Section 3

The taxpayer (a member of the Quebec bar) who worked in a legal services department of Transport Canada as a full-time employee, also taught a law course at the University of Ottawa as a contract worker. Furthermore, she worked 5 to 15 hours a week providing legal services to clients of modest means. Of the four years in issue, practice revenues ranged between $850 (or 5% of claimed expenses) and $3,850 (37% of claimed expenses). Jorré J below had found that the taxpayer’s teaching activities were a distinct source of income from her law practice and also made the factual finding that her part-time law practice verged on charitable volunteerism (“du bénévolat”) – and, more generally, found that as such practice had a personal aspect, the question as to whether her practice was a business could (consistently with Stewart) be tested through determining whether it had a reasonable expectation of profit, as to which there was none. Her claimed losses were non-deductible.

In affirming the decision below, Nadon JA stated (at paras. 50-51, TaxInterpretations translation):

[S]he invoiced her clients for the expenses related to the file as well as for honoraria adjusted as a function of the capacity of the client to pay and … her primary goal was to exercise her profession in a conscientious and professional manner without necessarily making money. …

[T]here is no doubt that the law practice of the appellant, when the relevant circumstances are considered in their entirety, certainly qualifies as having a personal aspect.

Two of the taxpayers (“Ludmer” and Steinberg”) were invested along with family, friends and acquaintances (all resident in Canada) in a BVI company (“SLT”) whose investments were managed by a non-resident hedge fund manager (“GAM”). When GAM proposed that SLT be merged with another fund managed by GAM in which non-residents were investors, it was agreed that, in light of the merged fund being subject to a higher level of fees than those to which SLT had been subject, that a Bermuda company owned indirectly by two Steinberg and Ludmer non-resident trusts would receive annual “fees” from the time of the 1994 merger that effectively represented a rebate of the higher fees imposed on the Canadian investors (although they were described to be consideration for services that, in fact, were never provided). This arrangement was replaced in 2007 by a new agreement in which the “fees” were paid directly to two newly-established Canadian-resident family trusts.

In finding that it was not unreasonable for CRA to assess on the basis that these payments were includible in the income of Steinberg and Ludmer under s. 56(2), Hamilton JCS addressed the question whether such amounts would have been income form a source if they had been paid directly to such taxpayers stated (at paras. 614-615):

The GAM payments were not in the nature of a windfall. They were made pursuant to a contract. They were enforceable, organized, foreseeable and customary since 1995. …[T]he contracts provided for services to be provided as consideration for the payments. …

The argument put forward by Bowman that they are “nothings” for Canadian tax purposes because they are merely reputational payments arising in a non-business circumstance may ultimately be upheld by the Tax Court, but it is not so clear at this stage as to render the CRA’s position unreasonable.

Russel J found that the Minister's decision (in a s. 152(4.2) application) to treat the taxpayer's online poker winnings as income lacked intelligibility and justification. The Minister indicated that the taxpayer had a "system" to win, but did not identify what that system might be - moreover, winning does not prove the existence of a system - this is exactly the kind of retrospective approach rejected in Leblanc (para. 52). Russel J also stated (at para. 52):

• "chance remains the predominant factor in whether they [online poker players] win or lose";
• the use of winnings to finance a mortgage was no indication of running a business; and
• the taxpayer's cutting back on other work and income during poker wins was no indicator of running a business with a reasonable expectation of profit.

The taxpayer realized gains of $1.3 million from periodically placing funds with a rogue ("Lech") who, it was later discovered, had not invested the funds in options trading but instead used them in a Ponzi scheme. The taxpayer made periodic payments to Mr. Lech, who would in return issue approximately nine weekly post-dated cheques for (in aggregate ) a larger amount, which he then honoured with the exception of the last such transaction.

In finding that the net gains of the taxpayer were income from a source, Sharlow J.A. stated (at para. 46):

[The taxpayer] is not being taxed because she profited innocently from a Ponzi scheme. She is being taxed because she entered into a series of agreements with Mr. Lech to receive a profit on her investments with him, and she received what she bargained for. The fact that Mr. Lech funded her payments with the proceeds of a Ponzi scheme is irrelevant.

