Imagine you take a risk and start your own business. You incur expenses over
a number of years to get the venture going but unfortunately, never actually
sell anything.
Are your business expenses still tax deductible, even against other sources
of income? The Tax Court of Canada was faced with this question in a case
decided earlier this month involving a Montreal businessman who launched an
ultimately unsuccessful gold trading business.
Allan Tannenbaum's plan was to purchase 24-karat raw gold, have the gold
refined in Montreal, and then sell it to the gold bullion desk of a chartered
bank. According to Mr. Tannenbaum, "the key to obtaining high quality gold...was
to have good contacts in the trade...I could make a lot of money".
In his attempt to obtain gold contracts, Mr. Tannenbaum traveled to Europe to
meet potential gold sellers and made numerous overseas telephone calls to these
contacts. Although he did receive several offers to purchase gold, he was either
unhappy with the quality of the gold samples he received or was uncomfortable
with the people making the offers.
Mr. Tannenbaum's view was that "one deal could make it." Unfortunately, he
did not purchase and therefore did not sell any gold in 1998 and 1999, the years
in which his expenses were being challenged by the Canada Revenue Agency.
In each of these years, having no sales and thus no income from his gold
trading activity, he claimed business losses of $19,000, attributable mainly to
office expenses, including rent, telephone and utilities.
When Mr. Tannenbaum was originally assessed in 2000, the CRA denied Mr.
Tannenbaum's losses because, in its opinion, "he had no reasonable expectation
of profit." (REOP) In May 2002, the Supreme Court of Canada (SCC) struck down
the REOP test and found that where there was no personal element to a particular
activity and the activity was carried out in a sufficiently commercial fashion,
then the taxpayer should be permitted to deduct his or her expenses relating to
that activity.
In light of the SCC's comments, the CRA abandoned the REOP argument, instead
asserting that Mr. Tannenbaum's business expenses should not be deductible
because they were not "reasonable," a requirement under the Income Tax Act.
Fortunately for Mr. Tannenbaum, the Tax Court judge disagreed, stating "there
is no evidence that his expectations were unreasonable or that he was not acting
like a prudent businessman ... That Mr. Tannenbaum earned no income is not
necessarily a bar to him claiming expenses ... Expenses so incurred in a
reasonable manner are not unreasonable ... His predominant intention, even if
some people may characterize his intention as foolhardy or a gamble, was to make
a profit from buying and selling gold."
The judge concluded that, in fact, Mr. Tannenbaum's expenses for 1998 and
1999 were "quite modest" and since his activities were not of a personal nature,
they should be allowed.
This decision should prove encouraging to Canadian entrepreneurs, who already
take on substantial risk in getting their ventures off the ground without
worrying about the additional tax risk of having their legitimate business
expenses later denied.