Start-Up and Liquidation Costs

Prior to the introduction of mark-to-market rules in 2007, the taxpayer (which to that point only carried on its life insurance business in Canada) attempted to achieve a step-up to fair market value in the cost amount of its assets by purporting to commence carrying on business in Bermuda in December 2006. It relied on the s. 138(11.3) rule, which provides that where a Canadian life insurer also carried on business in another country and "designated insurance property of the insurer for a taxation year [2006], was owned by the insurer at the end of the preceding taxation year [2005] and was not designated insurance property of the insurer of the insurer for that preceding year," such property could be bumped in the 2006 return.

Pizzitelli J found that the taxpayer did not commence to carry on business in Bermuda until 2008 when it "started serious efforts to be able to carry out a life reinsurance business, including the essential elements of sales, marketing, and hiring qualified staff, all of which in fact led to the Appellant applying for and receiving changes to its licence which allowed it to do business with unrelated persons… result[ing] in the execution of at least 5 life reinsurance contracts with unrelated parties from 2009 to 2011." Conversely, desultory and isolated acts before then including hiring a bookkeeper (purportedly the general manager but with no underwriting experience and very little to do) and entering into two reinsurance treaties with affiliates in March 2007 (but with one of them backdated to December 2006) and obtaining a licence whose scope was inconsistent with that of the purported business "were designed to give the appearance the Appellant was carrying on such business for profit, when in fact, its only supportable purpose was to obtain a tax benefit" (para. 160), namely, to mitigate "the pending changes to the Act as a result of mark to market rules effective January 1, 2007 that would have required it to realize a capital gain on its investment assets up to their fair market value" (para. 161). Accordingly, "its actions were nothing more than ‘window dressing'" (para. 156), i.e., "a deception that is not about the legal validity of a transaction, as in sham, but about the taxpayers intention for entering into the transaction" (para. 158).

See summary under s. 138(11.3).

In August 2009 the taxpayer's wife purchased a home, which had been their principal residence, from the taxpayer in order to convert it to rental property. They implemented substantial touch-ups on the property and rented it for four months starting in December 2010 before it was sold in 2011. The taxpayer claimed losses for 2009 and 2010, which arose from deducting (post-acquisition) mortgage interest, property taxes, insurance and utilities. The Minister denied the deduction of these expenses (whose claiming by the taxpayer rather than his wife was not discussed) on several grounds, including that a rental operation had not commenced until towards the end of 2010.

In allowing the taxpayer's appeal, Campbell J noted the concession in the Minister's pleadings that the taxpayer and his wife were renovating the property between August and December 2009.

The taxpayers acquired a lot in order to build a health complex. Unable to secure any lease commitments, they abandoned the project and sold the lot. The Minister argued that the taxpayers had not yet started up a business, and that their sole purpose in acquiring the lot was a subsequent sale of the property.

Favreau J found that the taxpayers seriously intended to build and operate and office building. The loss on the lot itself was capital in nature, but the related expenses were deductible as business losses.

The taxpayer was wholly owned and directed by an individual ("Brisson"), and employed Brisson at $50/hour to develop prototypes of pedal and steering systems for adult tricycles. The Minister disallowed the taxpayer's claimed scientific research and experimental development credits, as well as claimed input tax credits and business expenses, on the basis that the taxpayer's activities were merely preliminary to setting up a business - that it had not yet put into place a structure for the business it wished to carry on.

Paris J found that the taxpayer had been carrying on a business and allowed the taxpayer's appeal. He stated (at para. 24):

The fact that the Appellant had no revenues in 2002 and 2003 is not determinative of whether a business had begun operating. It must be kept in mind that by its very nature the Appellant's business, that is, the development of a new product, involves a longer start-up time than is necessary for other kinds of businesses.

Many of the Minister's arguments related to whether operations were carried on in a commercial manner. Stewart establishes that commerciality is only relevant where the business has a personal element (para. 26).