Regarding the taxpayer's contention that Ponzi schemes cannot be a source of income because the are "by their very nature, doomed to collapse," Sharlow J.A. stated (at para. 43):

A Ponzi scheme may well be a source of income for some participants during some part of its existence. This case suggests how that could be so. Hypothetically, if Ms. Johnson had made her payments to Mr. Lech knowing that he would use the money to operate a Ponzi scheme, she would have profited exactly as she did in the years in issue in this case, 2002 and 2003.

The taxpayer's degree in mathematics and experience with various forms of gambling were not a sufficient basis to reverse the trial judge's finding that the taxpayer's gambling losses were not incurred as part of a business, given evidence that the taxpayer's principal motivation in gambling was thrill-seeking and that he lacked any systematic gambling practice or methodology (for example, a portion of his losses were incurred on slot machines).

The taxpayers claimed deductions relating to their investments in purported partnerships whose purported business would be the production of sound recordings. In fact, the bulk of the moneys invested were simply re-routed into the pockets of the fraudulent promoters, and the small amounts which were not so diverted were spent on window-dressing to give the appearance of business activities by the partnerships.

In dismissing the taxpayers' appeals, Sharlow JA stated (at para. 3):

This is not a case of a business that suffered losses because it was ill conceived or poorly managed, and the tax authorities are second guessing the business acumen of a taxpayer. This is a case where, in fact, there was no business. There were no business expenses.

The taxpayer was a co-owner in a clothing manufacturing company. He acquired a gem inventory over several years. A business contact informed him of an interested offshore purchaser, and offered to sell the gems on his behalf at approximately a tenfold profit in exchange for substantial up-front fees, variously described as performance bonds, insurance, shipping, sales commissions and administration charges.

The business contact was a rogue, and absconded with the fees, which exceeded $1.6 million, and the gems. The Minister allowed a business loss for the gems but not for the professional fees.

Noël JA dismissed the taxpayer's appeal. He stated (at para. 28):

A fraudulent scheme from beginning to end or a sting operation, if that be the case, cannot give rise to a source of income from the victim's point of view and hence cannot be considered as a business under any definition.

The taxpayer was not entitled to deduct losses from an alleged business as an artist given the finding of the trial judge (supported by the evidence) that his endeavours had a personal element and were not carried out in a commercial manner.

The Tax Court had correctly found that the taxpayer, who worked as a full-time employee, was not using his residence in connection with an auto sales business. As there was a personal element in his use of the residence, it was appropriate for the Tax Court Judge to apply the reasonable expectation of profit test.

The fact that a rental property of the taxpayer had formerly been his home and that he used the property as collateral for a line of credit pertaining to his realty business were not elements sufficient to make the taxpayer's dealings in respect of the property something other than a commercial activity. Accordingly, the trial judge erred in applying the reasonable expectation of profit test to find that the property did not constitute a source of income to the taxpayer.

The taxpayer, who derived personal benefits from the ownership of a two storey residence containing four bedrooms by having her family live on the premises with her, was correctly found to not have a reasonable expectation of profit given that she did not advertise, she took no steps to rent a vacant room when her mother died, she experienced expenses that consistently exceeded her rental income, and her calculations as to future profitability were not realistic.

There was a personal element in the acquisition by the taxpayer of a cottage property close to that of his parents, and the Tax Court judge had properly considered all the evidence, including the fact that interest payments on the mortgage substantially exceeded gross rental revenue, in concluding that the taxpayer did not have a reasonable expectation of profit from the operation of renting the property.

The manner in which a full-time employee of BC Rail conducted a fishing guide activity from which he reported revenues under 5% of expenses was not necessarily incompatible with an intention to pursue profit. The decision of the Tax Court Judge was set aside and the matter remitted for decision by a different judge.

The Tax Court Judge did not commit a reviewable error when he found that the taxpayer's activities lacked commercial flavour and that the taxpayer was not engaged in farming activities to make a profit, but primarily to provide food for his table. As such, his activities did not amount to a business.

The trial judge had not erred in finding that a property owned "under" a partnership of the taxpayers, which was rented at a significant loss to their handicapped son, was not operated with a reasonable expectation of profit.

