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Federal Tax - Business Definition. Brown v. Canada
In Brown v. Canada (Fed CA, 2022) the Federal Court of Appeal considered the approach to use when determining whether a source of income exists:A. The Approach to Follow in Determining if there is a Source of Income
[21] In paragraph 50 of Stewart, the Supreme Court set out the two-stage approach to determine if a taxpayer has a source of business or property income for the purposes of the Act. The first stage is described as:(i) Is the activity of the taxpayer undertaken in pursuit of profit, or is it a personal endeavour? [22] The Supreme Court noted that activities which are clearly commercial in nature do not require any further analysis to determine if a person has a source of income. The Supreme Court clarified in paragraphs 53 and 60 that a personal endeavor is one where there is some personal or hobby element to the activity in question. If there is some personal or hobby element to the activity, further analysis will be required to determine if it is being carried on in a sufficiently commercial manner to make it a source of income.
[23] The Supreme Court also noted in paragraph 51 of Stewart: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”. [24] In Canada v. Paletta Estate, 2022 FCA 86 there was no suggestion that there was any hobby or personal element to the activity in question. This Court confirmed that the activity still had to be carried out in pursuit of profit in order to be a source of income. There are undoubtedly many activities which do not have a hobby or personal element. The person undertaking these activities will not have a source of income unless that person is pursuing profit in carrying out these activities.
[25] The approach to determine if a person has a source of income can therefore be rephrased as follows:. Is there a personal or hobby element to the activity in question?
. If there is a personal or hobby element to the activity in question, the next enquiry is whether "“the activity is being carried out in a commercially sufficient manner to constitute a source of income”" (Stewart, at para. 60).
. If there is no personal or hobby element to the activity in question, the next enquiry is whether the activity is being undertaken in pursuit of profit. B. Is There a Hobby or Personal Element to Mr. Brown’s Management Services Activity?
[26] As noted above, in paragraphs 53 and 60 of Stewart, the Supreme Court emphasized that the additional enquiry related to the commerciality of the activity is only triggered if there is a hobby or personal element to the activity in question:[53] We emphasize that this "pursuit of profit" source test will only require analysis in situations where there is some personal or hobby element to the activity in question. With respect, in our view, courts have erred in the past in applying the REOP test to activities such as law practices and restaurants where there exists no such personal element: see, for example, Landry, supra; Sirois, supra; Engler v. The Queen, 94 D.T.C. 6280 (F.C.T.D.). Where the nature of an activity is clearly commercial, there is no need to analyze the taxpayer's business decisions. Such endeavours necessarily involve the pursuit of profit. As such, a source of income by definition exists, and there is no need to take the inquiry any further.
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[60] In summary, the issue of whether or not a taxpayer has a source of income is to be determined by looking at the commerciality of the activity in question. Where the activity contains no personal element and is clearly commercial, no further inquiry is necessary. Where the activity could be classified as a personal pursuit, then it must be determined whether or not the activity is being carried on in a sufficiently commercial manner to constitute a source of income. However, 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. ...
[emphasis added] [27] To determine if the further analysis with respect to the commerciality of the activity is required, the focus is on the activity itself and whether there is any personal or hobby element to the activity. In this case, the activity is management services. The question is therefore whether there is any personal or hobby element to the management services Mr. Brown was providing. In my view, Mr. Brown’s decision to provide these management services as a result of his wife’s inability to continue to manage the gallery, does not mean that there is a personal or hobby element to his management services activity, as contemplated by the Supreme Court.
[28] Many businesses are passed from one generation to the next. As noted above, the Tax Court Judge found a personal element to Mr. Brown’s management services activity when he commenced that activity as a result of his spouse’s inability to continue managing the gallery. Applying this logic to an intergenerational transfer of a business, whenever the next generation takes over an endeavour from their parents as a result of their parents’ inability to continue the endeavor, the analysis to determine if the next generation is carrying on the activity in a sufficiently commercial manner to qualify as a source of income would be triggered. However, simply because a child takes over an endeavor from his or her parent because that parent is not able to continue conducting that endeavor should not result in a finding that there is a personal element to the endeavor that the child is now undertaking.
