Learning from Recent Tax Court Cases

The Tax Court of Canada:

The Tax Court of Canada publishes on its website, the full details of each case that it completes. In 2024, the Court completed approximately 100 cases, mostly in respect of the Income Tax Act of Canada. We can learn a lot from these cases, perhaps some more than others. When we examine recent cases, we may see trends in how the Courts and CRA are interpreting the prevailing legal authorities. We may also discover certain tax planning avoidances or strategies that we can apply to other taxpayer situations. Recent cases may take a while before they become a common reference for tax practitioners. 

Thus, we can study an individual case to identify/learn many things.

Reviewing a Tax Court of Canada Case:

Here are some questions to ask yourself when reviewing a recent Tax Court of Canada case.

• • • What was the Judgment and was it one-sided or balanced? (This is usually presented first in the final document.)
    • How complex a case was it? How many years were involved and how large were the monetary amounts at issue?
    • What were the main issues presented by the Respondent (e.g. His Majesty The King, who is defending the appeal) against the Appellant (the Taxpayer, who is filing the Appeal), together the “Parties”?
    • What were the bases of any Notices of Assessment and Reassessment issued by the Minister of National Revenue (the “Minister”) as represented by the Canada Revenue Agency (the “CRA”)?
    • What penalties did the Minister assess the Taxpayer and why?
    • What provisions of the Income Tax Act were referred to by the Parties?
    • What interpretations did the Parties make?
    • What defences did the Taxpayer provide to support their position?
    • What misrepresentations did the Minister claim the Taxpayer made on their tax returns?
    • What was the role of any lawyers and/or accountants involved in assisting the Taxpayer file the tax returns? What did the Judge say about that?
    • What interviews of the Taxpayer by the Minister were presented as evidence?
    • What other case law did the presiding Judge refer to in analyzing the facts and making a final decision?
    • How did the Judge assess and weigh the evidence presented? Did the Judge criticize the Minister for its actions? What mistakes did the Taxpayer make?
    • What costs were awarded to the Parties by the Judge and why?
    • Did the Judgement set a new standard or precedent insofar as Canadian tax law is concerned? (Usually when this happens, the CPA profession makes a lot of noise about the case.)
    • Is this case potentially helpful in assisting a different Taxpayer to take, document and support a filing position for their own situation?

A Recent Tax Court Case:

A recent Tax Court of Canada case, Boles v. The King – 2024 TCC 167 (2024-12-20) is an interesting one this author decided to review. I will not answer all of the questions listed above, but I will cover enough of them in my writeup below, including the very last one (i.e. assisting other taxpayers) which is especially relevant.

The Judgment advises that:

In the context of these appeals, the Appellants (wife and husband, as partners) incurred losses during the above taxation years in respect of various dog-related activities (the “Dog Activities”), and they incurred losses during the 2006-2010 taxation years in respect of two residential real estate rental properties (the “Rental Properties”). Again, in the context of these appeals, the Appellants deducted the dog-related losses in computing their respective incomes for 2004-2010, and one Appellant deducted the rental losses in computing her income for 2006-2010. The Minister disallowed the losses deducted by both the Appellants in respect of the Dog Activities and the rental losses deducted by one Appellant, on the basis that:

a. the Dog Activities were a hobby, and thus, were not a source of income, and

b. the claimed rental-property expenses were not incurred, or if incurred, were not incurred for the purpose of gaining or producing income from a business or property, and/or were personal in nature.

But, in the final decision:

• • • The Minister was precluded from reassessing the tax payable by the Appellants for 2004 to 2008 inclusive, except in respect of the portion of the personal or living expenses and the unreasonable expenses listed in Schedule C to the Reasons.
    • The Dog Activities were held (by the Court) to not be a source of income for 2008, 2009 and 2010, though the Appellants’ filing position that they were a valid source of income for the years 2004 to 2007 was reasonable.
    • A failure to file penalty assessed by the Minister for each of 2004 and 2009 were allowed, but not for 2008.
    • For each item above, the judgment was based on an understanding and interpretation of the facts by the Court.

While I could spend a lot more time (and write many additional paragraphs) analyzing the specific details of the case and all the related judgments, instead here are some interesting observations and “pearls of wisdom” that I discovered:

