GST/HST INPUT TAX CREDITS: Reasonable
Expectation of Profit

Posted on December 22nd, 2022 in Domestic Tax

Two horses racing at a farm. One horse black and one brown. Red barn in background.

A July 28, 2022, Tax Court of Canada case considered whether input tax credits (ITCs) in respect of a farming operation’s expenditures were available. The farming activity consisted of breeding and racing various horses and involved at least four full-time employees at one point. Over a nine-year period (2007 2015), the operations never experienced positive net earnings and more than $4 million in losses were accumulated. The owner partially financed operations with earnings from his law practice.

In order for ITCs to be available, supplies must have been made in the course of a commercial activity. For a commercial activity to have occurred, there must have been a reasonable expectation of profit.

The Court considered the following criteria when determining whether the taxpayer carried on a commercial activity:

profit and loss experience;
the taxpayer’s training;
the taxpayer’s intended course of action; and
the capability to show a profit.

Taxpayer loses

While the Court noted that the taxpayer was clearly passionate and knowledgeable about horses and had invested significant funds and time, it was insufficient to demonstrate that there was a reasonable expectation of profit. Ultimately, the Court found that the taxpayer’s lack of financial organization (he did not have financial statements) and lack of financial tools left him without the ability to diagnose the causes of his farm losses. Without the ability to understand the losses, he did not have the ability to truly stem them, and therefore he did not have a reasonable expectation of profit. The ITCs were denied.

ACTION ITEM: Ensure to sufficiently compile financial records and information such that you can reasonably identify the profitability problems in your operation.

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Article originally published in: Tax Tips & Traps 2022 Fourth Quarter – Issue 140.