written on behalf of Feigenbaum Law
When people start a business, it makes sense that their goal is to eventually turn it into a successful venture. But anyone who has been involved in starting a business knows that making a profit can be extremely difficult. A 2018 report from the Government of Canada stated that only 43% of new businesses survived to make it to their tenth birthday.
Fortunately, there are tax breaks available for businesses that struggle to turn a profit during their first years of operation, and proper tax planning and compliance can help ease the difficulty of those early years. However, even the most optimistic business owner will eventually have to decide whether or not their business will ever turn a profit. A recent decision from the Tax Court of Canada shows that eventually, the ability to declare losses might not be available to a struggling business.
From the 1990s, the appellant has owned a farm in Florida. On the farm, he bred and raced horses. In 2017, the appellant claimed input tax credits of just over $30,000. Input tax credits are a way for a business to reclaim any HST that they paid. If a business claims that it paid more GST or HST than it collected, it could be eligible for a credit.
The Canada Revenue Agency (CRA) took issue with the appellant’s claims. The CRA argued that, in the course of his commercial activities, he had not made purchases that included tax. Even though the purchases were for what appeared to be business purposes, he was required to demonstrate that he was carrying on the business breeding horses with a “reasonable expectation of profit.”
The court stated that the parties did not dispute that during the years following the purchase of the farm and up to the 2017 tax year, the appellant operated a business with a number of horses. The appellant also employed at least four people at all times. The question, however, was whether he did so with the reasonable expectation of process.
The Supreme Court of Canada established the test to determine if there is a reasonable expectation for profit in a 1978 decision known as Moldowan. In that decision, the court listed a number of criteria that should be considered, noting the list was not exhaustive:
- 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
In this case, the court looked at each piece of that criteria. Starting with an analysis of the appellant’s profit and loss experience in past years, the court looked at his income between 2007 to 2015. The appellant practiced law in each of those years, and in all but one turned a profit in his professional income. However, his net farming income failed to ever show a profit, including over $1 million in losses in both 2010 and 2014.
The court noted, however, that the appellant did not include any details which explained how he arrived at a net loss each year despite having gross profits. The court found the appellant did not provide clear answers to its questions, including stating that his horse racing was not profitable in part because there is “a certain amount of luck, but there’s a lot of bad luck too. I mean, I’ve had horses break their legs. I mean, it’s incredible.”
Additionally, the court pointed out that during the years 2010-2016, the farming operation lost a total of over $4 million, stating that “such a record is not supportive of any future expectation of profit, reasonable or otherwise.”
The court then turned to the appellant’s training, stating that his only professional training was in the law. He worked as a lawyer from 1977 until 2017, at which time he was disbarred. The appellant had no training on operating a business or a horse farm.
When asked how he intended to make the farm profitable, the appellant stated he had decided to move his operation to Canada, having bought a farm and started to build a facility. He said, “I just believe I can make it work…I am positive I can make it work.” He also stated that he brought a business partner on board, who agreed to cover all of the costs associated with running the business for 50% of profits.
The court then turned to the last factor, which is the capability of the venture as capitalized to show a profit. The court found that the appellant failed to produce a balance sheet to show how the farm was currently capitalized, leaving the court unable to draw any inference in favour of him. However, he did state that his income from his practice of law allowed him to subsidize his farm losses.
Ultimately, the court found that the appellant was not able to satisfy the criteria needed to establish that there was any hope of turning the farm into a profitable business. As a result, he was on the hook for the taxes the CRA claimed he owed.
Work with the experienced tax lawyers at Feigenbaum Consulting to help with your corporate tax needs
Whether you have corporate tax needs in Canada or the United States or are looking to expand your business to have a presence in both countries, the experienced tax team at Feigenbaum Consulting led by Mark Feigenbaum can help you plan for success. We help our clients optimize the structure of their businesses to minimize tax liability while also taking full advantage of the tax breaks or credits available to them through Canadian or American tax laws. In the event that tax litigation is necessary, we also represent clients through that process. Please reach out to us online or by phone at 1-877-695-1269 to speak to a talented member of our tax team and find out how we can help you achieve peace of mind for tax matters today.