Sotheran v. R., [1998] 2 C.T.C. 3222

Rowe D.J.T.C.:

1 The appellant appeals from assessments of income tax for his 1992, 1993 and 1994 taxation years. In computing income for those years, the appellant deducted the amounts of $13,652, $9,542 and $4,700 as business losses incurred as a result of operating a fishing charter enterprise. The Minister of National Revenue (the “Minister”) disallowed the losses, as claimed, on the basis the appellant did not have a reasonable expectation of profit from the activity and also decided any expenses incurred were personal or living expenses.

2 The appellant testified he resides in Maple Ridge, British Columbia and works as a truck driver. He stated he began his fishing charter business in 1991, operating on the west side of Vancouver Island, on the basis of offering one to three-day trips designed for the specific needs of clients. He had experience, for one year, as a commercial fisherman and also operated, as skipper, a 52-foot boat out of Granville Island in Vancouver which took people on cruises around the local waters. The boat had a capacity of 30 passengers. In addition, he had been sportfishing for 25 years near Vancouver or in areas off Vancouver Island and was well experienced in various aspects of fishing, boathandling and dealing with people in the context of operating a tourism business. He stated his plan was to develop the business by relying on word-of-mouth advertising and on repeat customers so that he could quit his truck-driving job and then operate the charter business full time. During the years from 1991-1995, he worked full time for Canada Safeway - on the Lower Mainland and in other parts of interior British Columbia - driving an 18-wheel tractor/trailer unit - until he accepted a buy-out offer, following which he began working as a driver/trainer for another company. The appellant explained that, leading up to the change of management and re-structuring at Canada Safeway, he worked a lot of overtime as it was apparent there was more money to be made driving truck than in taking out fishing charters. He identified a Schedule of Disallowed Expenses together with a Schedule of Non-Capital Losses Disallowed - Exhibit A-1 - prepared by his Chartered Accountant, Barry Ward. During the years under appeal, the appellant stated he lived in Maple Ridge. When people booked a charter with him, he would hook up his trailer to his truck and haul the boat to Sooke - on Vancouver Island - or to another Island location. During the summer months, he would leave the boat in Victoria and return it to Maple Ridge at the end of the season. He stated he found clients for the charters through friends, business contacts and acquaintances. He did not maintain any log of time spent on the charter business. In 1992, he was able to take 10 weeks holiday and used some of that time to operate the charter business. He stated he ceased operations following reassessment by the Minister, the result of which was to disallow his losses.

