Taxpayer’s management services not a personal endeavour
Amit Ummat of Ummat Tax Law on a successful appeal of a Tax Court decision involving a dispute over non-capital losses and the concept of a personal element
Brown v. Canada 2022 FCA 200
Amit Ummat is principal counsel of Ummat Tax Law and a certified specialist in taxation law.
The Appellant Mr. Darrell Brown (“Mr. Brown”) appealed his reassessments to the Tax Court of Canada (“TCC”) and lost. He appealed that decision to the Federal Court of Appeal (“FCA”) and was successful in having the matter sent back for loss calculation purposes.
Mr. Brown was providing management services to a numbered company owned by himself and his spouse. The numbered company operated an art gallery. The TCC Judge found that, since Mr. Brown commenced the management services activity because his spouse was no longer able to manage the gallery as a result of her illness and pregnancy, it was a personal endeavor. The main issue in his appeal was whether the TCC Judge erred in finding that there was a personal element to Mr. Brown’s management services activity.
Mr. Brown is a lawyer and his spouse is an artist. They opened an art gallery in Toronto. They operated the gallery through a numbered company with shares split 51/49 for Mr. Brown and his spouse, respectively.
The gallery opened in 2010 and seemed to be doing well. Mr. Brown was only minimally involved in the operation of the gallery at that point.
Later that year Mrs. Brown fell ill and also became pregnant, which limited her ability to perform her gallery functions. In January of 2011, Mr. Brown became far more involved in the gallery operations. The numbered company resolved to retain Mr. Brown to provide management services to the numbered company. The compensation to be paid to him was a management fee equal to 20% of the amount by which the gallery’s annual revenue exceeded $100,000. This agreement to provide services was eventually extended the following year for a five-year term.
Since the gallery did not earn over $100k in the years at issue (and posted losses some years), Mr. Brown was not paid for his services.
Mr. Brown claimed non-capital losses in 2011, 2012 and 2013. Mr. Brown was reassessed to deny the non-capital losses on the basis that his management services activity was not a source of income and that the amounts claimed as expenses were not reasonable. He appealed to the TCC.
The TCC relied on the Stewart test to determine if Mr. Brown had a source of income. It is a two-part test:
- i) Is the activity of the taxpayer undertaken in pursuit of profit, or is it a personal endeavor?
(ii) If it is not a personal endeavor, is the source of the income a business or property?
The TCC found there was a personal element, and that therefore there was no source of income from which Mr. Brown was able to deduct non-capital losses. The TCC found that the personal element arose when Mr. Brown took over for his ill spouse. The TCC also found that the activity was not carried on in a sufficiently commercial manner to constitute a source of business. Mr. Brown did not show that his predominant intention was to make a profit from the activity.
The FCA was tasked with determining whether the TCC had erred in finding a personal element in Mr. Brown’s activity. Justice Webb answered this in the affirmative. He ruled that the TCC misinterpreted the Stewart decision.
Justice Webb reframed the test as follows:
- Is there a personal or hobby element to the activity in question?
- If there is a personal or hobby element to the activity in question, the next enquiry is whether “the activity is being carried out in a commercially sufficient manner to constitute a source of income” (Stewart, at para. 60).
- If there is no personal or hobby element to the activity in question, the next enquiry is whether the activity is being undertaken in pursuit of profit.
In the Court’s view, the question became whether there was any personal or hobby element to the management services Mr. Brown provided. The answer was no, there was not. Mr. Brown’s decision to provide management services due to his spouse’s illness did not mean that there was a personal or hobby element to his services. The activity in question in this appeal was providing management services to the corporation that was carrying on the gallery business. These management services allowed the gallery to continue to operate. There is no indication that there was any personal or hobby element to these management services. The only personal element identified by the TCC was Mr. Brown’s motivation to provide these services because his spouse was unable to continue managing the gallery.
The next question was whether Mr. Brown pursued profit. The Court found that he was in fact pursuing profit. By providing the management services that allowed the gallery to continue to operate until it could generate sufficient revenue to cover all of its expenses, Mr. Brown’s intent was to allow the gallery to generate revenue which, in turn, would generate the management fees payable to him, and hence, profit for his management services activity.
The FCA found that the determination of the expenses Mr. Brown claimed was still an open issue and sent the matter back to the TCC to determine the amount of the non-capital losses.
It is important to note that conducting business activities with a personal intention does not convert the activity itself to a personal endeavour. Justice Webb makes interesting comments on this issue:
Many businesses are passed from one generation to the next. As noted above, the Tax Court Judge found a personal element to Mr. Brown’s management services activity when he commenced that activity as a result of his spouse’s inability to continue managing the gallery. Applying this logic to an intergenerational transfer of a business, whenever the next generation takes over an endeavour from their parents as a result of their parents’ inability to continue the endeavor, the analysis to determine if the next generation is carrying on the activity in a sufficiently commercial manner to qualify as a source of income would be triggered. However, simply because a child takes over an endeavor from his or her parent because that parent is not able to continue conducting that endeavor should not result in a finding that there is a personal element to the endeavor that the child is now undertaking.
A person’s personal motivation or reason for conducting an activity cannot, in and of itself, result in there being a personal or hobby element to the activity. It is possible to find a personal reason why any person is carrying on a particular activity. For example, a person may be motivated to conduct a particular activity to generate money to fund his or her personal lifestyle or because they are personally motivated to provide better services or products than are currently available in the marketplace.
What Justice Webb is saying here is that any commercial endeavour will encompass a personal element. It is critical to avoid conflating this general personal element to all commercial activity with a personal endeavour that may incidentally resemble a commercial enterprise. A germane example would be a person knitting scarves and occasionally selling one. Furthermore, the relationship between business owners cannot determine whether the activity is an active commercial enterprise. These comments by Justice Webb provide beneficial guidance in this context.
 Stewart v. Canada 2002 SCC 46.
 Decision, at paragraph 25.
 Decision, at paragraph 43.
 Decision, paragraphs 28-29.
Amit Ummat is principal counsel of Ummat Tax Law and a certified specialist in taxation law. Top photo: iStock. Author photo courtesy Ummat Tax Law.