Landry v. The Queen, 94 DTC 6624, [1995] 2 CTC 3 (FCA)

Décary J.A.:—The issue in the Tax Court of Canada was whether the applicant had a reasonable expectation of profit during the 1987 and 1988 taxation years from carrying on his profession, the practice of law, so that he could deduct the losses incurred in his practice from the income he received from other sources. After examining the evidence, Judge Garon reached the following conclusion: [1]

From the evidence as a whole it seems clear that, on an objective view of the facts, the appellant did not have a reasonable expectation of profit in the two years in question in light of the principles stated by the Supreme Court of Canada in the notorious decision Moldowan v. The Queen, [1978] 1 S.C.R. 480, [1977] C.T.C. 310, 77 D.T.C. 5213.

He added:

I see no reason why the reasonable expectation of profit test should not apply to any profession, liberal or otherwise, any occupation or activity which purports to be in the course of carrying on a business. As I see it, the reasonable expectation of a profit is a general rule applicable to any activity which may give rise to business income. The courts have in fact used this test in various types of factual situations.

[Official translation.]

These comments and conclusions appear to me to be immune to any criticism and are not in any way open to judicial review.

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 for the purposes of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the ’’Act”). For the purposes of determining whether there is a source of income, only an activity that is profitable or that is carried on with a reasonable expectation of profit is a business. If one thing is clear in what the Supreme Court of Canada said in Moldowan, it is the passage in which Mr. Justice Dickson, as he then was, summarized the present state of the law with respect to reasonable expectation of profit (at S.C.R. 485-86, C.T.C. 313-14, D.T.C. 5215):

Although originally disputed, it is now accepted that in order to have a "source of income" the taxpayer must have a profit or a reasonable expectation of profit....

There is a vast case literature on what reasonable expectation of profit means and it is by no means entirely consistent. In my view, whether 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. The list is not intended to be exhaustive. The factors will differ with the nature and extent of the undertaking....

It would be incorrect to try to reduce the scope of this passage to include only farm losses such as were in issue in Moldowan. Mr. Justice Dickson was referring to the general law as it stood, before undertaking a more specific analysis of the case of farm losses, and he was careful to specify that the factors he identified were not exhaustive and would vary depending on the nature and size of the business.

There comes a time in the life of any business operating at a deficit when the Minister must be able to determine objectively, after giving someone a head start for a number of years, as the case may be, that a reasonable expectation of profit has turned into an impossible dream. As Mr. Justice Pigeon noted in Deputy Minister of Revenue (Que). v. Lipson, [1979] 1 S.C.R. 833, [1979] C.T.C. 247, at page 839 (C.T.C. 250):

The only evidence submitted was as to the expectations they had on signing the lease, but these expectations were not realized, and the factors which caused the losses in the first three years were still present when the lease was renewed. No one could therefore imagine that a loss would not be incurred....

Apart from the tests set out by Mr. Justice Dickson, the tests that have been applied in the case law to date in order to determine whether there was a reasonable expectation of profit include the following: the time required to make an activity of this nature profitable, the presence of the necessary ingredients for profits ultimately to be earned, the profit and loss situation for the years subsequent to the years in issue, the number of consecutive years during which losses were incurred, the increase in expenses and decrease in income in the course of the relevant periods, the persistence of the factors causing the losses, the absence of planning, and failure to adjust. Moreover, it is apparent from these decisions that the taxpayer’s good faith and reputation, the quality of the results obtained and the time and energy devoted are not in themselves sufficient to turn the activity carried on into a business. [2]

These comments by Chief Justice Couture in Zolis at page 185 (C.T.C. 2201) appear to me to provide a good summary of the approach that should be taken by a judge who must determine whether there is a reasonable expectation of profit:

The aspirations or ambitions that a taxpayer may have entertained in respect of an activity in which he was engaged are not alone sufficient to bring it within the strict meaning of business in the relevant legislation no matter how genuine they might have been. What must be examined apart from the structural features of the undertaking is the manner in which it is carried on or operated by the taxpayer and from the interplay of these elements a determination made whether it is capable of yielding a profit in due course. The Court has to deal with concrete facts and from those facts alone assess the validity of the contention of the existence of a business for the purpose of the Act.

The profession of lawyer is not exempt from these rules, although the very nature of that profession suggests that the tests that may have been developed for businesses which are, for example, entirely commercial in nature should not be blindly applied. Thus the test of the profit and loss Situation must take into account certain forms of billing that are undoubtedly unique to the profession of lawyer; I am thinking specifically of fees the amount of which will depend on whether there is ultimate victory or which are expressed as a percentage of the amount ultimately obtained. Certainly the services rendered by a lawyer are not always as easily and quickly converted into cash as in other fields and losses incurred in a year may conceal short-, medium- and long-term income.