The taxpayer and his wife carried on a consulting business through a partnership. They taxpayer subsequently became employed by the partnership's principal client, but his employment was terminated after a change in management. Various expenses incurred after the termination were deducted in computing the losses from the partnership. In denying these deductions, Bowie J. found that the partnership had ceased to be a source of income as (para. 7)

There is no commerciality or businesslike activity here. There is simply someone looking [unsuccessfully] for work.

The taxpayer, who had degrees in economics, business and accounting, retired from chartered accountancy for health reasons and proceeded to set up a securities trading business. He spent several years training, and researching technology and tools. Hershfield J. denied the taxpayer's purported business losses for those years. While it was clear that the taxpayer's intentions of beginning a business were genuine, he was well qualified, and the expenses were reasonable, Hershfield J. found (at para. 11) that "a continuing and underlying theme in all of Mr. Walsh's testimony [was that] Mr. Walsh was in school throughout the period under appeal." The taxpayer had conducted a few trades in 2006, but the total amounts were in the hundreds of dollars and were essentially "practice exercises" (para. 12).

Accordingly, the taxpayer's activities "did not yet reach the level of commerciality to justify a finding that a business had commenced" (para. 18).

The taxpayer ceased regular operation of her retirement home business, and took five years to sell the property. She deducted related expenses for that period, including interest, property taxes and utilities. In allowing the deduction of these expenses, Boyle J. remarked at para. 29:

It is simply incontrovertible that the general rule is that business closing costs are deductible business expenses.

And at para. 32:

Once it is established that [taxpayers'] business or investment activity is a source of income from a business or property, their risk/reward analysis, risk tolerance, judgment and decisions are not generally open to be challenged by the CRA... .

The taxpayer sustained a total loss with respect to a joint venture to buy laptops and resell them at a gain, given that a purported vendor of the laptops was engaged in fraud. The taxpayer's loss was a fully deductible loss given that he and his co-venturer attended meetings with the seller's representatives and were not mere passive investors.

However, in another transaction with the same vendor, the loss was a capital loss and not a fully deductible loss given that the taxpayer played no active role and had no knowledge of the details of the transaction, which suggested that there were no indicia of a business.

In 1988 the taxpayer decided to discontinue the operation of the largest dairy farm in Nova Scotia and over the following period of over 10 years disposed of the land in a piecemeal fashion while earning modest sharecropping revenues and incurring losses. His losses for the 1999 to 2001 taxation years were deductible in computing his income given that "as a general rule, there was no reason that business shut down or termination expenses incurred post-closure of operations cease to be deductible business expenses in ordinary commercial and business-like circumstances" (para. 14).

Various professional expenses that the taxpayer incurred with respect to a proposed venture of providing on-site mobile message therapy services to corporate clients through massage buses were found to have been incurred in connection with a business given that (para. 11):

In this case it seems clear that Mr. Caballero's business efforts went well past the contemplation stage and he was pursuing the essential preliminaries, not merely hopefully reviewing business possibilities. He was making serious and reasonable continuous efforts to begin normal operations.

However, given that (para. 14) expenditures for the creation of a business entity or structure are on capital account, they qualified as eligible capital expenditures rather than as fully deductible expenses.

Before going on to find that legal fees incurred as a result of a cancellation by the taxpayer of an agreement to purchase a building were capital expenditures, Paris J. rejected a submission that they should not be considered to have been incurred in connection with a source of business. A business commenced where some significant activity was undertaken as "an essential preliminary to normal operations" (para. 14) and (at para. 16) "in the case at bar, the Appellant promised, in an enforceable contract, to purchase the building, and that is an essential preliminary to the operation of the property".