[29] A person’s personal motivation or reason for conducting an activity cannot, in and of itself, result in there being a personal or hobby element to the activity. It is possible to find a personal reason why any person is carrying on a particular activity. For example, a person may be motivated to conduct a particular activity to generate money to fund his or her personal lifestyle or because they are personally motivated to provide better services or products than are currently available in the marketplace.
[30] As a result, every activity could potentially be subject to the further analysis to determine if it meets the test of commerciality. In effect, this would mean that the reasonable expectation of profit test (which the Supreme Court restricted to activities that have a personal or hobby element) would be applicable to all activities. This cannot be what the Supreme Court intended in Stewart.
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[33] As noted above, the intention to profit is necessary in order to find that Mr. Brown was carrying on a business. The Tax Court Judge’s findings with respect to his intention to make a profit are set out in paragraph 36 of his reasons:The evidence is that Mr. Brown provided management services to the Gallery in order to help Mrs. Brown and to offload as much as possible of the Gallery’s expenses to himself. This was done in order to allow the Gallery to be in operation until it [sic] revenues be sufficient to pay all of its expenses. This is what Mr. Brown stated in his testimony. Based on the evidence, this never changed during the relevant taxation year [sic]. Clearly, Mr. Brown did not begin providing services and did not continue to do so with the goal of making a profit. On that basis alone, the Court has concluded that Mr. Brown did not establish on the balance of probability that his predominant intention was not [sic] to make a profit from the activity and therefore, the activity was not a source of business income during the relevant taxation years. [34] The Tax Court Judge based his finding on Mr. Brown’s predominant intention. In Massé v. Canada, 2003 FCA 351, this Court, after referring to paragraph 60 of Stewart, noted:[20] Henceforth, the Court may consider the factors enumerated in Moldowan v. The Queen, 1977 CanLII 5 (SCC), [1978] 1 S.C.R. 480, only to the extent that the activity bears some personal element. More specifically, the existence of a personal element... requires the taxpayer to establish that his or her predominant intention is to make a profit from the activity and that the activity has been carried out in accordance with objective standards of businesslike behaviour. (Stewart, at par. 54) [35] The presence of a personal element in the activity in question will trigger the inquiry into the predominant intention of the taxpayer. Absent a personal element in the activity, the question is whether the taxpayer is pursuing profit in undertaking the activity in question, not whether this was his predominant intention. If the evidence establishes that profit is not being pursued, then the taxpayer is not carrying on a business (Paletta, at paragraph 39).
[36] The Tax Court Judge, in concluding that Mr. Brown was not pursuing profit, focused on the deductions claimed by Mr. Brown. In essence, he was evaluating his expectations of profit rather than simply whether he intended to profit.
[37] The question of whether a person is pursuing profit is separate from the question of the deductibility of any expenses claimed. As noted by the Supreme Court in Stewart:[56] In addition to restricting the source test to activities which contain a personal element, the activity which the taxpayer claims constitutes a source of income must be distinguished from particular deductions that the taxpayer associates with that source. ... . Canada v. Paletta
In Canada v. Paletta (Fed CA, 2022) the Federal Court of Appeal considered whether an intention to profit (the "reasonable expectation of profit" or REOP test) was required to constitute a "business" to attract income taxation:[19] Despite having found that Mr. Paletta did not trade for profit or for commercial reasons, the Tax Court held that his trading activities gave rise to a business. Specifically, the Tax Court found that the fact that Mr. Paletta’s trading activities could at all times yield negligible gains and losses together with the fact that these activities were by their nature commercial and had no personal element, left it no choice but to hold that a source of income existed. According to the Tax Court, "“Stewart instructs us clearly that the source analysis in such circumstances must end there”" (Reasons, para. 204; referring to Stewart v. Canada, 2002 SCC 46, [2002] 2 S.C.R. 645 [Stewart]).
[20] The Tax Court added that the Supreme Court in Walls v. Canada, 2002 SCC 47, [2002] 2 S.C.R. 684 [Walls SCC] confirmed that an intent to profit was not a prerequisite in order for a business to exist when it held that Mr. Walls was engaged in a business, despite the fact that the activity in question was not undertaken for profit and was entirely devoted to the avoidance of tax (Reasons, para. 202). The Tax Court’s theory that Stewart and Walls SCC could be so read was developed without the assistance of the parties as both argued their case at trial on the basis that an intent to profit had to be present before a business could be found to exist.