A limited partnership that had purchased mini-warehouses was found to have a source of income for purposes of s. 9 of the Act with respect to the resulting storage park operation, given that there was no evidence of any element of personal use or benefit in the operation. The Court noted that "although we state in Stewart supra, at para. 55, that reasonable expectation of profit may be used as one factor in making the overall determination as to whether or not the taxpayer's activities are personal or commercial, where, as here, the activities have no personal aspect, reasonable expectation of profit does not arise for consideration."

In addition, "although the respondents in this case were clearly motivated by tax considerations when they purchased their interests in the Partnership, this does not detract from the commercial nature of the storage park operation or its characterization as a source of income ... ."

There was no evidence that the taxpayer had acquired condominium rental units for his personal benefit. Accordingly, his property rental activity was clearly a commercial activity, so that it was a source of income. Only where the nature of a taxpayer's venture contained elements which suggested that it could be considered a hobby or other personal pursuit did it become necessary to establish that the taxpayer had an objective intention of profit and that there was evidence of businesslike behaviour which supported that intention.

In response to a submission of the taxpayer that he should be treated as an individual and that the involvement of his wife and company with respect to hedging transactions should be ignored, Rothstein J.A. stated (at p. 5561):

"Viewing the appellant in his own right, it is inescapable that he had no reasonable expectation of profit from his own transactions; no source of income and therefore no basis for deducting expenses."

In reversing a finding of the Tax Court Judge that a teacher was not entitled to deduct the losses of his Amway distributorship, Rothstein J.A. stated (at p. 5359):

"There is no indication that the Amway distributorship was being operated for any non-business motive. In the circumstances, the reasonable expectation of profit test should be applied sparingly and not to second-guess the business judgment of the appellant."

An operation of the taxpayer in renting or trying to rent out two units and a spare room in his Burlington home was not engaged in with a reasonable expectation of profit given the predominance of the personal element (the spare room was rented to the babysitter, and in order to protect his children he sometimes limited his rental income) and the fact that the pro rata portion of the mortgage interest alone exceeded the rental income.

The Court affirmed a finding of the Tax Court that partnerships in which the taxpayer invested did not have a reasonable expectation of profit in light of the commercially unrealistic nature of the arrangements they had entered into including the lack of clarity that even if the entity from which they had acquired a royalty produced a "mega hit", either partnership would be in a position to claim any benefit from it.

The realization of profit from its rental operation was found not to motivate the partners of a limited partnership in which the taxpayer was a limited partner given the heavy debt load which was projected to remain undiminished throughout the first ten years of its operation. In the case of a second partnership in which the taxpayer was a limited partner such an expectation is found to be present given that the partnership enjoyed profits in two of the three years in issue.

The Court reversed a finding of the trial judge that a husband and wife team of practising physicians were not engaged in operating an "English riding" school and raising horses for competition in jumping events with a reasonable expectation of profit. The trial judge erred in finding that love for one's work attracted the scrutiny mandated by the Tonn case; in second-guessing the business decisions made by the taxpayer; and in failing to recognize that a minimum of five or six years was needed in the best of circumstances for such an activity to become profitable.

The taxpayer had acquired a co-ownership interest in a residential property by assuming his share of a first mortgage and borrowing money for the balance of the purchase price. Mogan T.C.J. had applied s. 67 to disallow the deduction of the interest paid on the personal loan, and found that, after such adjustment, the taxpayer had a reasonable expectation of profit. Before going on to find that such resort to s. 67 was improper, Robertson J.A. noted (at p. 5506) that where a property has been acquired on which the interest expenses exceed the revenue, "the taxpayer must establish to the satisfaction of the Tax Court that he or she had a realistic plan to reduce the principal amount of the borrowed monies", and further stated (at p. 5510) that "the judicial doctrine of reasonable expectation of profit and the concept of reasonable expenses under section 67 of the Act are to be invoked and applied independently of one another".

