CVITP Assist: Test to Determine if you have Income or Loss from a Business

While reference is often made to “self-employment income” as a source of reportable income, the Income Tax Act doesn’t actually use that term. Instead the Act requires a person to report income from “business”, and in particular, “profit from that business”.^[1] The Act also permits a person to report a “loss” from business, which can be used to offset other income and thereby reduce taxable income.^[2]

The Income Tax Act doesn’t really define what is a business.^[3] But court decisions have developed a test arising out of these two contexts (mostly the second one):

The leading decision is Stewart v. The Queen, a 2002 Supreme Court of Canada case about an individual claiming multiple-year losses from buying and renting out condo units. Prior to the Stewart case the general rule was that an individual could not claim a loss from their activity unless they had a reasonable expectation of profit. Stewart replaced the rule with a new one. There are some small differences in the say subsequent decisions and authors (including the CRA) have summarized the Stewart decision in their own words, and so it may be helpful to directly quote excerpts from the decision:

Is the activity of the taxpayer undertaken in pursuit of profit, or is it a personal endeavour?

…where the nature of a taxpayer’s venture contains elements which suggest that it could be considered a hobby or other personal pursuit, but the venture is undertaken in a sufficiently commercial manner, the venture will be considered a source of income for the purposes of the Act.

This “pursuit of profit” source test will only require analysis in situations where there is some personal or hobby element to the activity in question. Where the nature of an activity is clearly commercial, there is no need to analyze the taxpayer’s business decisions. Such endeavours necessarily involve the pursuit of profit. As such, a source of income by definition exists, and there is no need to take the inquiry any further.

The source of income assessment is not a purely subjective inquiry. Although in order for an activity to be classified as commercial in nature, the taxpayer must have the subjective intention to profit, in addition, … this determination should be made by looking at a variety of objective factors. Thus, in expanded form, the… above test can be restated as follows: “Does the taxpayer intend to carry on an activity for profit and is there evidence to support that intention?” This requires the taxpayer to establish that his or her predominant intention is to make a profit from the activity and that the activity has been carried out in accordance with objective standards of businesslike behaviour.

The objective factors…were: (1) the profit and loss experience in past years; (2) the taxpayer’s training; (3) the taxpayer’s intended course of action; and (4) the capability of the venture to show a profit.

…this list is not intended to be exhaustive, and that the factors will differ with the nature and extent of the undertaking. We would also emphasize that although the reasonable expectation of profit is a factor to be considered…, it is not the only factor, nor is it conclusive. The overall assessment to be made is whether or not the taxpayer is carrying on the activity in a commercial manner. However, this assessment should not be used to second-guess the business judgment of the taxpayer. It is the commercial nature of the taxpayer’s activity which must be evaluated, not his or her business acumen.

In summary, the issue of whether or not a taxpayer has a source of income is to be determined by looking at the commerciality of the activity in question. Where the activity contains no personal element and is clearly commercial, no further inquiry is necessary. Where the activity could be classified as a personal pursuit, then it must be determined whether or not the activity is being carried on in a sufficiently commercial manner to constitute a source of income.

The activity generating the income or loss is from a business if undertaken with the predominant intention of making a profit.

If the nature of the activity is purely and genuinely commercial, further analysis is not required because such activity is inherently pursued for profit. However, if the activity has elements of a hobby or other personal pursuit, it is necessary to to determine whether the activity was undertaken in a sufficiently commercial manner with the predominant intention of making a profit.

If you are claiming a loss, and your activity may have a personal element to it, the CRA may ask you to produce information and documents to show commerciality and that you had an intention to make a profit. In particular they may ask for information and documents addressing:

If you don’t already have a business plan, you could write an explanation of how you intended (or intend) to profit. Provide any supporting documents you may have such as a resume or CV, budget projections, travel logs, diaries, financial statements, and supporting statments from persons involved in your actitivies. The form of documents can include emails or texts.

Sometimes the nature of a business is such that losses can be expected for many years before a profit may be realized. If this applies to you, this should be explained and supported.

