Stewart v. Canada

[Arthur Rubin]

Is Stewart v. Canada, [2002] 2 S.C.R. 645, 2002 SCC 46, still good law. It appears to be a Canada Supreme Court decision overriding the "reasonable expectation of profit" required to take a business deduction, there.

[Burnaby49]

Stewart is still the Canadian standard for analyzing business v. hobby or personal. All Tax Court cases on this issue use the Stewart rules as guidance.

I spent 35 years as a CRA auditor and, when Stewart came out, there was great lamentation about how reasonable expectation of profit was now dead and taxpayers could get away with anything. Turned out to be not the case. The CRA now has to show a personal rather than business purpose to the expenses by demonstrating a lack of business application. Typical cases are hobbies such as car racing, art (requires travel), writing (ditto) where the taxpayer claims the expenses as part of a business. For a random example of how this is applied go to;

http://www.canlii.org/en/ca/fca/doc/201 ... fca30.html

In Stewart the Supreme Court said that it wasn't the CRA's role to second-guess business decisions and subjectively decide who could make a profit and who couldn't. In Stewart the taxpayer was claiming rental losses although he was charging market rent because of the high interest costs. On the face of it he couldn't make a profit but the court determined he had a business so these were business expenses. To quote the decision;


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.

The full decision can be found at;

http://scc.lexum.org/en/2002/2002scc46/2002scc46.html

[Arthur Rubin]

My reason for asking is that there is a customer on JustAnswer who apparently had an Amway distributorship? (whatever it's called) from 1995, and is apparently still in audit. She also says she did some stupid things, including "detax" methods. She now regrets that, believes her case is still open (I doubt it, but...) and wants to know if Stewart v. Canada applies retroactively. I normally wouldn't consider it, but a former detaxer who wants out deserves all the help she can get.

If there are any Experts on Just Answer, the details are at http://www.justanswer.com/canada-tax/68 ... wever.html

[Burnaby49]

I'm not going to wade into that one but its my opinion she's toast. The information provided is so vague that it isn't possible to analyze with any confidence however it doesn't look like they have actually filed an appeal with the Tax Court of Canada. The CRA can't, as a matter of law, take collection action against a taxpayer while an appeal is ongoing so, if their house is about to be sold, it appears that their "litigation" and other actions, have not been in respect to an ongoing still-current valid objection. If not she and her husband are screwed, they are long out of time. The filing rules are very specific and the Tax Court has no discretion to vary. They had 90 days from the date of assessment to appeal and collection action would start after the appeal period expired. It looks like they were assessed at least a decade ago.

The law is quite specific and reads;

165. (1) Objections to assessment -- A taxpayer who objects to an assessment under this Part may serve on the Minister a notice of objection, in writing, setting out the reasons for the objection and all relevant facts,

(a) where the assessment is in respect of the taxpayer for a taxation year and the taxpayer is an individual (other than a trust) or a testamentary trust, on or before the later of

(ii) the day that is 90 days after the day of mailing of the notice of assessment;

166.2 (1) Extension of time [to object] by Tax Court -- A taxpayer who has made an application under subsection 166.1[(1)] may apply to the Tax Court of Canada to have the application granted after either

(a) the Minister has refused the application, or

(b) 90 days have elapsed after service of the application under subsection 166.1(1) and the Minister has not notified the taxpayer of the Minister's decision,

but no application under this section may be made after the expiration of 90 days after the day on which notification of the decision was mailed to the taxpayer.

See a recent decision on this issue at;

http://decision.tcc-cci.gc.ca/en/2012/2 ... tcc29.html

Now, as to the merits of her case, It's my opinion they are still screwed even if it goes to court under a Stewart analysis. The CRA has a long and successful history of reassessing claimed Amway losses. The requirement under Stewart is that there must be a business. Almost of their claimed expenses will be items normally considered personal such as home mortgage interest, heat light power, car expenses, etc, the normal personal non-business expenses we all have. The CRA does not generally consider Amway to be a business but just a tax avoidance method for personal expense write-offs. I'd guess that, even using Stewart as guidance, the Tax Court would conclude that there is no business and the expenses are all personal.

However, again, there is not enough information to determine the basis of her reassessments. If she's used Detax methods as part of her 15+ years of delay who knows what else is in mix? I can guarantee that neither the CRA and courts will cut her any slack if she and hubby have shown a total lack of co-operation as Detaxers.

[Arthur Rubin]

However, again, there is not enough information to determine the basis of her reassessments. If she's used Detax methods as part of her 15+ years of delay who knows what else is in mix? I can guarantee that neither the CRA and courts will cut her any slack if she and hubby have shown a total lack of co-operation as Detaxers.

I quite agree that the taxing agency and courts will not cut her any slack as detaxers, but Quatloosians do.

I appreciate the effort you've put into this. I'm considering answering, based on this information, even though there doesn't appear to be anything she can do.

[Burnaby49]

However, again, there is not enough information to determine the basis of her reassessments. If she's used Detax methods as part of her 15+ years of delay who knows what else is in mix? I can guarantee that neither the CRA and courts will cut her any slack if she and hubby have shown a total lack of co-operation as Detaxers.

I quite agree that the taxing agency and courts will not cut her any slack as detaxers, but Quatloosians do.

I appreciate the effort you've put into this. I'm considering answering, based on this information, even though there doesn't appear to be anything she can do.

Just don't link it to me. I spent my career, in part, dealing with these guys and I have no enthusiasm for re-entering the fray on retirement. I'd prefer not to become a de-facto adviser to Canadian Detaxers.

[Arthur Rubin]

I don't know your real name. To be safe, though, I won't refer to Quatloos at all.

[Burnaby49]

I don't know your real name. To be safe, though, I won't refer to Quatloos at all.

That's what I meant. Otherwise they could sign up for Quatloos then PM me for more advice or try and squabble over some new Detax theory that will save them at the last minute. Not a problem as much as a nuisance. I lost any sympathy I for them after too much sitting across the table listening to their blather.

[Burnaby49]

Just had another look at her JustAnswer posting and noticed she stated;

However I really want to get to the root of my case which I have fought for 13 years (sometimes in stupid detaxing ways). Court, letters etc.

While this is almost incoherently vague it seems to imply that she has already been to Tax Court on the issue. If so she obviously lost. So, even if she wasn't out of time (which seems clearly the case), she is res judicata (also known colloquially as SOOL) and her legal remedies are extinguished. She can't have another crack at it just because she thinks that she has found a new way out that she didn't try at the original Tax Court hearing. Canadian courts really hate people trying to re-litigate decided issues. The CRA wouldn't be taking her house if there was any possible recourse in law for her. Her best bet is to (maybe for the first time) try and co-operate fully with the CRA and see if there is any last chance to settle. Unlikely but her best shot.