Before going on to find that the deduction of farming losses by the taxpayer was restricted by s. 31(1) of the Act, Robertson J.A. stated (at p. 5501) that in the case of the reasonable expectation of profit test:

"The taxpayer need only show that there is or was an expectation of profit, be it $1 or $1 million. It is well recognized in tax law that a 'reasonable expectation of profit' is not synonymous with an 'expectation of reasonable profit'."

In finding that the taxpayer could not deduct the costs incurred by her in seeking to develop her daughter (who was in the taxation years in issue between 13 and 15 years of age) as an Olympic-calibre equestrian show jumper, Décary J.A. stated (at p. 5461 that "the start-up period, in a case such as this one, can only begin, not when the rider is reasonably expected to become an accomplished rider, but when she has become one", and that "until then, the cost of training the rider can only be described as training expenses prior to the day the business is commenced".

The Court reversed a finding of the Tax Court judge that the taxpayers were entitled to deduct their net loss from a rental property notwithstanding that they had no reasonable expectation of profit. The reference in the Tonn decision to applying the Moldowan test "sparingly" where, for example, there was no personal element in the venture, meant only that the judge should apply the reasonable expectation of profit test less assiduously than he or she might do if such a factor were present. There also was no basis for postulating (as alleged by the Crown in this case) that the Court in Tonn had confused the concept of deductibility of an expense with the concept of deductibility of rental losses from income derived from other sources: it recognized that the latter was the issue before it.

Before finding that equipment that the taxpayer received on the winding-up of one subsidiary and held for five days before transferring it to another subsidiary satisfied the income-producing purpose test in Regulation 1102(1)(c), the L'Heureux-Dubé J. stated that the income-producing purpose test in Regulation 1102(1)(c) and paragraph 18(1)(a) was distinct from the reasonable expectation of profit test, which was principally directed at differentiating between a business and personal pursuit, and was not suited to determining whether a particular item of expense was deductible.

Major J. stated, in an obiter dictum (at p. 6120) that "in the long line decisions that distinguish a 'business' from a 'hobby', it has been consistently held that where the activity in question falls outside the definition of 'business', any profits recognized are not subject to tax under s. 3."

Pratte J.A. noted (at p. 6067) (and Linden J.A. concurred at p. 6069) that the reasonable expectation of profit doctrine had no application where it was admitted that the taxpayer's activities were a business.

In 1989 the taxpayer purchased a vacant residential property in Scarborough, containing two residential rental units, with the expectation that the initially-anticipated monthly rental revenues of $1,900 per month would increase by approximately 6% per annum in succeeding years. Before going on to reverse a finding of the Tax Court that the properties had not been acquired with a reasonable expectation of profit, Linden J.A. stated (at p. 6009) that the reasonable expectation of profit test appearing in the Moldowan case:

"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 that competent."

In finding that the taxpayer operated his farm in his 1986, 1987 and 1988 taxation years with a reasonable expectation of profit Jerome A.C.J. noted that the farm showed a profit in 1992 and presumably would have continued to do so had it not been for severe drainage problems, and that the taxpayer in 1981 and 1982 had spent an amount approximately equal to the cost of the land in rehabilitating the land (which Jerome A.C.J. characterized (p. 6640) as "the act of an individual who has a long term commitment").

Before finding that the taxpayer - who returned to the practice of law in 1979 at the age of 71, organized his practice in a similar manner to that in which he had conducted a law practice commencing in 1936, and was only able to identify two clients for the period 1979 to 1992 - was not able to deduct his losses for his 1987 and 1988 taxation years, Décary J.A. stated (at p. 6625) that:

"It is possible for someone, with the best will in the world, to practise an activity that takes all his or her time and that activity may still not be a business".

In his dissenting reasons, Marceau J.A. stated (at p. 6628) that a finding of no reasonable expectation of profit "necessarily affects all expenses and not only, as the Minister's assessments would have it, those in excess of the fees earned". [Emphasis in original]

A condominium rental unit located at Paul Lake, near Kamloops, was found to have been purchased in December of 1980 with a reasonable expectation of profit. Unfortunately, three months later, a condominium association was formed in the complex and one of its first steps was to pass by-laws prohibiting short-term rentals by owners, or occupation by children under 12 years. Furthermore, the local economy suffered a significant decline.

