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UNDERSTANDING EXPENSE DEDUCTIONS

BUSINESS OR HOBBY?

For entrepreneurs, including independent sale contractors (“ISCs”) in the Direct Selling industry, understanding the rules around business expense deductibility is essential.  This area remains a focus for the Canada Revenue Agency (the “CRA”), as highlighted in a recent Tax Court of Canada decision in Boles v. The King (2024 TCC 167) (“Boles”).  The case offers a helpful reminder of how courts determine whether an activity is a business, and whether related expenses are deductible from income.

Background on Business Expense Deductibility

Section 9 of the Income Tax Act (the “ITA”) provides the framework for determining a taxpayer’s income or loss from business or property.  Generally, expenses are deductible only if they arise from a business activity.

The Supreme Court of Canada (the “SCC”) clarified the test for determining whether a business exists in Stewart v. Canada (2002 SCC 46).  The SCC outlined two questions that have to be considered:

1. Is the activity of the taxpayer undertaken in the pursuit of profit, or is it a personal endeavour?
2. If it is not a personal endeavour, is the course of income a business or property?

Where the activity contains no personal element and is clearly commercial, no further inquiry is necessary.  However, in many cases, the distinction is not clear-cut, which brings us to the Boles case.

Boles v. The King

In Boles, the taxpayers were assessed and denied losses associated with various “Dog Activities”, including breeding, showing, and leasing Rottweilers, as well as attending dog shows.  The key issue was whether these activities were conducted as a business or were merely a personal hobby.

The Tax Court considered a range of factors in its analysis, including the taxpayers’ intention, profit and loss experiences, training, intended and actual course of action, and capability of venture to show a profit.  The Tax Court ultimately found that the Dog Activities did not constitute a business.  Despite some potential commercial aspects, the Tax Court concluded the Dog Activities were not a source of income, pointing to loose management of expenses, lack of a separate ledger for the Dog Activities, and a restrictive marketing approach.  Accordingly, the associated losses were not deductible.

Commentary

The Boles decision is a useful reminder of the factors that both the courts and the CRA will consider when determining whether an activity qualifies as a business, and whether related expenses are deductible.  Even where a taxpayer claims to be operating a business, the claim must be supported by objective evidence. 

In addition to the basic test under section 9, the ITA imposes further limitations.  For example,  paragraph 18(1)(a) states that no deduction shall be made “(…) except to the extent that it was made or incurred for the purpose of gaining or producing income from the business or property.  Similarly, section 67 provides that all deductions for expenses must be “reasonable in the circumstances”.

Accordingly, ISCs are encouraged to operate their business in a professional, businesslike manner. This generally includes maintaining separate books and records, developing business plans, and analyze each business expense from a cost-benefit perspective.

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