When preparatory activities become business?

In Walsh, 2011 TCC 341 the Tax Court deal with a fundamental issue: when preparatory activities undertaken by a taxpayer towards establishing a business become a business.

In Walsh, the court denied the taxpayer’s claim of business losses as it was not satisfied, on the application of both subjective and objective tests, that the taxpayer’s activities – which were very extensive and included buying expensive software, taking courses, and even engaging into a several transactions – reached the requisite “level of commerciality to justify a finding that a business had commenced.”

As such, the taxpayer’s expenses (forming the losses) were denied.

The Tax Courts reasoning (copied below) is fairly consistent with the CRA position in IT-364

Date When Business Commences
2. It is not possible to be specific about the point in time when a contemplated business becomes an actual business. Generally speaking, it is the Department’s view that a business commences whenever some significant activity is undertaken that is a regular part of the income-earning process in that type of business or is an essential preliminary to normal operations. In order that there be a finding that a business has commenced, it is necessary that there be a fairly specific concept of the type of activity to be carried on and a sufficient organizational structure assembled to undertake at least the essential preliminaries… A business would be viewed as being merely contemplated for the future if no serious or reasonably continuous efforts are being made to begin normal business operations.

In this case, dropping $30,000 in two years by the taxpayer did not impress the CRA’s auditors. Nor they believed that all activities undertaken by the taxpayer amounted to “serious or reasonably continues efforts.”

What’s important, the court provided a broad review of the relevant jurisprudence.  The relevant excerpt is quoted below.

[14]     Mr. Baker arguing for the Respondent relied primarily on the 2002 Supreme Court of Canada decision inStewart to frame the required analysis.

[15]     He pointed out that where there is a suspicion of a personal element then the exercise is to ascertain, by looking at a variety of factors including objective and subjective factors, the intentions of the taxpayer.

[16]     That which would be a personal element, it is argued, is not just a hobby type activity but an educational pursuit, as well, even where it is aimed at preparing one for a business activity. That is, developing the know-how to operate a specific type of business, which was the intention here, is personal development not a commercial activity per se.

[17]     The objective factors listed in paragraph 55 of Stewart which include things like the profit and loss experience and the capacity of the operation to show a profit are said not to be exhaustive. The exercise is to seek to discover the commercial nature of the activity. Indicia of commerciality must be sufficient to warrant a finding that there is a source of income.

[18]     Consideration of relevant factors in this case lead one to conclude, both objectively and subjectively, that the activity in 2005 and 2006 was not a source of income. It did not yet reach the level of commerciality to justify a finding that a business had commenced.

[19]     While referring me to several other cases including Tax Court of Canada cases Coome v. Canada, Dreaver v. Canada, and Gartry v. Canada, counsel for the Respondent also referred me to my 2005 decision inMcNeil v. Canada  at paragraph 12 where, in that case, I referred specifically to a person who had been working on investment models and strategies to enable himself to carry on an investment activity for his family which I found was not yet a business activity. While in that case the taxpayer did not show the same background as the Appellant in the case at bar, and never demonstrated that he had ever developed a strategic planning model as Mr. Walsh seems to have done, the issue is the same – preparations leading to creating a business activity are not themselves yet a business. Reference might also be made to earlier decisions of this court in Sherman McClure and June N. McClure v. The Minister of National Revenue  and Cunningham v. Canada, essentially coming to similar conclusions that underline that educating oneself as a preparation to the start-up of a business is essentially a personal activity and not a business activity.

[20]     The Appellant argued that he had the background to pursue, with the necessary degree of sophistication, the trading business that he has carried out since 2004. He acknowledged that his work was devoted largely to determining the entry strategies given the small amount of capital he had to put at risk but, nonetheless, they were simply preliminary steps which were a part of a business. That is, as recognized in Interpretation Bulletin IT-364, preliminary steps are inherently part of a business. Every business must start with taking a preliminary step.

[21]     Nonetheless, I have to agree with the Respondent in this case. Subjectively, Mr. Walsh has admitted throughout his testimony that during the subject years he was at a pre-exploitation stage of the subject activity. This was not a case of preliminary exploitation steps. It is clearly subjectively and objectively pre-exploitation. He was researching the technology involved to start a business, he was researching the strategy steps that he needed to take to start a business employing his capital. He was taking courses, doing demonstration trades and getting a feel for a business that he felt he could yet pursue. I cannot find in such circumstances that the business had yet commenced in the subject years. Accordingly, the appeals will be dismissed.