3 In cross-examination, the appellant stated he is 43 years old, married, with one 6- year old boy. While living in Maple Ridge, he would drive truck to various points in British Columbia and worked between 40-60 hours per week for three years. On occasion, he would have to stay overnight at a destination. He also assisted his wife in operating a childcare business. He stated his parents, brother and sister live in Victoria. The trip from Maple Ridge to the ferry terminal at Tsawwassen would take one hour. Then, the ferry ride to Vancouver Island took one hour and thirty-five minutes after which he would drive to the fishing site. In total, it would often take eight hours from the time he left home until he arrived at the charter destination. After arrival, depending on the type of charter, he would attend to preparation of the boat or to provisioning, as some people wanted a complete service. He did not advertise his business but relied on contacts. The Georgia Strait is not known for “world-class” salmon unlike the west side of Vancouver Island which has big fish and cleaner water. The appellant explained he used a one-half ton truck to haul the trailer and boat. The ferry fares for truck and trailer were between $75-$85 - one-way - but it was less expensive when he was able to leave the boat in Victoria for the summer and merely pay the fare for the truck. The appellant identified his 1992 tax return - Exhibit R-1. He agreed the total Capital Cost Allowance (CCA) in relation to the boat and truck amounted to more than $4,600. His income that year from the charter business was in the sum of $2,525. The appellant's 1993 tax return was filed as Exhibit R-2. During that year, his revenue was $4,825 and his expenses were $14,367. The appellant's 1994 tax return - Exhibit R-3 - showed revenue in the sum of $5,330 and expenses in the amount of $10,030 - including $4,562 in CCA - leading to a loss of $4,700. One item - insurance and permits - cost $1,905. During the years under appeal, the appellant stated he assisted his wife in a day-care business which they operated as 50-50 partners. He often started driving truck at 5:00 a.m. and would finish by 2:30 p.m. so as to be available to assist in the day-care. He identified a letter - Exhibit R-4 - dated June 5, 1996 he had received from R.K. Bidlake, an auditor at Revenue Canada. Mr. Ward replied on July 3, 1996 (Exhibit R-5). The appellant stated that other than a “shakedown cruise” at the beginning of each fishing season he did not fish in waters near Vancouver. The only other use of the boat was in Alouette Lake - a freshwater lake - into which he put the boat to flush out salt accumulated during a fishing season. The appellant agreed that, in 1992, he took out a total of six customers on charters on the following days: June 28, July 19, August 25, 26, 27 and 30. On the June 28 trip, he earned $375. The July 19 charter produced $450 in revenue and the trips during the week at the end of August produced gross revenue in the sum of $1,500 but he brought along another boat and rotated the clients between it and his regular boat. In 1993, the appellant agreed he had seven clients in total which had been taken out on trips on the following days: June 5 and 6, June 25 and 26, July 16-19, July 23-26, and August 6 and 7. The charters were to Sooke, Bamfield and Tahsis, all on the west coast of Vancouver Island. On occasion, he would pay a facility to provide accommodation for his guests and included that expense as a disbursement in the invoice submitted to them as part of the calculation of the total cost of the charters. He operated from June to August - a period of 12 weeks - and most of the fishing trips were on Fridays, weekends, or Mondays or on other days during which he was able to take time off from work. A trip to Bamfield lasted two or three days. The appellant stated he loved to fish - as a hobby - but used a 16-foot boat, with oars, and drifted on rivers. The boat used for charters was not taken on his personal fishing trips. One repeat client during the three years under appeal was Brad Tate, his cousin. The appellant stated it was necessary to purchase life jackets, fishing gear and safety equipment to be carried on the boat. He stated he was aware he had fixed costs and needed to increase revenue but he was working a lot of overtime for Canada Safeway and receiving more income from his high hourly wage than could be generated from the fishing business. Currently, the appellant is seven years from retirement and is aware he cannot operate the charter business full time unless he relocates to Vancouver Island. Because holiday entitlement at Safeway was based on seniority, he was not able to obtain enough time off during summer and had to use up the majority of his holiday time in February. The appellant stated he did not think he had encountered any unusual expenses in operating the charter business during the years under appeal.

4 Robert Bidlake testified he has been employed for 26 years by Revenue Canada, the last 12 of which he has worked as an auditor. He performed an audit on the appellant's charter activity from the perspective of determining whether or not the appellant had a reasonable expectation of profit and also reviewed material pertaining to expenses claimed. This process does not involve visiting the appellant or attending at his place of business. Bidlake referred to his handwritten notes made during the course of the audit - Exhibit R-6 - and identified a letter - Exhibit R-7 - dated August 2, 1996 he had sent to the appellant following completion of the audit. Bidlake stated that of the $4,825 gross revenue from the fishing charters in 1993, the sum of $1,284 was attributable to reimbursement for accommodation paid by the appellant for guests. In 1994, $400 of the revenue - out of a total of $5,330 - was attributable to repayment for accommodation costs. He determined these amounts by looking at receipt books provided by the appellant. Referring to his working notes for the 1992 taxation year - included in Exhibit R-6 - Bidlake stated he discovered receipts in the sum of $4,173.67 pertaining to items which were capital in nature such as navigation equipment, fishing reels, depth sounder, and similar products. He also did not agree with the appellant's contention the truck had been used 20% for business as a perusal of receipts indicated locations of fuel purchases were for personal use and, as a result, set the level of personal use at 90%. As well, he was not able to verify interest charges and decided 50% of the amount claimed was appropriate. In addition, the appellant had claimed - as business expense - personal items such as a swimsuit, shorts, shirts, and pullovers. Bidlake stated the time of purchase - between December and April - indicated they were not made for business reasons and he also disallowed certain travel costs on the ferry as the trips were made during winter months and included family members of the appellant. Bidlake stated he undertook the same sort of analysis with respect to the 1993 and 1994 taxation years and then concluded that, although there were various expenses claimed which would be subject to disallowance for various reasons, there was no reasonable expectation of profit, at all, from the charter activity. All of the revenue was from six or seven customers and there had been no method of advertising to attract a larger client base.

