Tax Court of Canada Judgments

96-4783(IT)I

BETWEEN:

HUGH VINCENT LUNN,

Appellant,

and

HER MAJESTY THE QUEEN,

Respondent.

Appeals heard on June 29, 1998, at Kingston, Ontario, by

the Honourable Judge D. Hamlyn

Appearances

Counsel for the Appellant:          The Appellant himself

Counsel for the Respondent:      Karen Cooper

JUDGMENT

          The appeals from the assessments made under the Income Tax Act for the 1991, 1992, 1993 and 1994 taxation years are dismissed in accordance with the attached Reasons for Judgment.

Signed at Ottawa, Canada, this 14th day of July 1998.

"D. Hamlyn"

J.T.C.C.

Date: 19980714

Docket: 96-4783(IT)I

BETWEEN:

HUGH VINCENT LUNN,

Appellant,

and

HER MAJESTY THE QUEEN,

Respondent.

REASONS FOR JUDGMENT

Hamlyn, J.T.C.C.

[1]      These appeals are in respect of the Appellant's 1991, 1992, 1993 and 1994 taxation years.

THE PROJECT

[2]      The project is the building of a wood frame Spitfire replica.

[3]      For the last several years, Mr. Lunn has been building a full size wooden frame Spitfire aeroplane. This project started in 1986 and is still ongoing. During this period, Mr. Lunn claimed Scientific Research and Experimental Development ("SR & ED") expenses for efforts toward building a Spitfire and also for cost associated with building in his successive houses an enclosure sufficiently large to house the Spitfire. Also, he claimed for the purchase of special tools and equipment to be used in building the aeroplane. The construction is based on a set of plans that were designed by Mr. Marcel Jurca. These plans were purchased by Mr. Lunn and are the basis from which he is attempting to build the Spitfire.

[4]      The special features of the full size Spitfire being built are in addition to its wooden frame different from the aluminium used in World Ward II, a fire wall located forward in the cockpit leaving less engine room than what was in the original World War II model. Also, other minor modifications were made, the plan includes a tail wheel replacing the tail drag assembly found in the World War II model.

[5]      The type of wood consists mainly of sitka spruce which is laminated and glued.

SIGNIFICANT EVIDENCE FROM THE APPELLANT

[6]      The purpose of the project is to reduce the weight of the plane, to increase the fuel economy and to change the flight dynamics of the original aeroplane and eventually to market this aeroplane to private licensed pilots to give them a higher performance aeroplane. His evidence also clarified several points.

[7]      There was no organized testing of the project.

[8]      There was no business plans or market surveys.

[9]      No income was reported by the alleged business.

[10]     There was no product produced.

[11]     No profit was expected for at least twenty to thirty years.

[12]     Many of the expenditures were to allow for aeroplane parts and construction accommodation in his residences, and as well, other expenditures, were for accounting and legal matters with respect to problems with his employer.

FACTS

[13]     The Appellant claimed business losses for a business called Historic Aircraft Replication ("Historic") for the 1991, 1992, 1993, and 1994 taxation years in the following amounts:

                   Year                       Business Losses

                   1991                       $25,311

                   1992                       $23,066

                   1993                       $27,947

                   1994                      $23,365

[14]     The Respondent also noted in its pleadings that in the six taxation years prior to 1991 the Appellant reported a series of business losses.

[15]     The assumptions of fact pleaded in the Reply to the Notice of Appeal and presumably relied upon by the Minister of National Revenue (the "Minister") at the time of reassessment are that during the taxation years of 1991, 1992, 1993 and 1994 the Appellant:

a.        did not report any income from sales or from the provision of services;

b.        did not have a product for resale with respect to Historic;

c.        did not engage in the manufacture or processing of any product with respect to Historic; and

d.        did not create or develop any new product with respect to Historic.

