Christmas has come early in our home. Delivered to our door, unsolicited, was $245 in gift cards for products attractive to pregnant women. I appreciated the free gifts. I appreciated even more the fact that my 19-year-old daughter, to whom the gift cards were addressed, is not in fact pregnant. As it turns out, a marketing company used a mailing list of young women they somehow compiled. Let’s just call this a false positive. Positive in the sense that we now have $245 of free stuff.
Christmas also came early this year for Dustin Crockett – a Canadian taxpayer who just won a battle against the taxman when the Tax Court of Canada (2019 TCC 203) sided with him in a dispute over rental losses. His case is a reminder that justice can prevail when the taxman is being unreasonable.
What’s so unfortunate here is that the Canada Revenue Agency wasted time and money (your tax dollars at work) to fight a case that they should have known they would lose. Further, the costs to the CRA to fight this case would have, without question, far exceeded the taxes the CRA would have recovered (approximately $18,000). So, who at the CRA made the decision to take this case to court – wasting Mr. Crockett’s time, money and causing him unnecessary stress in the process? This appears to be the modus operandi of a tax department that has been given more money and staffing in recent years than they know what to do with. But I digress.
Mr. Crockett was renting out a vacation property in Tulameen, B.C., and reported losses from this rental property for the first two years that he rented the place ($28,938 in 2013 and $25,903 in 2014). He showed that there were substantial startup costs because the house was in need of numerous repairs, and also made upgrades to the property to make it more appealing to renters. It’s not unusual to incur losses in the first couple of years of any business activity.
Mr. Crockett had a business plan. The judge agreed that it was well conceived, and noted that Mr. Crockett’s sister had long-term success renting a vacation property in the same area. In the case, the CRA’s legal counsel acknowledged in her submissions that the endeavour would most likely have been profitable in the near future. The issue, however, was that Mr. Crockett shut down the rental business after two years, which the CRA took as evidence that his main goal was not to turn a profit – and so the taxman wanted to disallow the losses.
Mr. Crockett had chosen to shut down the rental operation at the time due to personal financial challenges and the fact that his wife was ill. He simply didn’t have the financial resources to cover the costs of the property and pay his personal bills too. Here’s where the culture at the CRA has changed: In years gone by, reasonable explanations and an understanding of a taxpayer’s personal circumstances would have been considered. No longer. Forget common sense, or heaven forbid, some empathy.
In 2002, the Supreme Court of Canada handed down a decision in the Stewart case (2002 SCC 46) which provides the criteria that the CRA – and the courts – must consider when evaluating business or rental losses and whether they should be allowed.
Where a “source of income” exists, then the taxman must allow reasonable expenses incurred for the purpose of earning that income. If this results in a loss for the taxpayer, the CRA can’t deny the losses. That is, the CRA cannot disallow losses just because the department believes there is no reasonable expectation of profit (REOP).
The Stewart case established that if an endeavour is commercial in nature, with no personal element to it, then a source of income does exist. The endeavour doesn’t have to produce a profit in any year. Where that endeavour is commercial in nature, there is no room to apply a REOP argument to deny losses.
There’s a requirement to show a sufficient degree of commerciality to demonstrate that your intention is to generate a profit. Mr. Crockett had no problem showing that his rental property was a commercial endeavour, with a reasonable explanation as to why he shut down the rental property and sold it afterward. So, the court sided with Mr. Crockett.
The lessons here? If you incur losses in the early days of your business or rental activity, be aware of the Stewart case that can support those losses claimed. Finally, the CRA needs to change its culture and use more common sense when evaluating a taxpayer’s circumstances, to save everyone money, time and stress.
Tim Cestnick, FCPA, FCA, CPA(IL), CFP, TEP, is an author, and co-founder and CEO of Our Family Office Inc. He can be reached at firstname.lastname@example.org.