Preston v. The King is an interesting case where the appellant scored a victory against CRA. This is a case involving business expense deduction, where the appellant won despite having a non-arm’s length relationship with his key business customer!
Case Facts – Business Expense Deductibility
Randall Preston, a seasoned business entrepreneur, created a business of using his business management and contract negotiation skills to further his daughter’s musical career. The daughter was seriously pursing this career, and Mr. Preston helped her meet with prospective customers, and record an album. At issue were significant losses emanating from business expenses incurred by Mr. Preston in 2017. The daughter and Mr. Preston were able to generate very marginal revenue from these activities. CRA disallowed the business expenses. There was barely any revenue in the venture, and large expenses, including $52,046 claimed for 2017.
What is interesting about this case is that there was a personal element (the client was the appellant’s daughter) which complicated things. Additional questions must be answered to prove the commercial nature of the arrangement if it is a non-arm’s length transaction. Yet despite this additional difficulty, the appellant’s appeal was successful.
Legal Framework
For a business carried on by an individual, if expenses exceed revenue, a loss can be claimed against other sources of income. The litmus test here is whether the income source passes the two-step approach set out by the Supreme Court of Canada:
- Is the activity in question undertaken in pursuit of profit, or is it a personal endeavor? Does the taxpayer intend to carry activity for profit and is there objective evidence to support their intentions.
- If the activity is not a personal endeavor, is the source of income a business or property?
If the activity is commercial, contains no hobby element and evidence is consistent with the view that it’s a profit-seeking venture, then it passes the test. Also, if the activity has elements of a personal hobby, that doesn’t necessarily mean losses cannot be claimed. The question to answer is whether the activity is being carried on in a sufficiently commercial manner.
The determination of “sufficiently commercial manner” includes a list of objective factors such as (a) profit/loss experience in past years, (b) the taxpayer’s training, (c) the taxpayer’s intended course of action, and (d) the capability of the activity to show a profit.
Analysis of case facts
In this case, there was a definite element of personal endeavor because the artist client was the taxpayer’s daughter. However, that didn’t mean it was not a commercial endeavor. Mr. Preston was able to show significant objective evidence to support his arguments of carrying on a commercial endeavor.
Objective facts to support appeal – key here is that on a substantive level, the taxpayer took good faith steps to seek a profit in the business venture.
- The daughter had a number of talent competitions and received promising feedback from a judge in one of the musical talent contests, who helped her produce an album. There was a good faith attempt to find contracts.
- Albums were produced for the purpose of earning money from the musical venture. There was an objective attempt to try to earn income.
- Mr. Preston hired a music industry accountant to do his tax returns and help him understand the music industry from a financial lens. He was serious about setting up a business.
- The appellant also displayed intent of carrying on a commercial business by building up a network of industry contacts which led to a recording in Nashville (the music mecca) in 2017.
Conclusion
Mr. Preston proved based on objective evidence that his activities were of a commercial nature and although there was a personal element, he was genuinely seeking a profit. Therefore, his appeal of 2017 was allowed by the Tax Court, and he was allowed to deduct over $50,000 in losses, despite no material income generated from the business.