What do we have in this case, when we examine the sparse and confused evidence offered by the applicant?

The applicant returned to the practice of law in 1979, at the age of 71 years, after a 23 year interruption during which he worked as an impresario for various artists. He started over in 1979 as he had started out in 1936, without adjusting his method of practice to the new facts of life, without planning a budget, without keeping billings or books of account, without looking for clients other than by publishing his name in the telephone directory, and not billing or billing small amounts where the case was unsuccessful. The evidence does not even tell us whether he saw fit to enrol in refresher courses. He identified only two clients over the period from 1979 to 1992; one large client, for which he did a lot of work, and which allegedly owes him some $100,000 (we do not know at what point he earned these fees, in the course of this period which stretched over 14 years, and we have no information from which we could determine how and why the appellant arrived at that amount) but which we know has serious financial problems; and a nephew, to whom he rendered services of which we do not know the nature or the value. He mentioned other persons he says consulted him, but here again we know nothing about them, we know nothing about the services allegedly rendered to them and we do not know the value, if any, of those services. He says that some cases are awaiting judgments from the Court of Appeal, but we do not know what they are about, we do not know the amounts involved and we do not know their chances of success.

It is not surprising, in the circumstances, that during the eight years (1979-86) preceding the period in issue (1987-88), as well as the four years (1989-92) that followed that period, year after year, the applicant suffered losses carrying on his professional activities, as he himself admitted. For example, the evidence established that the amount of the losses claimed rose from $10,169 in 1986 to $23,140 in 1987, $31,137 in 1988 and $38,136 in 1989, while gross income fell from $2,975 in 1986 to $2,100 in 1987, $2,000 in 1988 and $2,020 in 1989. Even the $100,000 allegedly owing to him by his principal client would not eclipse the total amount of the losses incurred from 1986 to 1989. It should be noted that the Minister did not decide to intervene until 1989, when gross income was stagnant and the losses claimed were mounting considerably.

In short, the applicant, who candidly acknowledged that he had not changed his way of practising since 1936, incurred loss upon loss, and the losses grew each year. He had no plan for operating or for adapting, and no alternative plan. He made no effort to alter a way of practising which, to all appearances, had been overtaken by time and events and which, on the evidence, was not leading and could not lead anywhere. A lawyer may indeed operate at a loss for a number of years, while maintaining a reasonable expectation of profit within the meaning of the case law. However, he must still find some way of succeeding or at least some bases for having an objective expectation of succeeding some day.

I do not believe that in concluding that the applicant, on whom the burden of proof rested, ’’was unable to show realistically that he expected to derive income from his professional activities during the period at issue” [3] Judge Garon committed any error which is subject to judicial review. I doubt that he could have concluded otherwise, but regardless of whether he could, I see nothing unreasonable in the conclusion he drew after examining the evidence as a whole.

At the hearing, counsel for the applicant referred the Court to only two decisions: the decision of the Quebec Court of Appeal in Québec (Sous- ministre du Revenu) v. Comtois, [1988] R.D.F.Q. 199 (Que. C.A.), affirming [1983] R.D.F.Q. 98 (P.C.) and the decision of Mr. Justice Cattanach of the Trial Division of this Court in Tobias v. The Queen, [1978] C.T.C. 113, 78 D.T.C. 6028. Neither of these decisions is of any assistance to the applicant.

In Comtois, the Dean of the Faculty of Law of the Université de Montréal, who was a notary by profession, carried on a small practice in his home. He had incurred losses (the amount of which is not given in the judgment) from 1973 to 1976, and deduction of business losses of $4,649 for 1978 (fees of $9,993 and expenses of $14,642) had been disallowed. The Quebec Court of Appeal stated that it was bound by the decision of the trial judge who had found for Dean Comtois, as follows (at [1988] R.D.F.Q. 199 at page 201, as per Jacques J. A.):

The Court of Appeal is not to substitute its own interpretation of the facts when no rule of law has been violated by the trial judge, or when the trial judge’s interpretation of the evidence is reasonable....

I would add, however, that the trial judge’s interpretation lies on the borderline of what may be accepted as business losses and reasonable expenses "in order to make a profit or with a reasonable expectation of profit”.

[Translation.]

If, taking the extreme position, the case at bar is a borderline case, it is not for me any more than it was for the Quebec Court of Appeal in Comtois to substitute my opinion for that of the trial judge.

In Tobias the issue was the particularly well-documented search for a treasure and the evidence established that the taxpayer hoped to succeed, where others before him had failed, inter alia because he had more modern methods and equipment. If indeed that decision dealt with reasonable expectation of profit, I do not see its relevance in this case, other than that it establishes the point to which planning and adjustment of working methods are important factors in determining whether there is such an expectation.

