I’m working with a client whose first year of business in 2020 showed a modest profit. However, since 2021, the impact of COVID has prevented the business from recovering, and it has reported losses each year from 2021 through 2024.
At this point, I’m concerned the business may not be viable going forward. I’d like to understand how others have approached similar situations. Specifically, I want to avoid a scenario where CRA challenges the losses on the basis that there is no reasonable expectation of profit.
My current thought is to give the client one more year to attempt a turnaround, after which we may need to advise him to either cut his losses or consider engaging someone else.
I would appreciate thoughts on how others have approached similar situations.
The REOP test for income tax purposes was effectively eliminated by the Stewart case quite a while ago. Now it essentially comes down to whether the enterprise is operated in a businesslike manner. This is speaking in very broad strokes, of course, and the particulars of each case will matter.
A REOP test can still be applied for GST/HST purposes to determine whether the enterprise is a “commerical activity” since there are different bases for income tax and sales tax matters.
How large is the loss we’re talking about here? Is it a sole proprietorship who’s offsetting the losses against other income or is it a corporation? As long as he believes there continues to be a reasonable expectation of profit then he should be fine, provided it’s not the former where large losses are being used to shield other income.
If there are a significant losses, I can’t imagine the operator will have the means to continue for very long anyway.
Do you give your clients business advice? I certainly don’t. Advise him of his risks.
Losses range from $13,000 to $30,000. Between 2021 and 2024, one small profit was fully offset by prior year Business-use-of-home expenses available to carry forward. As a sole proprietor with no other income, his return shows zero income and because he’s married, his spouse (the income earner) claims the spouse or common-law partner amount.
Your topic title ‘Going Concern’ is not really what you are talking about:
“A going concern is an accounting term for a business that is assumed will meet its financial obligations when they become due. It functions without the threat of liquidation for the foreseeable future, which is usually regarded as at least the next 12 months or the specified accounting period (the longer of the two).”
You want to discuss the ‘Reasonable Expectation of Profit’. As such, have changed the topic title.
Yes, “going concern assumption” and REOP are two distinct animals. And, the going concern assumption really only is relevant in the context of an audit or review of financial statements. I had to deal with that for a client over a 2 or 3 year span. It amounted to more work, plus a one page note to the statements. People ran for cover. Bankers were the worst. They invited the client to find other bankers and doubled their interest rate. After being a loyal customer for about 40 years. Other bankers were found, and the business recovered from a low cycle and are now at the top of their game. Another client asked his banker - “you must hang your conscience at the door when you come to work each day.” Another comment was “never turn your back on a live banker.”
For compilations, I don’t think banks put much emphasis on financial statements. I haven’t had a client yet who didn’t have personal guarantees with the bank. Banks always make sure they have security greater than their lending exposure. Some clients lose money for years. Sometimes they refinance, but mostly, they invest their own capital. Or, they pay more attention to their business and turn it around.
Ongoing concern is an opinion of a business. But it really is not tax. A company can keep going and the owner keeps dumping money into it.
But for taxes, if the person is spending money in an attempt to make a profit, the tax courts appear to allow it. The argument is whehter the person incurs expenses
to attempt to make a profit or
for some personal endeauver which the courts would not allow the expenses claimed.
If it is a business, is there “a” source of income. Sell or make something.
The plain meaning of s. 20(1)(c)(i) does not support an interpretation of “income” as the equivalent of “profit” or “net income”. Nowhere in the language of the provision is a quantitative test suggested. Nor is there any support in the text of the Act for an interpretation of “income” that involves a judicial assessment of sufficiency of income.
We see from the quote above that the Moldowan test for reasonable expectation of profit has been, for all intents and purposes, been eliminated. The emphasis now when it comes to these cases is to determine whether the venture is a bona fide commercial activity or personal in nature.
Moldowan test was in 1977. Life has moved on. Some case afterward said tha they don’t look at this as long as it is not some sort of personal or hobby. Something to the effect of not looking at the REOP, as long as it is a bona fide business.
REOP is still being used and the last case I saw it was 2015. But the tax law does allow a few years of losses during startup. But the weight of this with Moldowan seemed to kind of diminished after 2001.
The Supreme Court said REOP is not valid unless there is a personal element to the business or rental property. Essentially, they said that if the taxpayer operates their business at a loss but can show they’re otherwise running their business with the intention of earning profit, that’s a business decision. Obviously, if the taxpayer is hiding income or claiming non-business or personal expenses, that’s a different issue that I’d raise with the client.
Everyone reading this should be mindful that this is our own interpretation of the income tax act, we do not have the power, authority, or anything to say that what we mentioned are right and should be taken seriously. So, no one should be relying on what we said here, and quoted it or use it as reference
Thank you for your response.
It is a rental condo that drop the price a lot so thinking to move in and claiming that loss that call it terminal loss and it is reduce income .