In finding that the taxpayers were entitled to deduct their losses on the unit for their 1984 taxation year notwithstanding the total absence of rental income for that year, Jerome A.C.J. stated (p. 6528):

"... where the business venture, under normal circumstances, would have realized a profit but fails to do so because of a dramatic change in conditions, a taxpayer should be granted a reasonable period of time in which to ascertain that no income is likely to be earned."

A venture of buying and selling various gift items, was marginally profitable while it was conducted by the taxpayer on a part-time basis or attended to by his wife. However, when he commenced devoting his whole-time efforts to the venture, he charged expenses to it that were substantially in excess of sales revenue and generated correspondingly large losses. Joyal J. found that in the first year of full-time operation, there was a reasonable expectation of profit given the past history of profitability, but for the subsequent taxation years there no longer was such a reasonable expectation. Consequently, for those subsequent years the resulting losses were not deductible from the taxpayer's other sources of income. Before reaching this conclusion, Joyal J. stated (p. 6282) that:

"... although a profit, expressed in percentage terms as a return on investment, on energy and time and effort expended, might not be of a nature to invite a take-over bid ..., the test of reasonableness is met if a profit has been realized."

An employee of M.L.W. Bombardier who only visited his farm once a week except on summer vacations, and whose farming operation suffered consistent and significant losses, was not able to deduct any portion of such losses from his employment income.

The taxpayers, who were full-time employees of the federal government, were found not to have engaged in the leasing of a yacht with a reasonable expectation of profit given the minimal income generated (revenues were approximately 1/3 of the interest expense and were also significantly less than capital cost allowance claims) and given that the chartering of the yacht in the Lake Ontario region rather than in the Caribbean ensured that revenues could only be generated for part of the year.

A full-time teacher was prohibited from deducting losses incurred in automobile performance rallying in the absence of any record of achieving profit over the life of the venture, the relatively small size of purses, the difficulties of obtaining sponsors and the lack of evidence of systematic planning on her part.

A teacher who earned approximately $1,000 per year in farm revenues in the taxation years in question was unsuccessful in deducting farm losses arising from expenses of approximately $8,000 per year. The taxpayer's professed expectations of profit reflected "invincible optimism".

The taxpayer, who in his 1978 and 1979 taxation years was a full-time employee in a potash mine, was found not to be carrying on a thoroughbred horse breeding and raising operation with a reasonable expectation of profit in light of the facts that he did not achieve a profit in any of the subsequent taxation years (up to 1986) in evidence, with the exception of a small gain in 1985 (attributable to an accounting change), his lack of formal training in horse breeding, and the fact that he did not begin investing more money and time in the operations until subsequent taxation years.

A husband and wife, who were full-time employees, and who in 1981 purchased farmland which required considerable work before it would become suitable for farming, were able to establish that the farming operation would be a paying proposition once the mortgage was paid off and that the complete liquidation of the mortgage was at all times their goal. The considerable delay before the farm became profitable was attributable to some unexpected setbacks in 1984. Accordingly, losses which they incurred in 1981 and 1982 were deductible subject to the $5,000 limit in s. 31(1).

The taxpayer was found to have held his condominium with a reasonable expectation of profit after the time that he abandoned his intention to hold it for use as a residence notwithstanding that during the taxation years in question he was unable to rent it out.

The taxpayer, who worked full time as a co-ordinator of special education but had a passion for flying, purchased a high performance aircraft and made it available to various flying academies. Revenues which he received from the academies consistently were small in relation to the expenses borne by him (including maintenance expenses, interest and CCA) and, in fact, a large portion of the revenues were attributable to his personal use of the plane, for which he paid regular rates to the academies.

Muldoon, J. held that the taxpayer's projections of profitability had been unrealistically optimistic and "that personal use was the principal reason for the plaintiff's acquisition of the aeroplane. The leasing business venture was his means of supporting his own flying of that high-performance aircraft."

The taxpayer's tree farm was found to have a reasonable expectation of profit in light of the reforestation operation being undertaken in a systematic way and in accordance with accepted reforestation practices. "The fact that the ultimate harvest from the anticipated crop was some thirty or forty years removed does not operate, in my view, to make the operation less of a business and more of a hobby."

