INCOME TAX
Income Calculation
Deductions
Appeal from Tax Court of Canada (T.C.C.) decision (2004 TCC 595) denying appeal against reassessments—Issue deductibility of expenses of $1,651,766 paid by taxpayer to fraudulent agent in sale of gems—T.C.C. found expenses not incurred for purpose of earning income from business under Income Tax Act (ITA), s. 18(1)(a), expenses not reasonable in circumstances, not deductible under s. 67—In 1987, taxpayer, co‑owner of clothing factory in Guelph, began buying gems for resale from Toronto area company—When contact moved to another company, taxpayer continued to buy gems from new company until July, 1992—By 1994, taxpayer had gems worth $529,926—When advised contact time to sell, contacted by Premier Group Investments, allegedly as result of referral by contact—Over next few years, taxpayer had contact with Premier representatives—Taxpayer confirmed their advice with other gem investors, consultants—Premier, presented taxpayer offer from offshore purchaser, terms of which would generate substantial profit but large up‑front fee would have to be paid—Sale did not close and process was repeated four more times—All five offers were fraudulent but taxpayer paid Premier, or as directed by Premier, $1,651,766 —In 1996, taxpayer went to RCMP, which raided Premier, arrested representative, who fled when released on bail, apparently with taxpayer’s gems—Respondent allowed taxpayer business loss with respect to theft but denied prepaid expense deduction with respect to payments made to or as directed by Premier—According to agreed statement of facts, this was business as adventure in nature of trade—Amounts paid verified by RCMP—Gems never insured—Taxpayer made substantial payments in respect of five “offers of purchase” without questioning legitimacy, did not demand receipts—Failed to explain to T.C.C. why paid out money time and again—In confirming reassessments, M.N.R. found expenses not reasonable in circumstances—T.C.C. concluding taxpayer not involved in business as victim of fraud from beginning to end, did not do his homework, motivated by greed—T.C.C. held ITA, s. 67 stands for proposition that for expenses to be deductible, must be reasonable—Uncontested fact finding of T.C.C. appellant fraud victim from outset and that certificates as to value of gem inventory insufficient to establish fair market value, fatal to appellant on issue whether expenses incurred to earn income from business—Not case where Court had to consider taxpayer’s state of mind nor was it defalcation case where business defrauded by employee or third party so that issue whether loss incidental to income‑ earning activities—Scheme fraudulent from outset cannot give rise to source of income from standpoint of victim, thus cannot be considered business under any definition—But, says appellant, not open to T.C.C. to hold expenses not deductible on that basis, Minister having conceded taxpayer engaged in adventure in nature of trade—Argued T.C.C. bound by facts as admitted, even if contrary evidence adduced at trial—But taxpayer chose not to have appeal disposed of on agreed statement of facts, placed extensive evidence before Court as to nature, extent of scam—Civil litigation cited by appellant inapplicable to tax case, public funds being involved so that case does not belong to parties—They cannot, by agreement, dictate outcome of tax appeal—T.C.C. could not turn blind eye to evidence before it—Nor was there any basis for submission finding not open to T.C.C., statutory period for reassessment having expired when made—Decision of T.C.C. confirmed reassessments on primary basis on which issued— Appellant called, as expert witness, RCMP constable who investigated this fraud—Appellant’s name would have been “sold” to Premier—There is no secondary market for precious gems and appellant’s initial purchases may have been at early stages of scam—Victim having no market, can only turn to seller—Victim is promised enormous profits but up‑front payments required—On this evidence, open to T.C.C. to conclude taxpayer fraud victim throughout—Sufficient to support conclusion expenses not incurred to earn income from business—Appellant pointed to pair of 1995 sales to arm’s length purchasers with 25% profit made on each—Yet these were not reported until 1996, after taxpayer devised strategy for claiming $1,651,766 “selling” expenses, $529,926 “inventory costs” lost due to scam—Taxpayer first disclosed was in gem business in 1996 tax return, declared proceeds of two sales which, if they ever happened, ought to have been reported previous year—Odd that transactions unsupported by documentation if sales to bona fide purchasers—Also no indication as to where inventory of gems underlying these two sales came from as agreed statement of facts disclosing crooks had absconded with all gems—Furthermore, at dates of these sales, taxpayer still believed could recover ten times his cost of gems so unclear why would have made sales for mere 25% advance—Also, sales at odds with expert testimony no secondary market for taxpayer’s gems—While sufficient to dispose of appeal, Court commenting on scope of s. 67, application herein—To date courts have said “reasonable” in s. 67 relates to amount of deductions claimed, not type of expense; purpose to prevent taxpayers from artificially reducing income by deducting inordinately high expenses but, in Stewart, S.C.C. suggested s. 67 might have broader application—Stewart eliminated “reasonable expectation of profit” test as lacking statutory foundation, creating more problems than it solved—S.C.C. said if expense unreasonable in relation to income source, s. 67 provides mechanism to reduce or eliminate amount of expense—Thus S.C.C. recognized s. 67 as means of testing reasonableness of expense once business found to exist—S. 67 could be used to deny total amount of expense, if shown to be unreasonable—Here, it was open to T.C.C. to find taxpayer’s entire expenditures unreasonable—Appeal dismissed—Income Tax Act, R.S.C., 1985 (5th Supp.), c. 1, ss. 18(1)(a), 67, 248(1) “business” (as am. by S.C. 1995, c. 21, s. 47).
Hammill v. Canada (A‑507‑04, 2005 FCA 252, Noël J.A., judgment dated 7/7/05, 24 pp.)