• • 1. This was a split victory as some of the Appellant’s appeals were allowed. Accordingly, no costs were awarded by the Judge to, or against either party. It should also be noted that the case was delayed due to the Covid-19 pandemic during which time the original Judge assigned to the case retired.
    2. The new Judge indicated concern that the Crown seemed to have changed its position (on November 9, 2023) with respect to a statement previously made (on February 3, 2020) whether certain rental expenses were actually “incurred.”
    3. While the Appellants had used a variety of accountants over the years, the Judge found that the accountants involved had not committed any misrepresentations in preparing/filing the Appellants’ tax returns.
    4. Two sections in the Judgement were presented as Legal Authorities. They were: A. Statutory Provisions – Limitation on Reassessment; and B. Jurisprudence – Source of Income.
    5. With respect to the Statutory Provisions, the Judge noted that … Re the Limitation on Reassessment (i.e. reassessing a return after the normal three-year period), Subparagraph 152(4)(a)(i) of the ITA provides that the Minister may reassess a taxpayer outside the normal reassessment period only if the taxpayer or person filing the return “made any misrepresentation that is attributable to neglect, carelessness or wilful default or has committed any fraud in filing the return or in supplying any information” under the ITA.
    6. The Judge opined that in this case, “the Appellants are not subject to an evidentiary burden requiring them to demolish the assumptions of fact made by the Minister.” In reviewing the evidence, the Judge determined that some reporting errors, made in certain years by the Appellants on their tax returns, constituted misrepresentations for the purpose of applying Subparagraph 152(4)(a)(i) of the ITA, as previously mentioned. However, the judgment by the Appellants that they had engaged in a business is not a misrepresentation in itself (just because the Minister disagreed with their filing position) unless it is clearly obvious that there was no business. In other words, there was no neglect, carelessness or wilful default, or any fraud committed by a taxpayer or that person filing the return, where the filing position for a given tax year was reasonable.
    7. The Judge also pointed out that the Minister has a limited scope to reassess. Subparagraph 152(4.01)(a)(i) of the ITA clarifies that “statute-barring” is determined on an issue-by-issue basis (or technically, a reasonably-related-to-the-misrepresentation matter-by-matter basis). In other words, the reassessment must be confined to the subject matter of the misrepresentation and any other matter that can be reasonably be regarded as relating to that misrepresentation. For the years 2004 to 2007, the Taxpayers’ filing position (that it was engaged in a dog business) was reasonable and, therefore, that filing position was effectively “statute-barred.” This was not the case for the years 2008 to 2010 where the Dog Activities were considered by the Judge to be largely unstructured and loosely managed, and therefore no longer a real business.
    8. The Judge also stated that “start-up losses are not uncommon in any new business, particularly one that requires the development of championship-pedigree breeding stock and that involves raising show dogs, which must be two years old to participate in regular competitions.”
    9. With respect to the Jurisprudence, the Judge referred to various cases including recent ones, in which the Tax Court of Canada referred to them in determining whether a taxpayer had a source of income. These previous cases included:

Stewart v. The Queen [2002]: ascertaining commercial intent of the Taxpayer; reasonable expectation of profit is not the single test; instead it should be a two-stage approach: i) Is the activity of the taxpayer undertaken in pursuit of profit, or is it a personal endeavour?; ii) If it is not a personal endeavour, is the source of the income a business or property? Both may lead to a source of income at some point. The Supreme Court noted that the pursuit of profit source test applies where there is some personal or hobby element to the activity in question. Even if a taxpayer’s venture suggests a hobby or other personal pursuit, if the taxpayer is able to prove that the venture was undertaken in a sufficiently commercial manner, the venture will be considered a source of income. The taxpayer’s predominant intention matters most, though consideration may also be given to whether there is a reasonable expectation of profit. It was also noted that the following factors may be considered in assessing whether there is a business: profit and loss of past years, the existence of training, the intended course of action and the capability to show a profit.

Tweneboah v. The King [2023]: Several questions were considered in determining whether the activities had been conducted in the pursuit of profit. These included specific questions about charging time for revenue purposes, tracking and categorizing of expenses, and strategies considered and adopted to deal with problems encountered in the business. It appears that there is also an expectation that if a venture is a real business, there will be better record keeping and better strategies employed to deal with problems that arise.

Conclusions

The Judgment for this case mentions that this was a six-week trial in which counsel for the Appellants tediously took the Court through invoice after invoice, receipt after receipt, in respect of both the Dog Activities and the Rental Properties. The documents took up 54 large three-ring binders, without a table of contents, which created challenges for the Court. One wonders why it was done this way by the Appellants’ Counsel. The total business expenses at issue over several years amounted to approximately $1 Million, while total income was less than $50,000. More than half the losses claimed were eventually disallowed, nevertheless, the allowed losses were still significant.

In the Boles case, the Judge separately considered the following factors for the Dog Activities and the Rental Activities, to determine whether each activity on its own demonstrated a source of income:

A. Personal endeavour vs. pursuit of profit – The Judge said that the focus should be on whether the activity is a source of income, not whether it has an element of personal endeavour or hobby.

B. Intention – The intention to make profit. Significant study and research was done by the Appellants and this helped to identify intention. Also, it was noted that the main Appellant had a history of engaging in entrepreneurial ventures to diversify her income.

C. Commerciality – Look for objective standards of businesslike behaviour, using these factors:

i) Profit and Loss Experience – consider the amounts of profits/losses and the existence of improving trends

ii) Training – to what extent was training used to develop the business venture?

iii) Intended (and actual) course of action – consider business plans and goals, financing, budgeting and expense management, risk management, advertising and marketing, record keeping, business strategy, redirection as needed

iv) Capability of the venture to show a profit

In this case, the Appellants satisfied these commerciality factors to varying degrees of success—more so in the initial years of the Dog Activities where the business losses were allowed. Except for a few specific expenses, the rental losses were also allowed.

I’m not going to review other details here as they are not especially important to me in writing this article and using it to guide others.

Final Thoughts:

Any taxpayer who wants to take a filing position that they were engaged in a business venture (especially one generating losses) should carefully consider the factors (A, B and C) listed above in the Boles case conclusions and how these factors might be applied to their own situation. This goes much further than merely taking the position that there was/is a reasonable expectation of profit. You have to be able to prove intention and commerciality for each year of operation. This should likely be your goal whether you are trying to convince The Minister/CRA (during an audit) or the Judge (during a court case).

In addition, the Minister’s limited scope to reassess on the basis of a misrepresentation by a taxpayer is another important nugget to be remembered when it comes to the Minister trying to open up tax returns that are otherwise statute-barred.

And just because the Minister disagrees with the taxpayer’s filing position, this doesn’t automatically mean the Minister will be allowed to successfully reassess on the basis of a misrepresentation, if the original filing position is reasonable and well-documented.

These last two points may prove useful for reminding The Minister/CRA of their limitations in the event of an audit dispute.

This recent case is potentially very helpful in assisting other Taxpayers in supporting their own tax filings.

George Supol, CPA CA, CITP