Running a money-losing business doesn't always mean you can claim tax losses

National Post


It’s not easy running a small business, especially in the early years. Whether a business will ultimately become profitable, producing income that will one day be taxable, depends on many factors. But in the meantime, if you experience business losses, they will generally be tax deductible against any other income you have, provided you have a legitimate business, run in a commercial manner with a view to a profit.

This was the issue at the heart of a Tax Court decision in August involving a Brampton, Ont., taxpayer who was reassessed by the Canada Revenue Agency for claiming business losses of $55,728 for 2008, $37,975 for 2009, $41,229 for 2010 and $17,779 for 2011. The CRA disallowed these losses on the basis that the taxpayer had no source of income and, therefore, no true business.

In the years in question, the taxpayer engaged in two so-called businesses that gave rise to his claimed business losses: a website business, and a painting and cleaning business. These businesses were in addition to his day job as a certified quality engineer for various auto industry suppliers. Each weekday, he commuted to and from his job in Oakville, Ont., leaving for work around 7 a.m. and returning home at 6 p.m. He ran his two businesses after hours and on weekends.

The goal of the taxpayer’s website business was to create a platform for individuals to market their homes and sell their personal items. His children were deeply involved in building the website, entering data, distributing flyers and putting up promotional posters. One of the children testified about both his own and his siblings’ involvement in a variety of web-related activities.

The taxpayer, when asked what he did to help make the website profitable, said he planned to modify the website to allow it to be viewed on social media and mobile devices, and that he “increased his advertising.” In addition, he introduced some vitamin products in 2011 to the website in a multi-level marketing scheme that generated a commission loss of $2,186 that year.

Despite the taxpayer’s “unbroken string of losses,” he was confident “there will be a time … to become (a) profitable business.” The judge was skeptical: “The basis for the (taxpayer’s) optimism remains unexplained, particularly since he had claimed a continuous series of losses on his tax returns as far back as 1993.” The taxpayer eventually closed his website in 2017 without experiencing a single profitable year.

The taxpayer also ran a painting and cleaning activities business. Asked by the CRA why he started that business, he responded he had “some free time” on the weekends. The taxpayer conceded his painting and cleaning activities were not very active, and they ended in 2010.

The judge reviewed the case law, particularly a landmark 2002 Supreme Court of Canada decision that established the test to determine whether or not a taxpayer has a “source of income.” This is essential because to deduct a business loss, you must have a source of income. The highest court said the starting point was to ascertain whether a taxpayer’s activity was undertaken in “pursuit of profit” or was personal. Where there is a personal element, the activity must have a sufficient degree of “commerciality” to be considered a source of income.

The judge also cited a pair of 2022 Federal Court of Appeal decisions concluding that an activity without any personal element must be conducted with a view to making a profit to constitute a source of income.

In this case, the judge said both taxpayer activities had personal elements. Because his children were deeply involved in helping the website business, their activities offered the taxpayer’s family an opportunity to spend time together. And because his painting and cleaning activities were intended to occupy the taxpayer’s free time, they were personal as well. In the end, there was no evidence that either activity was conducted with sufficient commerciality to constitute a source of income.

The judge added that even if he had determined that neither activity had a personal element, he would have concluded that neither was conducted in pursuit of a profit since the taxpayer was unable to produce any evidence to demonstrate that either activity could be profitably conducted. Accordingly, the losses the taxpayer attempted to claim were denied.

The taxpayer also tried to argue that the CRA wasn’t entitled to reassess his 2008 taxation year because it was beyond the normal three-year reassessment period. To do so, the CRA must demonstrate, on a balance of probabilities, that a taxpayer made a misrepresentation attributable to “neglect, carelessness or wilful default or committed fraud” in filing his tax return.

The CRA noted the taxpayer claimed in his 2008 tax return that he drove 49,000 kilometres that year for his website business, and 31,000 kilometres for his painting and cleaning activities.

The judge noted that given the taxpayer had full-time employment in 2008, any claim that a total of 80,000 kilometres were driven for his website and painting and cleaning activities that year was “absurd,” since the taxpayer left for work at 7 a.m. and returned at 6 p.m. each weekday. Claiming what were primarily personal automobile expenses as business expenses is clearly a misrepresentation. But was this attributable to neglect or carelessness?

The judge felt it was because the taxpayer failed to “thoughtfully, deliberately, and carefully” determine how many kilometres he drove in 2008 for each of his alleged businesses. The taxpayer claimed he maintained an automobile logbook, but failed to bring it to court on the first day of trial, nor did he bring it on the second day. “This strongly suggests that no logbook exists,” the judge said.

As a result, the judge said the CRA was “fully justified” in reassessing the taxpayer’s 2008 taxation year beyond the normal reassessment period since the taxpayer made a misrepresentation that was clearly attributable to neglect or carelessness.