The taxpayer was assessed for amounts that she embezzled from her employer in 2000, declared bankruptcy because of this claim against her and, after her discharge (without having paid any of the assessment), began pursuant to a court order paying back to her employer the amount she had taken. In finding that the taxpayer was not entitled to deduct these amounts in computing her income from a business, Bowman C.J. stated (at p. 2733) that "I start from the premise that income from criminal activity is income from a business" and that (at p. 2734) that it is "settled law that a business continues to be carried on so long as the obligations arising out of the business remain unfulfilled" but went on to state:

"I think it may be a little unrealistic to say that the appellant here continued in 2002 and subsequent years, to carry on the business that she carried on in 1997 to 2000, simply by reason of her complying with the restitution order".

The amounts paid by her pursuant to the restitution order were not deductible in computing her income.

A corporation had been incorporated for the purpose of developing a business that offered various services in the automotive field and it had bought land for that purpose, but the only activities carried on by it consisted of the production of preliminary sketches, supported by a construction progress report, for which no contract had been entered into.

As the corporation had not established a sufficient organizational structure to commence activities relating to the operation itself, it did not qualify as a small business corporation.

Whether shares sold by the taxpayer qualified as qualified small business corporation shares turned on whether a subsidiary was engaged in an active business at the relevant times. The subsidiary had rights to a waterfall site that could be developed for the production of electricity. Although various activities, such as negotiations, took place during the relevant period, Garon T.C.J. found that the subsidiary had not actually started to carry on business given that in order for a decision to be made to proceed with the proposed venture, it was necessary first to obtain the agreement of Hydro-Quebec to purchase electricity at an acceptable price, which had not yet occurred.

The taxpayer, who worked as a full-time locomotive engineer, was not able to deduct losses from a proposed sawmill operation given the length of time it took to commence operations (over 10 years, and after the taxation years in question) the undercapitalization of the project, and the failure during the years in question to hire the necessary manpower to commence operations.

The taxpayer incurred legal expenses in defending against narcotics charges. Before going on to find that these expenses were non-deductible on other grounds, Bowman T.C.J. rejected a Crown submission that they were non-deductible because they were incurred after the narcotics business had ceased, stating (at p. 903) that the Emerson case (86 DTC 6184) had "no application to the case of liabilities that arise directly from a business that was carried on but that are asserted after that business had ceased".

Dussault T.C.J. found that the taxpayer, which had carried on a meat processing business, had ceased to carry on that business by the second anniversary of the destruction of virtually all its equipment by fire because no decision had yet been made as to whether to acquire the assets and personnel necessary to start up again. Accordingly, various expenses were non-deductible. He stated (at p. 645):

"... For a business to exist and to have commenced, one must have gone beyond the stage of merely intending to commence it. ... The essential elements relating to the very structure of the business, that is the necessary financing, assets and labour, must have been sought out and brought together before it can be stated that the business exists and that it has commenced."

The taxpayer acquired farmland and buildings for $130,000 and rented the farm out at $2,500 per year with the intention that they would not farm the land until after a mortgage on the farm for $80,000 was paid off in approximately three years' time. S.20(2) applied to deny the deduction of interest and property taxes on the property given that they were not in the farming business in the relevant years.

A corporation which previously had earned income from commissions by negotiating contracts for various commodities and that prior to the taxation year in question had become insolvent and reported to the Alberta Corporate Tax Administration that it had ceased operations nonetheless was found to be carrying on business because it still had assets, liabilities and contracts to pursue and some minimal expenses had been incurred as it tried to negotiate contracts on a local basis in Alberta. Accordingly, losses sustained by the taxpayer on loans made to the corporation qualified as business investment losses.

The taxpayer, after moving to Toronto, made vigorous but unsuccessful attempts attempts to rent out his former principal residence in Sarnia. In finding that various expenses of the taxpayer such as utilities, insurance, realty taxes and advertising were non-deductible, Bowman T.C.J. found (at p. 1026) that the taxpayer's "proposed rental operation never got off the ground" and that "a mere intention to rent it out does not, in itself, convert an asset originally acquired for personal reasons to a rental property, even if attempts to rent it are made".