5 In cross-examination, Bidlake stated that he is aware some employees at Revenue Canada may send out a questionnaire of the type shown to him by the agent for the appellant and filed as Exhibit A-2 but he did not request the appellant to complete such a document. Bidlake stated he assessed the appellant's personal use of the boat at 50% on the basis there had been no log maintained of the time spent on charters and did not discuss the matter with the appellant prior to completing the audit.

6 The agent for the appellant submitted the appellant had the right to develop the business and that it was not reasonable to expect profitability during this period but that, overall, it was a viable enterprise.

7 Counsel for the respondent submitted the jurisprudence supported the position taken by the Minister.

8 In Tonn v. R. (1995), 96 D.T.C. 6001 (Fed. C.A.), the Federal Court of Appeal examined the concept of reasonable expectation of profit as it has evolved over the years since the judgment of the Supreme Court of Canada in Moldowan v. R. (1977), [1978] 1 S.C.R. 480 (S.C.C.). In the case of Tonn supra, Linden, J.A., writing for the Court, undertook an analysis of the case law and at p. 6009 stated:

A closer look at this jurisprudence will illustrate that this is the approach now taken in most of the cases. The cases in which the “reasonable expectation of profit” test is employed can be placed in two groups. 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.

9 In the recent decision of the Federal Court of Appeal in Mastri v. R. (1997), 97 D.T.C. 5420 (Fed. C.A.)Robertson, J.A., writing for the Court, dealt with the issue of whether or not there had been a misapprehension by the Tax Court of the true import of Tonn supra. At p. 5423, Robertson, J.A. stated:

First, it was decided in Moldowan that in order to have a source of income a taxpayer must have a reasonable expectation of profit. Second, “whether a taxpayer has a reasonable expectation of profit is an objective determination to be made from all of the facts” (supra at 485-86). If as a matter of fact a taxpayer is found not to have a reasonable expectation of profit then there is no source of income and, therefore, no basis upon which the taxpayer is able to calculate a rental loss. There is no doubt that, post- Moldowan, this Court has followed and applied that decision: see Landry v. Canada, 94 D.T.C. 6624; Poetker v. Canada, 95 D.T.C. 5614; and Hugill v. Canada, 95 D.T.C. 5311. The only remaining issue is whether Tonn departs from that jurisprudence by postulating that the reasonable expectation of profit test remains irrelevant to the question of deductibility of losses until such time as it can be established that the case involves an inappropriate deduction of tax, the presence of a strong personal element or suspicious circumstances. There are two passages in Tonn which are cited in support of that proposition of law and are worthy of reproduction (supra at 6009 and 6013):

The Moldowan test, thereofre is a useful tool by which the tax-inappropriateness of an activity may be reasonably inferred when other, more direct forms of evidence are lacking. 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.

...I otherwise agree that the Moldowan test should be applied sparingly where a taxpayer's “business judgment” is involved, where no personal element is in evidence, and where the extent of the deductions claimed are not on their face questionable. However, where 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. Suspîcious circumstances, therefore, will more often lead to closer scrutiny than those that are in no way suspect.

In my respectful view, neither of the above passages support the legal proposition espoused by both the Minister and the taxpayers. It is simply unreasonable to posit that the Court intended to establish a rule of law to the effect that, even though there was no reasonable expectation of profit, losses are deductible from other income sources unless, for example, the income earning activity involved a personal element. The reference to the Moldowan test being applied “sparingly” is not intended as a rule of law, but as a common-sense guideline for the judges of the Tax Court. In other words, the term “sparingly” was meant to convey the understanding that in cases, for example, where there is no personal element the judge should apply the reasonable expectation of profit test less assiduously than he or she might do if such a factor were present. It is in this sense that the Court in Tonn cautioned against “second-guessing” the business decisions of taxpayers. Lest there be any doubt on this point, one need go no further than the analysis pursued by the Court in Tonn.

