To refresh memories I have written extensively on two Canadian tax scams that have generated a large volume of litigation. One moronically obvious scam was the Fiscal Arbitrators. A group of promoters sold the concept to gullible and/or greedy taxpayers that you could legally claim massive totally fake expenses against your taxable income. The theoretical fig leaf covering this was the claim that any expenses you incurred, food, mortgage, Vegas spree, could really be considered as tax deductible because they were necessary to keep you alive and functioning and earning taxable income. Even this was just bullshit since there was never any attempt by Fiscal Arbitrator promoters to determine their client's actual living expenses, the promoters just arbitrarily picked stunningly large numbers for their clients to claim as expenses. So somebody making, say, $60,000 a year would claim half a million in expenses. None of the Fiscal Arbitrator clients were charged with tax evasion although they were all hit with a gross negligence penalty of 50% of the taxes owing. The promoters went to jail.
The second scheme was the Paradigm Education program. Paradigm was even more of a criminal scam than the Fiscal Arbitrators but it attracted, on average, a higher income level of taxpayers. Dentists were particularly enthusiastic participants in the scheme. Paradigm was the brainchild of Russell Porisky, a carpenter with absolutely no training or experience in income tax or law. Very basically Porisky (later convicted of tax evasion and counseling fraud) taught that individuals could legally separate themselves from government legislation and thereby not be subject to the Income Tax Act. They did this by becoming a "natural person" as opposed to their current status as a "legal person". In Porisky's idiotic scam natural persons (a term not included in the Income Tax Act) were exempt from paying income tax but only he, among all of Canada's tax experts, had the analytical brilliance necessary to figure this out.
Well and good. But Paradigm's clients went a step too far. Had Porisky advised his clients to declare their income on their tax returns but not pay the taxes they would have been legally in the clear. The Canada Revenue Agency would have gone after them for the tax and they would have ended up in Tax Court defending their position but no laws broken. But apparently Porisky advised that doing all of that was a waste of time and money. Since those he enlightened knew they weren't taxable there was no reason to go through all of the hassle of having to defend their rights in Tax Court against a hostile CRA trying to conceal the truth. It was a lot simpler to just not tell the CRA about the income they weren't taxable on anyhow. So that's what they did. It was this deliberate non-reporting of income that turned the Paradigm scheme's followers from just out-of-pocket participants in a stupid scam, like the Fiscal Arbitrators, into convicted tax evaders. The government went after the Paradigm participants with criminal charges and, as I've related in Quatloos, resulted in many criminal convictions and, in the case of the promoters, jail sentences.
This brings us to Rolf De Geest. From 1979 to early 2006 De Geest operated a sole proprietorship under the name De Geest Construction. During this period he carried on the business of performing general construction work including window installations. He duly reported all of the income he from his business in these years and paid tax on it. Then he attended a Paradigm presentation and made friends with convicted income tax evader and Paradigm promoter Cory Stanchfield. Cory is no stranger to Quatloos, there are numerous references to him salted throughout the Paradigm threads and this is his dedicated discussion;
http://www.quatloos.com/Q-Forum/viewtop ... 4&p=189744
As a result of his Paradigm enlightenment De Geest realized that, like a complete fool, he'd been paying taxes all those years when the Income Tax Act, as interpreted by Russell Porisky's natural man dual identity bullshit and supported by the Stewart decision from the Supreme Court of Canada, allowed him the choice to opt out of paying taxes if he chose. And so he did. Sadly all good things come to an end and, after a few years of not reporting his income for tax purposes, the Canada Revenue Agency, having seized all of Paradigm's client information thanks to Russell Porisky's computer files, located and reassessed De Geest for all back taxes and interest. However, unlike the vast majority of the Paradigm cases I've reported on Quatloos, he was not charged with income tax evasion. He was instead penalized by being hit with a gross negligence penalty equal to 50% of all taxes he'd avoided paying.
This same penalty was also applied to all of the Fiscal Arbitrator clients. Almost all of them accepted their tax reassessments but appealed the application of the penalty on the grounds that they were not grossly negligent in claiming hundreds of thousands of dollars of totally bogus business losses that they knew were fake. The Tax Court decided otherwise and almost invariably upheld the penalty. However De Geest went for the gusto and appealed both the penalty and the CRA's claim that he owed any taxes at all. As far as he was concerned it was still 2006 and Paradigm's tax evasion scheme was valid and binding on the CRA.
