If you start a side business, you’re presumably doing so to make a profit, but this is not always the case. Some taxpayers operate a business as a way to write off personal expenses as business expenses, hoping to claim the resultant business losses against their day-job income, thus lowering their tax bill.

But you’ve got to be careful because if you don’t run your business in a sufficiently commercial manner with a view to making a profit, your losses may be denied. A recent example of this occurred earlier this month when a taxpayer went to Tax Court to challenge the

Canada Revenue Agency

’s denial of the 2019 and 2020 business losses he had claimed from running an Amway business.

The taxpayer began selling Amway products in April 2019, devoting 15 to 20 hours per week to the task in addition to his regular full-time employment as an account administrator for a property management company. During the years in question, the taxpayer would meet a potential customer in person or via social media and go over Amway’s offerings, which were typically household products, such as shampoo, body wash and multivitamins.

If the customer decided to purchase an item, the taxpayer would set the selling price such that he would receive what he referred to as a “premium,” usually in the range of five per cent to 10 per cent, but sometimes as high as 15 per cent. He would then order the products from the Amway website and after receiving them, he would personally deliver them to the customers and get paid in cash.

The taxpayer testified that he also participated in Amway’s leadership training development, in which he was partnered with a mentorship group that teaches people how to run a successful Amway business. Under this program, he paid fees to attend weekly workshops, quarterly functions and business seminars/conferences, and purchased a number of books and CDs.

On the taxpayer’s 2019 tax return, he reported gross revenue of $3,150 and expenses of $6,404, resulting in a net business loss of $3,254. On his 2020 return, he reported gross revenue of $5,556 and a net business loss of $12,684. The CRA reassessed the taxpayer’s 2019 and 2020 tax returns on the basis that his Amway activities were not a source of income.

The judge reviewed the case law, specifically 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 taxpayer said his Amway activities did not have any personal element, and that everything he did was done with the intention of creating revenue, so he did, indeed, have a source of income. The CRA disagreed, saying that the taxpayer’s participation in Amway was predominantly a personal endeavour, characterizing it as “a hobby with a business flair.”

The judge reviewed the facts and evidence, noting that in 2019 and 2020 combined, the taxpayer had only earned a total revenue of $8,706 on about 70 sales to fewer than 40 customers — a “modest sales and customer base.” Yet, during the same period, the taxpayer testified that he devoted 15 to 20 hours per week to Amway, he attended numerous weekly workshops organized by people who were successful in the Amway business and he attended quarterly functions out of town, including two business seminars/conferences in the United States.

Furthermore, the taxpayer claimed his cellphone was used 70 per cent of the time for business purposes to e-mail, text and call customers, prospective customers, business coaches, mentors, business partners and prospective business partners, and to network online.

He also claimed more than 6,000 kilometres as the business portion of his motor vehicle use, claiming he used it to meet customers and prospective customers, to deliver products to customers and to attend weekly workshops, business coaching and networking meetings.

Notwithstanding this, the judge concluded that the level of activity the taxpayer described was “far in excess of what would be needed to acquire and support his modest sales” and was more consistent with his activities having a significant personal element, namely to develop as an entrepreneur and businessperson in the broader sense, with Amway serving as his vehicle to do so.

The judge also questioned the taxpayer’s business accounting, calling it “so ill-advised that it undermines the contention that he was operating in the pursuit of profit.” For example, the taxpayer did not include the cost of the Amway products he sold in computing his income. In other words, there was no cost of goods sold in his financial statements.

The taxpayer said because he didn’t produce any of the products, but rather was “partnering with Amway,” it would have been wrong for him to include the products he purchased from Amway as an expense. The judge disagreed, noting that since he purchased the products and sold them to customers, his gross profit would be the difference between those amounts, regardless of his relationship with Amway.

The judge said that by ignoring the cost of the products he sold, this itself was an indicator of the non-commerciality of the business. If the taxpayer would have included the cost of goods sold in computing income, that would mean that for 2019 and 2020 combined, he would have had gross revenue of about $9,000, a gross profit of less than $1,000 (based on a 10 per cent markup) and other expenses of more than $25,000.

The quantum of the resulting losses relative to the level of sales, combined with the lack of any real plan to move to profitability, was a major indicator of non-commerciality.

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As a result, the judge dismissed the taxpayer’s appeals and said his losses for 2019 and 2020 were non-deductible.

Jamie Golombek,
FCPA, FCA, CFP, CLU, TEP, is the managing director, Tax & Estate Planning with CIBC Private Wealth in Toronto.
Jamie.Golombek@cibc.com

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