Reasonable Expectation of Profit

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.

A limited partnership purchased a mini-warehouse for a purchase price ($2.2 million) that was approximately twice the cost to the promoter-associated vendor of the property. The partnership was found by the trial judge not to have a reasonable expectation of profit given that the purchase price was largely financed with debt bearing interest at 24%, revenues of the warehouse prior to its acquisition were approximately $160,000 per annum and the partnership (in addition to offering costs of $429,000) was required to pay services fees amounting to a minimum of $718,000 annually. In reversing this finding, Robertson J.A. stated:

"... there is no 'personal element' involved in the series of transactions under review. The appellant taxpayers were limited partners who purchased an ongoing commercial business. The fact that the purchase was driven, in part, by favourable tax considerations does not detract from the ongoing and commercial nature of the endeavour."

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 TCJ. 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) f 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.

A limited partnership purchased a mini-warehouse for a purchase price ($2.2 million) that was approximately twice the cost to the promoter-associated vendor of the property. The partnership was found not to have a reasonable expectation of profit given that the purchase price was largely financed with debt bearing interest at 24%, revenues of the warehouse prior to its acquisition were approximately $160,000 per annum and the partnership (in addition to offering costs of $429,000) was required to pay services fees amounting to a minimum of $718,000 annually. Pinard J. stated (at p. 6146):

"The evidence in this case indicates that the only financial advantage that could reasonably have been expected by a purchaser of a limited partnership unit in this arrangement would have been by way of tax refunds as a result of claiming the inevitable losses from the arrangement."

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".