A campground operation on land in the Calabogie area of Lanark which an Ottawa resident with a full-time job had originally purchased as a holiday property was found not to be run as a business in light of its under-capitalization, the lack of any concerted effort to obtain anything approaching full occupancy, and the result of revenues as low as 1% of reported expenses.

Although the taxpayer purchased a 48-foot diesel cruiser with a sincere belief that he eventually would make a financial success of an operation of chartering the vessel, he was unable to provide objective evidence that this expectation was reasonable.

The taxpayer, who at all relevant times had a full-time job, purchased 1/2 of his father-in-law's run-down 200-acre farm in 1975 with the intention of farming in co-operation with him. However, his father-in-law was forced to retire completely from farming in 1977 as a result of a severe stroke and a plunge in cattle prices, and the taxpayer was forced during 1978 to 1983 to use his land for cash crops. Despite persistent losses until 1986, the taxpayer was held to have a reasonable expectation of profit, and his 1979 and 1980 losses were deductible subject to the s. 31(1) limit. "Unlike other businessmen, a farmer cannot simply change his location or line of products as the market shifts. He is restricted to dealing in what the land can produce, and his choices in that regard are determined by available capital."

London Life provided excess computer capacity to its subsidiary ("LDS") and charged LDS a fee that was calculated so as to avoid any profit or loss on the basis of accounting prescribed by the Superintendent of Insurance for life insurance companies. Since this basis of accounting still permitted London Life to realize a profit on a more normal basis of accounting, London Life had a reasonable expectation of profit from the arrangement and for purposes of the Act properly characterized the revenue from LDS as income from a business.

Two spouses, who carried on a truck repair service and an accounting service for truckers, were held not to be carrying on a small operation of breeding and training horses with a reasonable expectation of profit, and accordingly were not permitted to deduct their losses for 1981 and 1982. Revenues as a percent of expenses ranged from 0% to 68% over the period 1977 to 1985, substantial annual expenses were built into their operation in the form of mortgage interest expenses and the contracting out of training (necessitated by their lack of background in the training of horses), and there was no clear plan for making the operation profitable.

The taxpayer failed to establish that he acquired two Florida condominium units with a reasonable expectation of profit. One unit showed losses for both of the years that he held it and with respect to the other unit, in only two years, 1982 and 1985, had there been sufficient return for CCA to be deducted (one criterion for reasonable expectation of profit being the probability of the venture, as capitalized, to show a profit after the deduction of CCA). Nothing turned on the fact that the plaintiff made no personal use of one of the units.

A taxpayer's expenses may be deductible even if "there is neither immediate income nor an immediate source of income in his business." In the Trial Division, McNair stated, obiter: "Expenditures that are part of a taxpayer's working expenses and that are laid out as part of the process of profit earning are deductible in the year in which they are made, even though no profit results therefrom. Nor is there any limitation as to time in s. 18(1)(a) to prevent the deduction of such expenses against income in other years than that in which the expenditure was made."

A part-time farmer who realized farming losses for his 1977-1980 taxation years which were approximately twice his revenues was prohibited from deducting those losses. He had no background in horse breeding, he devoted little time to his operation, there was no evidence of any plan wherein he indicated how he expected ever to make a profit from his operation and he had had consistent losses from the farm since 1968.

A full-time professor at the University of Prince Edward Island who purchased an 117 acre farm 7 miles away in dilapidated condition, built his home there and during each of the following 5 years earned farming revenues equal, at most, to 20% of his expenses, was held not to be engaged in farming with a reasonable expectation of profit. His losses were non-deductible.

Dickson, J. stated that "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 ... [W]hether 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."

An unsuccessful 8-year search by the taxpayer for buried pirate treasure was a business rather than a hobby.

An operation of breeding and keeping horses for racing purposes was held to be carried on as a commercial venture and with a reasonable expectation of profit rather than as a hobby of the partners. The partners were successful businessmen with relatively little personal interest in horse racing (suggesting that they had not entered into the venture for amusement) and "very little additional luck in the various races by the partnership horses would have resulted in a favourable balance sheet".