[16]     Therefore, the Respondent submits that:

a.        the Appellant had no reasonable expectation of profit from Historic for the 1991, 1992, 1993 and 1994 taxation years;

b.        the Appellant's expenses with respect to Historic for the years in question were not made or incurred by the Appellant for the purpose of gaining or producing income from business or property; and

c.        the expenses claimed by the Appellant for the years in question were in fact personal and living expenses.

[17]     The Minister disallowed the business expenses claimed for 1991, 1992, 1993 and 1994 and reassessed the Appellant accordingly.

[18]     The Appellant also submitted a "Claim for Scientific Research and Experimental Development ("SR & ED") Expenditures Carried on in Canada" (T661(E)) to Revenue Canada for the years 1991, 1992, 1993 and 1994, claiming deductions for SR & ED expenditures in the following amounts:

                   Year                       SR & ED Expenditures

                   1991                                $13,650

                   1992                                $14,076

                   1993                                $54,191

                   1994                               $39,459

[19]     The Respondent's pleaded assumptions with regards to these expenditure claims which are as follows:

a.        the expenditures for the taxation years in question were not for work undertaken for the purpose of achieving technological advancement for the purposes of creating new, or improving existing, materials, devices, products or processes including incremental improvements thereto,

b.        the expenditures for the taxation years in question were not made on SR & ED carried on in Canada.

[20]     The Minister denied the Appellant's claim that these expenditures were qualified SR & ED within the meaning of paragraph 37(1)(a), paragraph 37(1)(b) or Regulation 2900 of the Income Tax Act (the "Act") and reassessed him accordingly.

ISSUES

[21]     The issues in these appeals are:

a.        Were the business expenses claimed by the Appellant for the taxation years 1991, 1992, 1993 and 1994 allowable under subsection 18(1) of the Act?

b.        Were the expenditures made by the Appellant for the 1991, 1992, 1993 and 1994 taxation years qualified SR & ED expenditures allowable under subsection 37(1) of the Act?

ANALYSIS

[22]     The Appellant claims an aeronautical engineer on behalf of the Minister reviewed the project for the taxation years and found the project to be scientific research and experimental development as defined in Regulation 2900(1)(c). Thus the project was eligible for SR & ED claim under the Act.

[23]     No record of this report could be found including a research under the Access to Information Act and the Appellant maintains such records have been destroyed. As a consequence he maintains this is a bar to further proceedings and should be a bar to collection by Revenue Canada.

[24]     Further, the Appellant argued the Minister's prior SR & ED approval to his project stands as a bar to this proceeding.

[25]     The conclusion to this submission is well tested. Each tax year stands on its own. The onus to prove the Minister's assumptions are incorrect lies with the Appellant and there is nothing before the Court to prevent the Minister from assessing as he has.

ALLOWABLE BUSINESS LOSSES

[26]     In order for Historic to claim business expenses for the 1991, 1992, 1993 and 1994 taxation years it must be a 'business' for the purposes of the Act. A 'business' for tax law purposes is an enterprise that is carried on for profit or with a reasonable expectation of profit.[1]

[27]     In this case, based on the profit and loss experience of the project, the lack of any business plan and the SR & ED Science Report of Jean E. Tardy, it appears that its preponderant purpose was not the making of profit. Rather, it appears the project was in the nature of a hobby and the expenses incurred were of a personal nature.

[28]     Historic was not in fact a business for the purposes of the Act and the expenses claimed in relation to Historic's operations cannot be deducted as business expenses because of the operation of subsection 9(2), paragraphs 18(1)(a) and 18(1)(h) of the Act.

SCIENTIFIC RESEARCH AND

EXPERIMENTAL DEVELOPMENT EXPENDITURES

[29]     Subsection 37(1) of the Act entitles a taxpayer to a full deduction for SR & ED expenditures. As well, such expenditures are "qualified expenditures" as defined in subsection 127(9) and entitle the taxpayer to investment tax credits.

[30]     In order to deduct such expenditures under subsection 37(1) and to claim an investment tax credit under section 127, a taxpayer must be carrying on a business and must be able to demonstrate that the expenditures incurred were for "scientific research and experimental development" as defined in the Act.