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[31] Pursuant to section 9 of the Act, the income derived from a business or property source is the "“profit”" derived therefrom, i.e.: the revenues less the expenses incurred to earn them (Russel v. Town and County Bank, (1883), 13 App. Cas. 418 at 424, cited in (PC) MNR v. Anaconda American Brass Ltd., 55 D.T.C. 1220; [1955] C.T.C. 311 (J.C.P.C.). The "“loss”" from a business or property is the result of the reverse equation. Because they are the reverse side of the same coin, the existence of a "“profit”" or "“loss”" for tax purposes is subject to the same conditions. In this respect, it is useful to note that no court has ever held that a "“profit”" or "“loss”" can arise under section 9 in the absence of an intent to profit, subject to the Tax Court’s unique reading of Stewart and Walls SCC. Section 9 reads in part:9 (1) Subject to this Part, a taxpayer’s income for a taxation year from a business or property is the taxpayer’s profit from that business or property for the year.
9 (1) Sous réserve des autres dispositions de la présente partie, le revenu qu’un contribuable tire d’une entreprise ou d’un bien pour une année d’imposition est le bénéfice qu’il en tire pour cette année.
(2) . . . , a taxpayer’s loss for a taxation year from a business or property is the amount of the taxpayer’s loss, if any, for the taxation year from that source computed by applying the provisions of this Act respecting computation of income from that source with such modifications as the circumstances require.
(2) […], la perte subie par un contribuable au cours d’une année d’imposition relativement à une entreprise ou à un bien est le montant de sa perte subie au cours de l’année relativement à cette entreprise ou à ce bien, calculée par l’application, avec les adaptations nécessaires, des dispositions de la présente loi afférentes au calcul du revenu tiré de cette entreprise ou de ce bien. Unless Mr. Paletta’s trading gains and losses emanate from a source in the form of a business, they do not come within section 9 and can neither be included nor deducted in the computation of his income pursuant to section 3.
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[33] Despite finding that Mr. Paletta did not trade for profit, the Tax Court held that the trading losses that he claimed originated from a business. The Tax Court explained that the decisions of the Supreme Court in Stewart and Walls SCC "“obliged”" it to hold that the trading activities gave rise to a source of income (Reasons, para. 271). The Tax Court read these decisions as authority for the proposition that where an activity appears to be inherently commercial, it is a source of income even where the activity is not in fact carried on for commercial reasons or with a view to profit. With respect, this is not what Stewart and Walls SCC stand for.
[34] The Supreme Court in Stewart was focused on doing away with the reasonable expectation of profit test (the REOP test). This test originally had a specific statutory underpinning, but became, over time, a broad-based test used in all kinds of situations to determine if an activity gave rise to a source of income or whether the taxpayer is engaged in a personal endeavour, typically in the form of a hobby (Moldowan v. The Queen (1977), 1977 CanLII 5 (SCC), [1978] 1 S.C.R. 480, 77 D.L.R. (3d) 112). The Court was particularly concerned by the fact that, in applying this test, judges were using hindsight and often second-guessing the business acumen of the taxpayers concerned, a role for which they were ill-equipped and no better positioned than those whose business decisions they were assessing (Stewart, paras. 44-47). More fundamentally, the REOP test, which has no statutory foundation as a stand-alone test of general application, had overtaken the long accepted common law definition of business which simply requires that the activity be undertaken in the pursuit of profit (Stewart, para. 38 citing Smith v. Anderson (1880), 15 Ch. D. 247 (C.A.), at p. 258; Terminal Dock and Warehouse Co. v. M.N.R., [1968] 2 Ex. C.R. 78, [1968] C.T.C. 78, aff’d [1968] S.C.R. vi, 68 D.T.C. 5316).
[35] The Supreme Court therefore devised a simple two-step test focused on the pursuit of profit that had withstood the test of time remarkably well until the decision under appeal was released:Is the activity of the taxpayer undertaken in the pursuit of profit, or is it a personal endeavour?