In Tonn, the Court clearly held that no personal advantage had accrued to the taxpayer who was seeking to deduct rental losses from his other sources of income. Nonetheless, the Court continued to pursue the deductibility of losses issue by applying the factors set out in Moldowan when assessing whether there was a reasonable expectation of profit. The Court's summary, provided at 6015, lays to rest any doubt as to what was decided in Tonn:

My disposition of this case is therefore as follows. The Tax Court Judge erred in principle as well as in his application of the reasonable expectation of profit test, as it is now understood. He did not consider all of the factors he should have considered, nor did he assess the context fully. The evidence clearly showed that the taxpayers engaged themselves in a business enterprise and their expectations of profit were not unreasonable in the circumstances. A small rental business was launched without the aid of sophisticated market analysis at a time when the rental market looked promising. Soon after, as a result of unforeseen circumstances, it became precarious. No personal benefit accrued to the taxpayers by the rental arrangements. The property was not a vacation site. The house was not used to give free or subsidized housing to relatives or friends. They made an honest error in judgment and lost money instead of earning it. It is not for the Department (or the Court) to penalize them for this, using the reasonable expectation of the profit test, without giving the enterprise a reasonable length of time to prove itself capable of yielding profits.

In summary, the decision of this Court in Tonn does not purport to alter the law as stated in Moldowan; Tonn simply affirms the common-sense understanding that it is not the place of the courts to second-guess the business acumen of a taxpayer whose commercial venture turns out to be less profitable than anticipated. Accordingly, the Tax Court Judge erred in his understanding and application of Tonn. The same holds true in regard to the following Tax Court cases which reveal a misunderstanding of the true import of Tonn: Howard v. Canada, [1997] T.C.J. No. 69 (QL); and Rossi v. Canada, [1996] T.C.J. No. 1632 (QL). By comparison, other Tax Court cases confirm my opinion as to what was decided in Tonn; see Joudrey v. Canada, [1997] T.C.J. No. 74 (QL); Stacey v. Canada, [1997] T.C.J. No. 117 (QL); Riddell v. Canada, 97 D.T.C. 51; Schimmens v. Canada, [1996] T.C.J. No. 539 (QL); Urquhart v. Canada, [1996] T.C.J. No. 208 (QL); and Wallace v. Canada, [1996] T.C.J. No. 583 (QL).

Before concluding, I wish to register my respectful disagreement with the finding made below that no “personal element” exists in the circumstances of this case. On the contrary, the evidence clearly shows that the Mastris entered into an agreement to buy the townhouse with the intention of occupying it themselves and that, roughly a year after purchase, they actually used the home as their principal residence. In my opinion, one can scarcely speak of the absence of a personal element in this situation - particularly since there is no evidence indicating that, at the time the taxpayers agreed to purchase the property for $159,000, consideration was given to whether the townhouse could be rented profitably.

10 On the evidence, it is apparent the appellant was attempting to prepare for a business which he could operate, part-time during the summer, after his retirement and which would be contingent on moving his residence and family to Vancouver Island. During the years under appeal, the appellant was not only working full time but was putting in overtime so that he worked as much as 60 hours per week. He did so because his rate of pay was such he could not afford to lose income while taking out any customers on a charter. In addition, he was a 50-50 partner with his wife, and actively worked in, a day-care business. He lived in Maple Ridge - on the Mainland - and it made no business sense at all to haul a boat, on a trailer, for eight hours only to produce two or, at best, three days revenue ranging between $1,200 and $1,500. The travel costs alone - even without hauling the trailer across on the ferry on each trip - were $250 or $300. The appellant still had to pick up the trailer and boat in Victoria and tow it up Island to the fishing site where he had other costs, including moorage. After three years, he still had only seven clients and they were a close-knit group composed of family, friends, and business acquaintances. There was a personal element in the sense the appellant's business venture was little more than a mechanism for sharing the cost of summer fishing trips with friends and providing him with an opportunity to visit his family in Victoria where he was able to store his trailer for the short time he was actually using the boat to generate revenue. This aspect was also borne out by the review of receipts which indicated the appellant's attitude was that a wide array of expenses could be charged against the purported business when they were clearly expenses - often out of season - of a personal nature. In effect, the appellant was operating the fishing charter activity in the sense of taking a dry run or “shakedown cruise” in preparation for his retirement which was - at the time - more than 10 years in the future. As structured, and in view of his choice to devote his time and energy to full-time employment and to the day-care business, it is clear the fishing operation was only in the experimental stage and, with low priority assigned to it, was not ready to produce sufficient revenue so as to have a reasonable chance to turn a profit. The Minister was quite correct in disallowing the claimed losses on the basis there was never any reasonable expectation of profit during the years under appeal.

11 The appeal is hereby dismissed.