[31]     Subsection 248(1) states that the phrase "scientific research and experimental development" has the meaning given to it by Regulation 2900 which states, in part:

... "scientific research and experimental development" means systematic investigation or search carried out in a field of science or technology by means of experiment or analysis, that is to say,

(a)         basic research, namely, work undertaken for the advancement of scientific knowledge without a specific practical application in view,

(b)         applied research, namely, work undertaken for the advancement of scientific knowledge with a specific practical application in view,

(c)         experimental development, namely, work undertaken for the purposes of achieving technological advancement for the purposes of achieving technological advancement for the purposes of creating new, or improving existing, materials, devices, products or processes, including incremental improvements thereto, or

(d)         work with respect to engineering, design, operations research, mathematical analysis, computer programming, data collection, testing and psychological research where that work is commensurate with the needs, and directly in support, of the work described in paragraphs (a), (b) or (c).[2]

[32]     The Appellant has not presented sufficient facts to support a claim that any kind of systematic investigation or search by way of experiment or analysis occurred, as required by Regulation 2900. There is no evidence of controlled experiments, of accurate measurements or a testing of theories against empirical evidence. The SR & ED report of Jean E. Tardy clearly states that the Appellant's project was not one that met the specified criteria for experimental development as defined in Regulation 2900(1).[3]

[33]     The evaluation of Jean E. Tardy, qualified at the hearing as an expert in the analysis of technology of aeronautics in terms of the criteria for scientific research and experimental development, was as follows:

Technological advancement

This project is to build a full size Spitfire replica which is built with a wooden frame rather than the original aluminium. ..., upon examination, we found that wooden frame aircraft of that size and power were built routinely in the 1930s.

... there are no features of the Spitfire ... that makes wooden frame construction uncertain or more advanced than the original aluminium. ...

The proposed Spitfire has a fire wall which is located further forward than in the original model. This is due to the fact that modern aircraft engines are smaller and more efficient than World War II engines. ... The use of a wheel, rather than a tail drag has also been standard technology for many years.

Technological uncertainty

... the project does have uncertainty but it is linked to the lack of knowledge or experience of the claimant and not to any technical advancement that was attempted. ... the uncertainty is linked to the specifics of this project rather than to the technology attempted. ...

Technological content

The project has been ongoing for at least 10 years. The duration of the project and the lack of project documentation points to an absence of systematic effort in this construction. The construction proceeded forward with techniques that are common to a hobbyist or home aircraft builder rather than to a systematic engineering project.

...

RECOMMENDATIONS

... the cost claimed by the taxpayer were not invested in the Spitfire itself but in building enclosures in Mr. Lunn's various homes that were large enough to contain the aircraft. ...

CONCLUSION

This project is an ongoing attempt at building a wood framed Spitfire airplane. It is an attempt by a homebuilder to replicate 1930's technology and does not meet any of the three criteria.

DECISION

[34]     Based on the finding that there was no business and the conclusion that the criteria for scientific research and experimental development have not been met, the appeals are dismissed.

Signed at Ottawa, Canada, this 14th day of July 1998.

"D. Hamlyn"

J.T.C.C.

COURT FILE NO.:                             96-4783(IT)I

STYLE OF CAUSE:                           Between Hugh Vincent Lunn and

                                                          Her Majesty The Queen

PLACE OF HEARING:                      Kingston, Ontario

DATE OF HEARING:                        June 29, 1998

REASONS FOR JUDGMENT BY:     The Honourable D. Hamlyn

DATE OF JUDGMENT:                     July 14, 1998

APPEARANCES:

For the Appellant:                      The Appellant himself

Counsel for the Respondent:      Karen Cooper

COUNSEL OF RECORD:

For the Appellant:

Name:                 --

Firm:                  --

For the Respondent:                  Morris Rosenberg

                                                Deputy Attorney General of Canada

                                                          Ottawa, Canada

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