The application for judicial review should be dismissed.

Marceau J.A. (dissenting):—I regret that I cannot concur in the opinion of my colleague Décary J.A. On the contrary, I believe that this application for judicial review is sound and should succeed. The reason why I would like to express my disagreement, with respect, but with some insistence, is that the scope of the decision a quo of the Tax Court of Canada, the first of its kind in the case law, to my knowledge, appears to greatly exceed the Specific case in issue here.

I am of course not disputing that the trial judge and my colleague have correctly formulated the question that must ultimately be resolved: did the applicant practise his profession as a lawyer in 1987 and 1988 with a reasonable expectation of profit? I believe, however, that it is important not to forget how that question arises.

Naturally, we must start from the basic rule in the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the ’’Act”) which provides that a taxpayer is taxed in a year on his or her total income from all sources, less losses from all his or her sources of income. Accordingly, under the general scheme of the Act, a source of income to a taxpayer is a source of income, despite the fact that he or she may have suffered a loss during the year, and all reasonable expenses attaching to one of the taxpayer’s sources of income are deductible from his or her total income. As a result, any activity carried on by a taxpayer which is undertaken not solely for his or her personal benefit but with the aim and expectation-reasonable, the courts have held-of earning a profit therefrom will be a source of income to the taxpayer and any normal expenses resulting from that activity will be deductible. The expenses that a taxpayer may not deduct are those expenses that are for personal or living expenses (cf. section 3, paragraph 18(1 )(h), subsection 248(1)). In his income tax return for each of the two years in issue the appellant had included in his total income the fees he earned as a lawyer, but in determining his taxable income he had also deducted all the expenses that resulted from the practise of his profession. The Minister disallowed the expenses, in so far as they exceeded income, not because they could be connected only artificially to the practice or because they seemed excessive, but because the expenses were not incurred by him with the aim or with a reasonable expectation of earning a profit. The Minister contended that they were non-deductible personal expenses. The question then really comes down to deciding whether the applicant practised his profession as a lawyer during the two years in issue with a reasonable expectation of earning a profit. However, it may be formulated differently, and in the opposite way, and it then takes on a perhaps more striking meaning: did the appellant incur the expenses connected with the practise of his profession at a time when he knew or ought to have known that he had no possibility of earning a profit, and accordingly solely for his personal benefit and as a ’’hobby"? We should also note immediately, in passing, that an affirmative response to the question necessarily affects all expenses and not only, as the Minister’s assessment would have it, those in excess of the fees earned.

I am of course also not disputing the accuracy of the facts set out by my colleague to explain his point of view. However, we have an obvious difference of opinion with respect to the impact of those facts, and this is why I would like to give a quick outline of the fact situation as a whole, as it is established by the evidence, in order to more easily identify the aspects that appear to me to be most significant.

During the two years in issue, 1987 and 1988, the applicant was a member in good standing of the Barreau du Québec and entitled to practise the profession of lawyer. He had an office in his home, used the services of a special telephone system and an agency to do secretarial work and was protected by a professional liability insurance policy. He devoted himself full-time to his practice in that he made himself entirely available. In fact, over the two years, he rendered professional services to several clients, among them one in particular which was caught up in a series of legal difficulties and which he had to represent on numerous occasions. His bookkeeping and billing system was abbreviated, but it was the same as he had always had since his first years n practice. Since he returned to the practice of law in 1979, after an interruption of more than 20 years, he had not succeeded in earning an annual profit, but in fact he had several accounts receivable and certain services already rendered could not be billed for some time. What is certain is that in 1987 and 1988, when he offered his services as a lawyer and devoted himself to the practice of law it was always with the aim and expectation of earning an income which would be in addition to his investment and pension income, as had been the case since he returned and as is moreover still the case today.

There are several aspects of the situation that emerges from these facts that should be clearly noted. Here we have an activity in which the taxpayer, whose ability to work is not diminished by any physical disability, is engaged full-time, not in any subsidiary, connected or secondary manner. (The applicant has other sources of income, certainly, since we are talking about deductions, but not because of parallel activities, since that other income was rental and pension income; the applicant is also of a certain age, since he is over 70 years old, but there is nothing to suggest that his physical ability has diminished especially.) Also, the issue is practising a profession, not carrying on a business or a commercial activity where the possibility of profit depends directly and necessarily on a physical base and underlying infrastructure. The profession in question is that of lawyer, the monetary success of which depends on the personal aptitudes and qualities of the person practising it, undoubtedly, but also on favourable circumstances which are often unforeseen and uncertain and which may almost always arise.

