) the fact that the chances of earning any profit were more in the nature of a gamble than of the prospective result of a concerted business enterprise;

(c) the unreasonable disproportion between the expenses claimed and the revenues generated.

I need not refer to the series of decisions that are routinely quoted in these cases: Moldowan v. R. (1977), 77 D.T.C. 5213 (S.C.C.); Tonn v. R. (1995), 96 D.T.C. 6001 (Fed. C.A.); Mastri v. R. (1997), 97 D.T.C. 5420 (Fed. C.A.); Mohammad v. R. (1997), 97 D.T.C. 5503 (Fed. C.A.). They all represent approaches to the problem of determining where one draws the line between what is a business and what is not.

I would have had no difficulty in dismissing the appeal based on the evidence and the cases I have cited above, as well as the many other cases that have been decided in this area of the law. Nonetheless, the recent decision of the Federal Court of Appeal (Décary, Létourneau, JJ.A. and Chevalier, D.J.A.) in Kuhlmann v. R. (1998), 98 D.T.C. 6652 (Fed. C.A.) could arguably be taken as overruling all previous decisions of all courts on the question of reasonable expectation of profit. The Federal Court of Appeal stated at page 6656 that:

Both counsel agreed that for an expectation of profit to be reasonable, it had to be not “irrational, absurd and ridiculous”. In the case at bar, the burden was on the Minister to establish on a balance of probability that the expectation of profit was irrational, absurd or ridiculous. Clearly, in our view, the Minister did not succeed and the Tax Court Judge could not have found otherwise had he applied the proper legal principles.

In that case two medical persons who had extremely high incomes claimed enormous losses from the horse business. Mogan J. had held that the respondent (who bore the onus of proof because of a change of approach taken at trial) had met the onus of proof and established a prima facie case that the activity had no reasonable expectation of profit, and was operated for personal satisfaction rather than for profit.

The Federal Court of Appeal in an oral judgment from the bench allowed the appeal.

The decision essentially overruled a finding of fact made by the trial judge based on his appreciation of the evidence. [1]

If it is now a principle of law, following Kuhlmann, that a taxpayer can establish that he or she, in carrying out what purports to be a commercial activity, had a “reasonable expectation of profit”, and therefore a business. by simply showing that the expectation was “not irrational, absurd and ridiculous” I would have to allow this appeal, because Mr. Rai’s expectation of earning profits was neither irrational, absurd nor ridiculous. It is not unheard of for people to make money raising and racing horses. Depending on the circumstances, the chances of earning a profit may be, I should think, easily as good as they are in many other risky enterprises such as drilling wildcat wells, or prospecting for gold. Nonetheless, I think that for a business to exist there has to be something more than an absence of irrational, absurd and ridiculous expectations. I do not read the Kuhlmann decision as suggesting otherwise.

I would prefer to read the passage quoted from the Federal Court of Appeal decision as reflecting the possibly hasty adoption of a proposition agreed to by counsel and therefore not thoroughly explored in argument rather than the enunciation of a new principle that in effect overrules over twenty years of jurisprudence.

The appeals are dismissed.

Appeal dismissed. perverse or based on no evidence. Schwartz v. R.. [1996] 1 S.C.R. 254 (S.C.C.) at 278-283: Beaudoin-Daigneault v. Richard, [1984] 1 S.C.R. 2 (S.C.C.) at 8-9; Janiak v. Ippolito, [1985] 1 S.C.R. 146 (S.C.C.) at 151; MDS Health Group Ltd. v. R. (1996), [1997] 1 C.T.C. 111 (Fed. C.A.) at 115; Flexi-Coil Ltd. v. R., [1996] 3 C.T.C. 57 (Fed. C.A.) at 60; cf. Cana Construction Co. v. R., [1996] 3 C.T.C. I I (Fed. C.A.), per Decary J. (dissenting) at 13.