De Geest v. The Queen
2019 TCC 33
http://canlii.ca/t/hxgdm
These were the issues at De Geest's appeal.
This is how the Tax Court reported events leading up to De Geest's reassessment;[1] The Appellant has appealed reassessments in respect of his 2009, 2010 and 2011 taxation years. For each year, the Appellant elected not to report any amount as income from his activities relating to the installation of windows and doors in homes. It is his position that the activities constituted a personal endeavour and were not a source of income.
[2] The Minister disagrees and assessed the Appellant on the basis that he had unreported income of $178,274, $196,490 and $250,392 in his 2009, 2010 and 2011 taxation years respectively. It is the Minister’s position that the Appellant earned the unreported income from the carrying on of a business. The Minister also assessed gross negligence penalties under subsection 163(2) of the Income Tax Act of $19,911, $22,366 and $31,212 for each of the 2009, 2010 and 2011 taxation years respectively.
After reviewing De Geest's story the Tax Court gave a summary of the relevant law;[8] The Appellant testified that he stopped carrying on this sole proprietorship in early 2006. He testified that “Okay, the fact is in early 2006 I made the conscious and purposeful decision to cease my concurrent pursuit of profit or commercial activities and exclusively pursue a non-commercial personal endeavour.” [1]
[9] During his testimony, the Appellant described this so-called noncommercial personal endeavour as follows:
[10] On cross-examination, he described the activities he performed in carrying out the so-called personal endeavour as follows:. . . I deny any business customers or clients for taxation years 2009 to 2011. My personal endeavour, which started after April 21st, 2006, was that of a general non-commercial contractor, overseeing commercial and non-commercial subcontractors in fulfillment of installing windows, doors and carpentry work within the general Victoria area for contractors and referrals.
I received compensation for my general non-commercial contracting duties. The quantum of compensation varied on each non-commercial contract. Generally, monies from this ongoing non-commercial activity were deposited into a joint personal bank account with my daughter and son-in-law.
- He negotiated contracts with individuals and companies who required him to do work for them. The individuals were referred to him by different window companies. During his testimony, the Appellant referred to the individuals and companies as “non-commercial” referrals and to the contracts as “noncommercial contracts”.
- The individuals and companies who entered into contracts with the Appellant paid him for his services. He acknowledged that they paid him $246,920 in 2009, $247,264 in 2010 and $371,962 in 2011.
- He oversaw the various installation projects.
- He hired subcontractors to install the windows.
- He purchased materials for use in the projects.
- He attended job sites.
[11] On cross-examination, the Appellant admitted that he devoted a lot of time to the activity of installing the windows and doors and providing carpentry work. He stated that the activity was not a charity and was not a hobby.
[12] The Respondent provided the Court with Exhibit R-1, which the Appellant acknowledged was a copy of a standard “private” contract he entered into with the companies and individuals that retained him to install windows. The document is entitled “Private Contract”, contains the Appellant’s name and address, describes the scope of the work to be performed and the amount to be charged, and contains the name and address of the person who retained the Appellant (that person being “Jubillee [sic] Windows Ltd.”).
[13] The Appellant testified that he created the document, and stated:
[14] He noted that the contract/invoice was a way in which he could tell his clients what he was doing for the money he charged.It’s a non-commercial invoice. At that time I understood that that was the same thing, so I put that on there because I wanted to be specific that it was private between the person and myself, that it was not a contract written up as a commercial contract for a business.
[15] The following is written across the bottom on the invoice: “All amounts received, are amount[s] received in my capacity as a natural person (as defined in Barron’s Canadian Law Dictionary 4th Ed) for my own benefit, and are not received and/or held for the benefit of the “taxpayer” (as defined in the Income Tax Act of Canada”). GST [is] non-applicable, as per Sec 240(1) of the Excise Tax Act of Canada”.
[16] The Appellant explained that he added these words for the following reasons:
. . . The reason for this notation was to express my non-commercial subjective intention in writing. Because I was not exercising a for-profit activity under the Income Tax Act I had to make sure that I was compliant with the Excise Tax Act, Part IX, and also that contractors and referrals also knew that I would not be charging GST as I was not carrying on a taxable supply in the course of a commercial activity. Nor was I required to be registered under section 240(1) of that Act.
[21] The first issue before the Court is whether the Appellant had unreported income in the relevant taxation years.