Although the taxpayers were unsuccessful in renting out a house in their 1989 year, they were able to deduct related expenses incurred in the year up till the date on which they listed the house for sale. The expenses incurred thereafter were characterized as capital outlays for the maintenance of the property with a view to its sale and, therefore, were non-deductible.

Boarding fees, training fees, entry fees and transportation expenses incurred by the taxpayer for the purpose of developing her teenage daughter's abilities as an equestrian show jump rider were found to be personal in nature rather than being incurred in relation to the development of a show jumping, training and stable business of the taxpayer.

After the taxpayer entered into an agreement entitling him to sell advertising and distribute a specified magazine in his particular area, nothing further was done by him or by a marketing company that supposedly was to sell advertising on his behalf. Accordingly, a sum that he paid as an advance against royalties did not relate to any business carried on by him and, therefore, was non-deductible.

Before going on to find that the taxpayer's interest in the Syncrude project did not constitute a "source" of income for its 1978 taxation year, McKeown J. stated (at p. 5202):

"In my view, a 'source' of income comes into existence only when all of the activities making up the 'source' are being carried on ... . I find that in 1978 Syncrude was not capable of being operated on a scale which could be expected to be profitable in 1978 or the near future."

In finding that the expenses of various categories of work done on a vessel before the vessel sank and before the taxpayer acquired title to it, were deductible except to the extent that they were capital expenditures, Bowman T.C.J. stated (p. 1949):

"... Where a taxpayer has taken significant and essential steps that are necessary to the carrying on of the business it is fair to conclude that the business has started. ... The appellant had borrowed money, agreed to buy the boat, and arranged for a crew, obtained the necessary licences, arranged with a substantial number of owners of boats with "G licences" to utilize the services when the boat became available, arranged and paid for modifications to be made to the boat and placed insurance. In my view the business had been commenced and was well underway when the expenses in question were incurred."

Expenses claimed by the taxpayer as soft costs in respect of condominium investments were found to have been incurred prior to the date of acquisition of the condominiums (notwithstanding that they were paid as "adjustments" at the time of closing), with the result that they were non-deductible to the taxpayers.

In finding that a franchise fee paid by the shareholder of the taxpayer prior to its incorporation was not deductible by the taxpayer, Bowman J. noted (p. 1469) that it was not:

"suggested that the payment was made as agent for the as yet non-existent Appellant, assuming such a relationship can exist as a matter of law. Even if that evidentiary hurdle had been surmounted I would still have been obliged to dismiss the appeal on the basis that the payment was essentially anterior to the commencement of a business which, as it turned out, never did commence (see Daley v. MNR, 50 DTC 877)."

Walsh, J. stated obiter that where a company has been incorporated but does not actually commence operations on any extensive scale until some years thereafter, it is not carrying on an active business.

The taxpayer paid the sum of £1,900 to the manager of its rubber plantation a few days before it completed the sale of the rubber plantation to arm's length purchasers. Such sum was paid in settlement of the manager's right to six months' notice of termination of his employment contract.

In finding that this sum did not represent "money wholly and exclusively laid out or expended for the purposes of the trade", Upjohn L.J. stated (p. 174):

"[T]his payment was not made for the purposes of the trade they were going to carry on; it was to get rid of a possible lawsuit after discontinuance."

Royalty income of the taxpayer from foreign patents was found to be income from a business as opposed to a mere property holding notwithstanding that it had no business operations to speak of, because previously the patents had been held in connection with a manufacturing operation that the taxpayer had disposed of and because the licences required the taxpayer to assist the licensees (although, in fact, such support was provided by a foreign parent of the taxpayer).

Prior to ceasing trading operations on November 30, 1921, the taxpayer made (or made provision for the payment of) various ex gratia payments to its employees. In finding that these amounts were not deductible, Rowlatt J. indicated (at p. 813) that it could not be found that "the payments were made for the purposes of the trade, because that must mean for the purpose of keeping the trade going, and of making it pay" whereas here "the purpose was to wind it up".