Intention to Pursue Profit
The Canada Revenue Agency cannot deny business losses simply because a taxpayer did not earn money. Many legitimate businesses lose money for years. However, the CRA still requires that a taxpayer genuinely pursue profit before losses become deductible.
This issue commonly arises in CRA audits involving rental losses, real estate ventures, consulting businesses, farming activities, and side businesses with little or no income. A Toronto tax lawyer will often see these disputes arise during CRA audits and objections involving denied losses.
The leading case is Stewart and more recent decisions, including Paletta Estate and Chan, confirm that while legitimate commercial losses remain deductible, activities undertaken primarily to generate tax losses may not qualify as a source of income at all.
Stewart v. Canada and Commercial Activities
Before Stewart, courts often applied the “reasonable expectation of profit” test. The CRA frequently argued that taxpayers could not deduct losses if a business was unlikely to become profitable.
The Supreme Court of Canada rejected that approach. Instead, the Court explained that the proper question is whether the activity is genuinely commercial or whether it contains a personal or hobby element.
The Court stated: “where the activity contains no personal element and is clearly commercial, no further inquiry is necessary.”
This was an important decision because it confirmed that a legitimate business does not stop being a business merely because it loses money.
The Chan and Paletta Estate Decisions
More recent cases have clarified that Stewart does not protect activities undertaken solely to generate deductions or losses.
In Paletta Estate, the Federal Court of Appeal explained that a taxpayer must genuinely pursue profit for a source of income to exist. The Court confirmed that an activity undertaken with no purpose other than generating losses may fail to qualify as a business altogether.
The Federal Court of Appeal reinforced this reasoning in Chan. The Court focused on whether the taxpayer was genuinely attempting to earn profit or whether the activity primarily existed to create tax losses. These decisions are important because they confirm that courts will examine the commercial reality of the activity, not simply whether expenses were incurred.
Why This Matters in CRA Audits
The CRA frequently raises “source of income” arguments during audits involving ongoing losses.
Common examples include:
- rental properties with repeated losses;
- side consulting businesses with minimal revenue;
- real estate activities;
- farming losses;
- alleged hobby activities; and
- transactions that appear primarily tax-motivated.
If the CRA argues that no source of income exists, the consequences can be significant. Losses may be denied entirely, prior-year reassessments may be issued, and gross negligence penalties may potentially apply.
Evidence Matters
These disputes are heavily fact-driven. Courts will often examine whether the taxpayer acted in a commercially reasonable manner by reviewing:
- advertising and marketing efforts;
- client development;
- business records;
- time devoted to the activity;
- attempts to generate revenue; and
- the overall commercial reality of the venture.
A taxpayer’s statement that they intended to earn profit is not enough on its own. The surrounding facts must support that intention. Proper documentation is often critical when defending denied losses in a CRA audit or Tax Court appeal.
Kirshen Tax Law Can Help
Disputes involving denied business losses can become complicated quickly, particularly where the CRA alleges that an activity lacked a genuine intention to pursue profit.
Kirshen Tax Law is a Toronto tax lawyer firm that assists taxpayers with CRA audits, objections, Tax Court appeals, and disputes involving denied business losses and source of income issues. If you are facing a CRA audit involving business losses, rental losses, or alleged non-commercial activities. Contact us today for a free consultation.
Jeff Kirshen BA, JD (CA), JD (US)
Tax Lawyer | Founder, Kirshen Tax Law
Disclaimer
The content on this website, including articles and blog posts, is provided for general informational purposes only. It reflects the laws and regulations as of the date of publication, which may have since changed. This content is not intended to serve as legal advice and should not be relied upon as such. Tax laws and situations can be complex and unique to each individual. The information provided may not apply to your specific circumstances. For personalized advice regarding your tax or legal matters, we recommend consulting a qualified lawyer.