[22] Section 3 of the Income Tax Act is the starting point for determining the income of a taxpayer for a taxation year. Section 3 provides that income includes the taxpayer’s income for the year “from a source inside or outside Canada, including, without restricting the generality of the foregoing, the taxpayer’s income for the year from each office, employment, business and property”.
[23] The issue in this appeal is whether the Appellant had income from a business.
[24] Business is defined in subsection 248(1) of the Act as follows:
“business” includes a profession, calling, trade, manufacture or undertaking of any kind whatever and, except for the purposes of paragraph 18(2)(c), section 54.2, subsection 95(1) and paragraph 110.6(14)(f), an adventure or concern in the nature of trade but does not include an office or employment.
[25] This definition is inclusive, not exhaustive.
[26] The approach to be taken in making the determination of whether the Appellant’s activities in 2009, 2010 and 2011 constituted a source of income is mandated by the 2002 decision of the Supreme Court of Canada in Stewart v. Canada [5] (“Stewart”). The Court set out the following two-stage approach that is to be followed when determining whether a taxpayer has a source of either business or property income:
. . . As such, the following two-stage approach with respect to the source question can be employed:
(i) Is the activity of the taxpayer undertaken in pursuit of profit, or is it a personal endeavour?
(ii) If it is not a personal endeavour, is the source of the income a business or property?
The first stage of the test assesses the general question of whether or not a source of income exists; the second stage categorizes the source as either business or property.
Equating “source of income” with an activity undertaken “in pursuit of profit” accords with the traditional common law definition of “business”, i.e., “anything which occupies the time and attention and labour of a man for the purpose of profit”: Smith, supra, at p. 258; Terminal Dock, supra. As well, business income is generally distinguished from property income on the basis that a business requires an additional level of taxpayer activity: see Krishna, supra, at p. 240. As such, it is logical to conclude that an activity undertaken in pursuit of profit, regardless of the level of taxpayer activity, will be either a business or property source of income. [6]
[29] The second issue before the Court is whether the Appellant is liable for gross negligence penalties.
[30] The introductory words of subsection 163(2) of the Income Tax Act state:
Every person who, knowingly, or under circumstances amounting to gross negligence, has made or has participated in, assented to or acquiesced in the making of, a false statement or omission in a return, form, certificate, statement or answer (in this section referred to as a “return”) filed or made in respect of a taxation year for the purposes of this Act, is liable to a penalty of the greater of $100 and 50% of the total of . . .
[31] The introductory words identify the following two conditions that must be satisfied if the assessment by the Minister of a penalty under subsection 163(2) of the Income Tax Act is to be maintained:
· - The Appellant must have made, participated in, assented to or acquiesced in the making of a false statement or omission in a return, form, certificate, statement or answer, referred to collectively as a “return”.
·
· - The false statement or omission must have been made by the Appellant knowingly or under circumstances amounting to gross negligence, or the Appellant must have participated in, assented to or acquiesced in the making of the false statement or omission knowingly or under circumstances amounting to gross negligence.
·
[32] Under subsection 163(3) of the Income Tax Act, the Minister has the burden of proving on a balance of probabilities the facts that justify the assessment of a penalty under subsection 163(2) of the Income Tax Act.
Then, after setting the background, the Tax Court judge stomped De Geest as flat as a squirrel under a bus tire;
[35] The Appellant during his testimony summarized his position as follows (transcript, pages 25 – 26):
[36] As my colleague Justice Visser stated in Meerman v. The Queen, [9] the Appellant’s argument is a nonsensical argument which seeks to twist the words and purpose of the source of income test set out in Stewart for the purpose of avoiding tax.My primary intention was to exercise the personal endeavour for all my personal expenditures and living expenses. My secondary intention was that there would be no tax liability. This is perfectly lawful, according to my understanding, and there is no law that I know of prohibiting this. And though there may be no tax payable on monies I received from my personal endeavour, I also recognize that I received no benefits.
[37] The Meerman appeal involved a fact situation nearly identical to the fact situation now before the Court. Mr. Meerman was a heavy-duty mechanic who until mid-2006, reported as income for the purposes of the Income Tax Act the compensation he received for the services he provided to a related company. He stopped reporting the compensation sometime in 2006 and was subsequently assessed for his 2006 to 2011 taxation years.