Let us now come to the decision a quo. The answer given by the trial judge to the question posed is thus that during the years in issue the applicant, contrary to what he may have thought in good faith, had no reasonable expectation of earning a profit from the practise of his profession as a lawyer, and accordingly the Minister was correct to consider these expenses, for renting an office, secretarial services, transportation and advertising, which he incurred in order to maintain his practice, as reasonable as they may have been, to have been merely non-deductible personal or living expenses. The only passage of his reasons in which the judge attempts to explain his conclusion comes after a brief statement of the facts and a review of some of the allegations in the Minister’s reply to the notice of appeal, and is as follows:

It was established that in the eight years preceding the period at issue as well as the four years following it, the appellant sustained large losses in the pursuit of his professional activities as a lawyer.

From the evidence as a whole it seems clear that, on an objective view of the facts, the appellant did not have a reasonable expectation of profit in the two years in question in light of the principles stated by the Supreme Court of Canada in the notorious decision Moldowan v. The Queen, [[1978] 1 S.C.R. 480, [1977] C.T.C. 310, 77 D.T.C. 5213].

[Official Translation.]

The reason I am of the opinion that this decision cannot stand is not solely because the judge’s conclusion does not appear to me to be validly Supported by the evidence; it is because it does not seem to me to have been reached as the Act intended. What I see are two errors of law in the judge’s approach and analysis.

The first is that in trying to answer the question put to him, the judge failed to take into account all the factors before him; this was contrary to the objective assessment he was required to make and precisely contrary to what the Supreme Court said in Moldowan, to which he referred. While he stated that he based his decision on the whole of the evidence and knew the principles laid down in Mo Ido wan, that statement, I repeat with respect, appears to me to be gratuitous. The only fact on which he specifically relied was the series of years with no profit. Certainly, while this is a significant fact, a factor that must be considered, there is no doubt that without the support of other significant facts it cannot be truly decisive. The judge did not refer expressly to any other fact, and moreover, I believe that there was none. I alluded directly to this in my earlier comments on the facts. I do not believe that the mere age of a person whose physical or mental powers are not diminished, or a return to practice after a prolonged absence, is a fact that can support the conclusion; moreover, it is not rare for lawyers to return to practice after a long absence in the public service or elsewhere. Nor do I believe that the use of billing or bookkeeping methods that were entirely up-to-date 30 years ago for lawyers practising alone, but which have become somewhat outmoded today, when practitioners are almost always in partnerships, is a fact that can support the conclusion. Finally, I do not believe that examination of annual balance sheets at this point, when the issue is not to determine whether or not the expenses were excessive, but solely to determine whether there was a reasonable expectation of profit, can support the conclusion.

It seems to me that, in the case of a lawyer, basing a conclusion on the single factor of the years without profit is a particularly poor response to the need for objective examination in that it amounts to giving effect to a judgment of aptitude made retroactively on the basis of negative results. In the case of a business or a commercial activity it may perhaps be concluded from the history of losses that the business or activity does not in itself present any possibility of profit. However, in the case of the practise of the profession of lawyer (like the practise of many other professions, artists being one example), in order to deduce from a series of years with losses that it would be unreasonable to think that the years to come might be different the lack of success would have to be linked directly with the individual’s personal lack of aptitude, of the aptitude for properly carrying out the role of lawyer or attracting clients. In my view, this is certainly not the sort of assessment that the Act intended to entrust to the Minister.

The second error of law that the judge committed, in my opinion, was to take into consideration the lack of profit during the four years following the period in issue. In his reasons, the judge even gave a lengthy description of the taxpayer’s income and expenses statement for the fiscal year ending on December 31, 1990. What we are trying to determine is whether, in 1987 and 1988, the applicant was practising his profession as a lawyer with the reasonable expectation of making a profit. It is hard to see what the results of subsequent years could tell us about this, unless it were an attempt to obtain even better confirmation of a judgment of personal lack of aptitude. I would repeat, however, that in my opinion Parliament certainly did not intend its tax legislation to enable the Minister to disapprove of the manner in which a taxpayer practised a particular liberal profession on the ground of incompetence or personal lack of aptitude.

I therefore believe that the judge did not do the analysis he was required to do in order to answer the question put to him in the manner required by the Act. Accordingly, his conclusion cannot stand. Moreover, that conclusion in itself seems to me to be difficult to accept, and for that reason I contend, even though the applicant had the burden of proof, that since the allegation was made by the Minister, the facts must be taken as speaking for themselves: I find it hard to see how it could be unreasonable for a lawyer in good physical health to expect to make a profit from practising his profession, even by making himself completely available to his potential clients after securing all the tools that he may need; I admit that I find it just as hard to see how a lawyer could devote himself full-time to the practice of law simply to pass the time, for his own pleasure.

I would allow the application and I would return the matter to the Tax Court of Canada for reconsideration in order to give effect to these reasons.

Application dismissed.