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March 2, 2024

Tax Perspectives

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Please note that these publications may not be up-to-date as taxation matters are subject to frequent changes.

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Winter 2003
Volume 2, Number 1

The information in Tax Perspectives is prepared for general interest only. Every effort has been made to ensure that the contents are accurate. However, professional advice should always be obtained before acting on the information herein.

Reasonable Expectation of Profit: The Demise — What's Next?

By Michael Cadesky, FCA, TEP
Cadesky and Associates LLP (Toronto)

In the mid-1990s, the Canada Customs and Revenue Agency (the "CCRA") discovered a weapon previously seldom used. It was a weapon of devastation to taxpayers, particularly individuals who purchased syndicated investments. In one sweep, the CCRA could disallow the tax deductions claimed by an entire investment syndicate, simply on the basis that it had failed to objectively establish that it could be profitable.

Having met with initial success, a theory developed in the CCRA that most syndicated investments were never designed to make a profit. Instead, they were clever arrangements designed to synthesize tax losses, without regard to the normal rules of business economics. While the CCRA would go through certain motions to demonstrate that they had objectively considered all of the facts, we have substantial evidence to indicate the opposite - in many cases the information provided by taxpayers to justify the investment's viability was simply ignored. Standardized responses on a mass-mailing basis were very much the order of the day from the CCRA.

Fortunately, the Supreme Court has put a stop to this. According to the Supreme Court, the reasonable expectation of profit test is only relevant where personal use is involved. Even then, it is necessary to carefully examine whether the project has economic viability.

How will the CCRA react to this decision, and what are the longer term implications?

While the CCRA must clearly be unhappy about the Supreme Court's decision, it is unlikely that we will see legislative changes as a result. There are already a number of tests in the Income Tax Act to govern expense deductibility, and these should be sufficient in and of themselves. Furthermore, sensitive areas, such as deducting losses created by claiming depreciation, already have rules which limit the deductions available.

It is our prediction that the CCRA will have to live with the Supreme Court's decision, and readjust their thinking on syndicated investments. Instead of being able to deny deductibility outright, based on general grounds, any attack will now have to be based on technical merit. This means that syndicated investments which are bona fide, and well constructed from a technical perspective, should yield tax deductions which are allowable. This may very well give rise to the rebirth of syndicated investments, as a means to own and finance real estate investments and business projects.