[38] Justice Visser noted that Mr. Meerman took the position that, during the 2006 to 2011 taxation years, he was exercising his private rights to his labour for the purpose of providing a livelihood for him and his family and that it was his intention at all material times to exclusively engage in a non-commercial personal endeavour.
Suddenly another old friend popped into the discussion;
[39] This is exactly the same position as that taken by the Appellant beginning in early 2006 and continuing throughout his 2009 to 2011 taxation years. This is not surprising since the Appellant testified that he had attended some meetings with the Paradigm Education Group and had adopted the personal endeavour approach after talking with his friend Cory Stanchfield. In addition, the Appellant was assisted in his appeal by David Lindsay. [10] In the Meerman appeal, Justice Visser referred to the involvement of Mr. Meerman with the Paradigm Education Group, Mr. Stanchfield and Mr. Lindsay as follows:
. . . Mr. Meerman previously attended seminars put on by one or more persons connected with the Paradigm Education Group and obtained the assistance of his friends, Cory Stanchfield and David Lindsay, in the preparation of his appeal. There have been many cases in Canadian Courts relating to individuals connected with the Paradigm Education Group. In the well-known case of Meads v. Meads, 2012 ABQB 571 (CanLII), Associate Chief Justice Rooke describes some of the Organized Pseudolegal Commercial Arguments, or OPCA, used by Paradigm Education Group and other detaxers and OPCA Litigants. Starting at paragraph 85 of Meads, Justice Rooke also provides an overview of various individuals and groups he describes as “OPCA gurus”, which he notes are “nothing more than conmen”. At paragraphs 87 through 98 of Meads he discusses Russell Porisky and the Paradigm Education Group and at paragraphs 100 to 108 he discusses David Kevin Lindsay, who he notes at paragraph 105 has been declared a vexatious litigant.
Our much-missed ex-poster Hilfskreuzer Mowe was a big fan of David Lindsay's work. We have a discussion on Lindsay here started by avid fanboy Mowe;
http://www.quatloos.com/Q-Forum/viewtop ... 48&t=10022
On with the judge's review;
[40] On the objective facts before me, it is clear that the activities of the Appellant relating to the installation of windows and doors and providing carpentry work were undertaken in pursuit of profit. The activities contained no elements that would suggest that they should be considered a hobby or other personal pursuit. In fact, the Appellant admitted on cross-examination that the activities were not a charity or a hobby. The activities were clearly commercial; they contained no personal elements.
[41] The Supreme Court of Canada in Stewart has made it clear that where the nature of the activity is clearly commercial a source of income exists by definition.
[42] Further, the activities were exactly the same activities as the activities the Appellant carried on before April 21, 2006. The Appellant treated the activities carried on prior to April 21, 2006 as producing income from a business.
[43] During the 2009, 2010 and 2011 taxation years, the Appellant negotiated contracts with individuals and companies to install doors and windows and perform carpentry work. He purchased materials and hired subcontractors to perform the work required under the contracts and supervised the performance of the work. During 2009, 2010 and 2011 he was paid $866,146 for such work and in fact realized a profit for the work. He stated that he used the money generated from the contracting activities to pay his personal expenses and living expenses.
[44] In short, when carrying on the activities of installing doors and windows and performing carpentry work, the Appellant carried on the commercial undertaking of providing these services and the required materials to third parties. This constituted a business (the “Contracting Business”) and a source of income. The Appellant not only carried on the activities in pursuit of profit, he actually earned a profit from the activities.
So, having settled that De Geest's claimed analysis of the Income Tax Act and the Stewart case was just preposterous gibberish on to part 2, the imposition of the gross negligence penalty. Was it valid to penalize him under the circumstances, those of a man just seeking the truth about income tax and finding it from the words of a carpenter? The judge had no problem with that one;
[45] I will now address the issue of whether the Appellant is liable for the subsection 163(2) gross negligence penalty.
[46] The previously discussed first condition of subsection 163(2) is satisfied since the Appellant made a false statement or omission in the income tax returns he filed for each of the 2009, 2010 and 2011 taxation years. The Appellant acknowledged that he prepared and signed each of the filed returns. Each of the returns failed to report the income he earned from the Contracting Business.
[47] The second condition of subsection 163(2) will only be satisfied if the Appellant made the false statement or omission knowingly or under circumstances amounting to gross negligence.