In many cases it might not be obvious what is the predominant intention in carrying out an activity. It may assist to consider the comments of the court in Martin v. The Queen (2003 Tax Court), which involved a fur trapper who had 12 successive years of losses. The court allowed all of the losses and stated:

“The existence of a personal element must be put in perspective. There is frequently a personal element in the carrying on of a commercial enterprise in the sense that the person derives great personal satisfaction from the activity. This does not make the activity any the less a business. Professional artists, photographers, writers, musicians (and sometimes even lawyers) no doubt derive great satisfaction from what they do but if their activity is commercial and is intended to yield a profit it is nonetheless a business. It is only where the personal element so overshadows any element of commerciality as to substantially displace it that one may conclude that the activity is merely a hobby and is not a business at all.”

Several individuals earned large sums of money over multiple years playing poker. They claimed it was not business income. The court held that the poker playing activity was not merely entertainment or recreation, and was undertaken is a sufficiently commercial manner such as to show an intention of making a profit. Therefore it was business income.

An individual, outside of his regular job, sold Amway products (eg shampoo, vitamins). He claimed losses over multiple years. The court held that the activity was not purely commercial and was more of a hobby. The evidence indicated that the individual was not undertaken in a sufficiently commercial manner such as to show an intention to make a profit. The losses were disallowed.

A father used his business management and contract negotiations skills to help manage the career of his musically talented daughter. They entered into a personal management contract in which the father would incur expenses up front and receive a commission if his daughter signed with a major record label. In the tax year in question, the father claimed a business loss of about $53,000. The court found that the father had an intent of making a profit, and so the loss was allowable.

An individual claimed business losses over multiple years. Outside of his regular job, he created a website with his children, intended to be a platform for marketing homes and personal items. The family promoted the website. The court held that the activity was not conducted in pursuit of profit, and the losses were not allowed.

A husband and wife, through a numbered company, operated an art gallery. The wife became ill, and then pregnant, and was no longer able to run the gallery. The husband, as an individual, entered into a management contract with the numbered company to provide services in exchange for percentage of the galleries revenue. He reported a substantial loss which the CRA disallowed. The court held that although there was a personal element to the husband’s activity, the evidence showed that he intended to profit, and so it reversed the CRA and allowed the losses.

An individual claimed business losses of about $50K to $75K over four years. He claimed that he was marketing a particular technology for processing sewage sludge. The CRA claimed that the business was not yet in operation over the years in question. The court upheld the CRA’s assessment since the individual failed to substantiate his testimony about his marketing activities with sufficient evidence. He supplied almost no documents to back up his testimony.

An individual claimed business losses in two years in connection with his activities in photography. The CRA disallowed the losses. The court upheld the CRA’s assessment, finding that on the evidence as a whole there was a lack of commerciality and the individual did not establish an intention to make a profit.

A 76 year old individual claimed a business loss denied by the CRA. His activities were directed at bringing together investors with mineral resource assets to be exploited over time and he would then share in the profits. For the tax year in question he earned no income. The court overturned the CRA and held the the invidividual intended to make a profit. The nature of the endeavour was such that profit, if it materialized at all, might not be gained until well into the future.

A fomer professinal journalist started a sports blog and reported losses in his first two years. He hoped to attract advertisors. His biggest expenses were for flights and car rentals to attend Maple Leaf games. He had not prepared any kind of business plan or projections. His ability to ever make a profit was doubtful. However the court found that Mr. Berger’s activity was beyond hobby and his predominant intention was to make a profit. He was allowed to claim losses.

[1] Section 3(a): “The income from a taxpayer..is..determined by the following rules:(a) determine the total amounts each of which is the taxpayer’s income for the year..from a source inside or outside Canada, including.. income for the year from business.” and s.9(1): “a taxpayer’s income for a taxation year from a business is the taxpayer’s profit from that business..for the year.”

[3] Section 248(1) states that “business” includes “a profession, calling, trade, manufacture or undertaking of any kind whatever and.. an adventure or concern in the nature of trade” However this isn’t really a definition.