Tramble v. The Queen | April2019Lynwestfall

Courts Find Meaning in Business Context

Redefining Income Tax Act's 'reasonable expectation of profit'

by Arthur Drache

One of the most important phrases in the Income Tax Act is "reasonable expectation of profit." If you undertake an activity which meets that test, you are carrying on a business, and if you incur losses, those losses can beset off against other sources of income. But if you don't meet that test, you have to bear the losses yourself.

Cases dealing with the practical meaning of the phrase are common and the courts look to the facts in coming to a decision. Do you have a business plan? Is your financing reasonable? Are your expectations reasonable or outrageous? But on the other hand, the tax authorities have to give you a reasonable amount of time toachieve a profit. In our column on July 5, for example, we reported on the case of an Amway dealer who won his case because the tax court decided that he was on the right track and that the CCRA had not given him enough time to establish the profit-making potential of the business.

The amount of time and the tests which are applied can vary with the nature of the business. And 15 or so years ago, after scores of Canadians artists, writers and poets were being dinged by Revenue Canada for not having a reasonable expectation of profit (can a poet ever achieve such a lofty goal?), the arts sector, backed by reports from parliamentary committees, worked with Revenue Canada to create criteria that would distinguish between those who pursue the arts as a hobby (that is, without a reasonable expectation of profit) and those who are professionals.These rules were embodied in Interpretation Bulletin IT 504R-2, which deals with visual artists and writers. Another Bulletin, IT525R, deals with performing artists.

In a recent case, Mr. Justice Donald Bowman, the associate chief justice of the Tax Court of Canada, had to decide whether artist Lyn Tramble (better known in artistic circles by her maidenname, Lyn Westfall) had a reasonable expectation of profit.

Ms. Westfall had all the indicia of a successful painter. She has had many one-woman shows, her works are found in a score of galleries and in many private collections. The problem from the CCRA's viewpoint was that on the face of it, she had losses (of acomparatively modest nature) in 19 of the past 20 years.

It seems abundantly clear that she was anything but a hobbyist, but did she have a reasonable expectation of profit? The answer, according to Judge Bowman, was yes. And his reasoning was based, at Ieast in part, on another provision of the Income Tax Act designed to help visual artists. That is a special provision (inserted after Vancouver artist Toni Onley threatened to burn his inventory on Wreck Beach back in 1983) that allows artists to value their inventory at nil, rather than the normal "lower of cost or market" which applies to other business people.

Judge Bowman said: "One final point deserves to be made. Artists can eIect under subsection 10(6) of the Income Tax Act to value their inventory at nil. What this means is that artists need not reduce their cost of goods sold by the cost or value of paintings remaining in inventory at year-end. The result is that effectively artists may report on the cash basis, and that is what the appellant is doing here. If she had to value her inventory at the lower of cost or market, given the number of unsold paintings in her inventory at the end of the year, it would seem likely that the Iosses would disappear and she would realizea profit, albeit a notional one, and would be taxed accordingly.

"It is ironic that the very concession that is made to artists insubsection 10(6) as an incentive to encourage artistic endeavour and to recognize the somewhat unique situation in which artistsfind themselves should give rise to the very losses that are used to justify the denial of their deduction on the basis that there was no reasonable expectation of profit."

The upshot was that Ms. Westfall was found to have met the"reasonable expectation of profit" test and could continue to set off her losses against other income. As Judge Bowman said, the tax authorities had picked the wrong case, if they were trying to make apoint.

The case is obviously important to artists, but it also points out the fact that the courts more and more often are taking a critical approach to the meaning of "reasonable expectation of profit" and looking at the meaning within a business context.

This does not mean that you will have any better chance than before of writing off costs for your Florida condominium because you try torent it out from May to November. But it does mean that you will have a good shot at winning if you can offer a logical explanation for losses incurred and show that your expectation of profit is not, in the words of one case, "irrational, absurd and ridiculous."

(This article appeared in the Financial Post on November 1, 2001)