[48] With respect to whether the false statement or omission was made knowingly, the Court must determine whether the Appellant knew he had income from the Contracting Business. Specifically, did the Appellant have the subjective knowledge that he was making a false statement in his income tax returns when he filed the returns?
[51] I have no difficulty finding that the Appellant knowingly made the false statement or omission. He admitted that he made the decision not to report the income, but argued that he had based that decision on a point of law, i.e., his socalled interpretation of Stewart as establishing that a person has no source of income if the person elects to carry on the person’s business as a “personal endeavour”.
[52] First, I do not believe that this was the Appellant’s interpretation of Stewart. This was a filing position suggested to him by Mr. Stanchfield and Mr. Lindsay. It is the same position as that taken by Mr. Meerman in his appeal. It is not a bona fide legal position; it is an argument used in a rather weak attempt to avoid paying taxes.
[53] The Appellant carried on exactly the same business before and after April 21, 2006; however, he chose to stop reporting the income from the business after April 21, 2006. The Appellant is an intelligent individual who made a conscious decision to stop reporting his income from the Contracting Business and to use Mr. Stanchfield’s nonsensical argument to try to support the failure to report his income. As a result, the Appellant knowingly made a false statement or omission in his returns.
[54] It is also my view that the Appellant made the false statement or omission in each of his 2009, 2010 and 2011 tax returns in circumstances amounting to gross negligence.
58] It is clear from the evidence before me that the Appellant is capable of understanding his duty not to make a false statement or an omission in a return. He is an intelligent person and clearly knows his duty to file his tax returns and report his actual income.
[59] As a result, the Respondent must establish, on a balance of probabilities, facts that lead to the conclusion that the making by the Appellant of the false statement in his 2009, 2010 and 2011 income tax returns was such a marked and substantial departure from the conduct of a reasonable person in the same circumstances that it constituted gross negligence.
[60] The Respondent has established such facts.
[61] A reasonable person presented with Mr. Stanchfield’s nonsensical argument would immediately realize that there was something wrong with it. A person cannot suddenly elect to have his income from a business not be subject to tax.
[62] The Appellant carried on the same activity after April 2006 as he carried on before, yet he takes the position that the activity became non-taxable in April 2006. This is patently absurd. In my view, a reasonable person would not believe that an activity of a commercial nature, such as the provision of contractor services, would suddenly become non-taxable because the provider of the services decided to label the provision of the services as a “personal endeavour”.
[63] This alone is sufficient for a finding of conduct that is such a marked and substantial departure from the conduct of a reasonable person that it constituted gross negligence.
[64] There are at least two other factors that support such a conclusion.
[65] The Appellant testified that he realized he was taking a risk and asked an accountant and a lawyer about the personal endeavour argument. When asked on cross-examination whether the accountant thought that it was a good idea to take the approach that he was engaged in a personal endeavour, he said “absolutely not”. And when asked whether the lawyer suggested to him that it was a good idea, the Appellant responded “of course not”.
[66] A reasonable person would have followed this advice. Two professionals advised the Appellant that he had no valid filing position.
The judge thought that Mr. De Geest was not an entirely credible witness just because he wanted to change his testimony to reverse the prejudice to his case caused by giving an honest answer on cross-examination;
[67] After the Appellant had provided on cross-examination his answers with respect to the accountant and the lawyer, the Court took a short recess. After the recess, the Appellant acknowledged that during the recess he had spoken with his friends who were present in the courtroom and helping him with his appeal. He then tried to change his testimony with respect to his conversations with the accountant and the lawyer. I do not accept this altered testimony; it was clearly an attempt to undo the damage caused by his earlier testimony while he was under cross-examination. The Appellant’s actions seriously damaged his credibility.
I'm assuming that Stanchfield and Lindsay were amongst these friends. Keep in mind that Stanchfield was convicted of counseling fraud, a criminal offense, for giving the same kind of advice to Porisky's clients a decade or so earlier.
Then, to add a bit more to the bill;
[73] For the foregoing reasons, the appeal is dismissed with costs to the Respondent.
[74] The parties will have 30 days from the date of this judgment to arrive at an agreement on costs, failing which they are directed to file their written submissions on costs within 60 days of the date of this judgment. Such submissions shall not exceed 10 pages.
[75] If the parties cannot agree on costs and do not make written submissions, costs shall be awarded to the Respondent pursuant to the tariff.