If it is not a personal endeavour, is the source of income a business or property? Where the activity contains no personal element and is clearly commercial, no further inquiry is necessary (Stewart, para. 60).
[36] Stewart teaches that, in the absence of a personal or hobby element, where courts are confronted with what appears to be a clearly commercial activity and the evidence is consistent with the view that the activity is conducted for profit, they need go no further to hold that a business or property source of income exists for purposes of the Act. However, where as is the case here, the evidence reveals that, despite the appearances of commerciality, the activity is not in fact conducted with a view to profit, a business or property source cannot be found to exist.
[37] The Tax Court read Stewart differently. It held that the Stewart test effectively did away with the pursuit of profit as a prerequisite for the existence of a business, and that as Mr. Paletta was engaged in what it viewed as a clear commercial activity with no personal element, it was bound to hold that a business existed despite the absence of any profit motive.
[38] This reading is incompatible with what the Supreme Court actually said in Stewart. Not only did Stewart not oblige the Tax Court to hold that there was a source of income in these circumstances, but it required the Tax Court to come to the opposite conclusion. In Stewart, the Supreme Court made it clear that the test being devised was consistent with the traditional common law definition of "“business”". The word "“business”" is given an inclusive and expansive meaning under the Act (subsection 248(1)), but is left otherwise undefined. As in such circumstances, the private law -- the common law on the facts of Stewart -- fills the gap, the Supreme Court explained that the Stewart test gave effect to the common law definition of "“business”" (Stewart, para. 51):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. ... [39] Yet, the Tax Court read Stewart as requiring it to equate "“source of income”" with an activity that is not undertaken in "“pursuit of profit”" and to provide for a result that conflicts, rather than accords, with the common law definition of "“business”". This turns Stewart on its head. Contrary to what the Tax Court believed, it could not hold that Mr. Paletta was engaged in a commercial activity in the face of evidence establishing that he had no intention to profit. The objective of the Stewart test, which was to reaffirm "“pursuit of profit”" as the decisive consideration in ascertaining the existence of a business, precludes the possibility that this test could be construed so as to require the recognition of a business in the face of evidence that establishes that profits are not being pursued.
This issue is further explored at paras 40-62, the conclusion being that an intention to profit was an integral aspect of being a "business".
. Vesuna v. Canada
In Vesuna v. Canada (Fed CA, 2022) the Federal Court of Appeal considered whether expenses were incurred in pursuit of a 'business':[2] For his legal costs to be deductible, Mr. Vesuna had to show that they were incurred for the purpose of gaining or producing income from a business: Income Tax Act, R.S.C. 1985, c. 1 (5th Supp.), s. 18(1)(a). The Minister denied Mr. Vesuna’s business expense claim on a number of grounds, among which was the failure by the appellant to demonstrate that his business had commenced in 2014. That decision was upheld by the Tax Court, on the basis that Mr. Vesuna had taken some preliminary steps to advance an idea and therefore had a subjective intention to conduct a business, but had not actually taken the essential steps to commence that business.
[3] It is well established that the essential elements of a business must have been in place for a taxpayer to be carrying on business, and that mere intention or the taking of preliminary steps is not sufficient: Gartry v. Canada, [1994] 2 C.T.C. 2021, 94 D.T.C. 1947 at 1949, cited in Morris v. R., 2014 TCC 142, [2014] 5 C.T.C. 2099, Tiede v. R., 2011 TCC 84, [2011] 3 C.T.C. 2153 at para. 12 and Hourie v. R., 2010 TCC 525, 2010 D.T.C. 1378; MacDonald v. R., [1997] 1 C.T.C. 2501, 97 D.T.C. 1554 (T.C.C.) at para. 18; Samson & Frères Ltée c. R., [1995] TCJ No. 1385, 97 D.T.C. 642 at para. 22 (T.C.C.), cited in Tri-O-Cycles Concept Inc. c. R., 2009 TCC 632, 2010 D.T.C. 1030 at paras. 21-23 and Malin v. R., 2007 TCC 516, [2008] 2 C.T.C. 2055. It is not in dispute that the Tax Court Judge applied that legal test.
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