This is not good news for Keith Lawson;
http://www.quatloos.com/Q-Forum/viewtop ... 6792825859
Keith was, like Stanchfield, convicted of income tax evasion and counseling fraud. However, unlike Stanchfield, Keith was sentenced to jail time. He is currently out on bail appealing his conviction. I wrote on November 8, 2016 in Lawson's thread;
This is the Stewart decision;This is Keith's last chance to save himself from jail time and he's gone off the rails in a doomed double-or-nothing suicide run. He's discarded all of his baggage from the past. He's abandoned capitalization, jurisdiction, even his beloved natural man, and is gambling everything on one last throw. He's going to convince the British Columbia Court of Appeal that the Supreme Court of Canada has told him that he could exempt himself from paying income tax by declaring his Paradigm income to be derived from a tax-free hobby.
So he hasn't evaded tax or counseled tax evasion because he never owed any income tax in the first place and the people he counseled were just hobbyists like himself. He was just diligently following the law which only he, with his genius for legal analysis, is able to comprehend. Hopefully the judges at his appeals court hearing are intelligent and learned enough to finally understand how the law really works after he explains it all to them.
He's relying on his totally deluded interpretation of the Stewart decision. I've already discussed Stewart in detail in this discussion and explained why Lawson is entirely wrong in his interpretation of it but, since it is apparently the hill that he's chosen to die on, I'll go through it one more time.
Stewart v. Canada,
[2002] 2 SCR 645, 2002 SCC 46
http://canlii.ca/t/51sg
And this is my analysis of the Paradigm interpretation of the Stewart case that I wrote in Keith Lawson's discussion.
So Lawson is basing his appeal on exactly the same argument that De Geest just lost, and lost badly, at Tax Court. The best that De Geest could have hoped for was that a sympathetic judge accepted that De Geest sincerely believed in the Paradigm bullshit and honestly thought his idiotic interpretation of Stewart was correct. This wouldn't have gotten him out of paying the taxes but there was a very, very slim hope the judge might have reversed the gross negligence penalty. If so this might have given Lawson at least a bit of ammunition in his appeal because one of his grounds was that he truly, really, honestly, sincerely believed that he was allowed to chose whether or not to pay tax because of his interpretation of Stewart. Instead the judge in De Geest said, to paraphrase, that even a complete idiot would have enough sense to realize how preposterous this tortured interpretation of Stewart was and it was clearly gross negligence to pretend to rely on it.This was a Supreme Court of Canada case about REOP (Reasonable Expectation of Profit). Up until Stewart the CRA could reassess someone on claimed business losses if the CRA auditor thought that the business did not have a reasonable expectation of profit. A purely subjective conclusion on the part of the Auditor. In Stewart a real estate investor lost money year after year on some rental apartments he owned because they were very highly levered and interest expenses exceeded the rent. He claimed losses and was reassessed on the basis he had no expectation of profit.
This is how the Supreme Court explained the decision
I'm guessing that Lawson wanted to use this as some kind of proof that, even if he made money from promoting Paradigm, he wasn't in business, it was a hobby and therefore not taxable. I'm assuming that he planned to rely on this sentence;The appellant, an experienced real estate investor, acquired four condominium units from which he earned rental income. The properties were part of a syndicated real estate development, and were sold on the basis that the purchaser would be provided with a turnkey operation, that management would be provided, and that a rental pooling agreement would be entered into. All units were highly leveraged with the appellant paying only $1,000 cash for each unit. The appellant was provided with projections of rental income and expenses in respect of each of the properties. The projections contemplated negative cash flow and income tax deductions for a ten year period. However, the actual rental experience ended up being worse than what had been set out in the projections. For the taxation years 1990 to 1992, the appellant claimed losses, mainly as a result of significant interest expenses on money borrowed to acquire the units. These losses were disallowed by the Minister of National Revenue on the basis that the taxpayer had no reasonable expectation of profit and therefore no source of income for the purposes of s. 9 of the Income Tax Act, and that the interest expenses were not deductible pursuant to s. 20(1)(c)(i) of the Act. Both the Tax Court of Canada and the Federal Court of Appeal upheld the decision.
Held: The appeal should be allowed.
The “reasonable expectation of profit” test should not be accepted as the test to determine whether a taxpayer’s activities constitute a source of income for the purposes of s. 9 of the Income Tax Act. In recent years, this test has become a broad based tool used by both the Minister and courts independently of provisions of the Act to second guess bona fide commercial decisions of the taxpayer and therefore runs afoul of the principle that courts should avoid judicial rule-making in tax law. The test is problematic owing to its vagueness and uncertainty of application; this results in unfair and arbitrary treatment of taxpayers.
The following two-stage approach should be employed to determine whether a taxpayer’s activities constitute a source of business or property income: (i) Is the taxpayer’s activity undertaken in pursuit of profit, or is it a personal endeavour? (ii) If it is not a personal endeavour, is the source of the income a business or property? The first stage of the test is only relevant when there is some personal or hobby element to the activity. Where the nature of an activity is clearly commercial, the taxpayer’s pursuit of profit is established. There is no need to take the inquiry any further by analysing the taxpayer’s business decisions. However, where the nature of a taxpayer’s venture contains elements which suggest that it could be considered a hobby or other personal pursuit, the venture will be considered a source of income only if it is undertaken in a sufficiently commercial manner. In order for an activity to be classified as commercial in nature, the taxpayer must have the subjective intention to profit and there must be evidence of businesslike behaviour which supports that intention. Reasonable expectation of profit is no more than a single factor, among others, to be considered at this stage.
The deductibility of expenses, which presupposes the existence of a source of income, should not be confused with the preliminary source inquiry. Once it has been determined that an activity has a sufficient degree of commerciality to be considered a source of income, the deductibility inquiry is undertaken according to whether the expense in question falls within the words of the relevant deduction provision(s) of the Act. To deny the deduction of losses on the simple ground that the losses signify that no business (or property) source exists is contrary to the words and scheme of the Act. Whether or not a business exists is a separate question from the deductibility of expenses. To disallow deductions based on a reasonable expectation of profit analysis would amount to a case law stop-loss rule which would be contrary to established principles of interpretation which are applicable to the Act. As well, unlike many statutory stop-loss rules, once deductions are disallowed under the “reasonable expectation of profit” test, the taxpayer cannot carry forward such losses to apply to future income in the event the activity becomes profitable.
In sum, whether a taxpayer has a source of income from a particular activity is determined by considering whether the taxpayer intends to carry on the activity for profit, and whether there is evidence to support that intention. In this case, the taxpayer purchased four rental properties which he rented to arm’s length parties in order to obtain rental income. A property rental activity which, as here, lacks any element of personal use or benefit to the taxpayer is clearly a commercial activity. As a result, the appellant satisfies the test for source of income and is entitled to deduct his rental losses. Section 20(1)(c)(i) of the Income Tax Act, which permits the deduction of interest on borrowed money for the purpose of earning income from a business or property, is not a tax avoidance mechanism and, in light of the specific anti-avoidance provisions in the Act, courts should not be quick to embellish provisions of the Act in response to tax avoidance concerns. In addition, since a tax motivation does not affect the validity of transactions for tax purposes, the appellant’s hope of realizing an eventual capital gain and expectation of deducting interest expenses do not detract from the commercial nature of his rental operation or its characterization as a source of income.
To try and persuade the jury that he didn't have the subjective intention to profit, he was just helping his fellow truth-seekers and therefore he didn't have a business.In order for an activity to be classified as commercial in nature, the taxpayer must have the subjective intention to profit and there must be evidence of businesslike behaviour which supports that intention.
However Lawson has it backwards. The point of the Stewart decision wasn't that profits can be made non-taxable based on your claimed subjective intent but to allow business losses when you conducted yourself in a business-like manner. Mr. Stewart lost money on his apartment rentals which he applied against other income to reduce his taxable income from other sources. The CRA disallowed those losses on the basis he had no hope of making an operating profit from his apartments (as opposed to long-term capital gains) and the Supreme Court allowed him to have them on the basis that he ran a business-like operation, acted in a prudent business-like manner, and that it wasn't up to the CRA to decide whether or not he had a business.
However you can't flip this around when you are doing something that makes a profit, say by flogging Paradigm materials, and rely on Stewart to make the profits non-taxable by just claiming that you didn't intend to profit and you are actually just doing it as a hobby. The fact that you are acting in at least a basic business-like manner by selling a course of instructions and the accompanying materials at an amount in excess of your cost, contracting to perform duties for a client, invoicing for materials sold and services and making a profit from this is proof you have an actual business regardless of whatever you chose to call it.
Lawson's appeal hearing is going to be entertaining. I hope to be there.
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