Tax Topics Number 1658-59 December 18, 2003 How Much Is That Doggie in the Window? Back As 2003 draws to a close, tax practitioners across Canada are arguing vehemently as to the winner of the “Most Important Technical Interpretation Issued by the CCRA During 2003” Award. Although the matter is not free from doubt (as a tax lawyer, I am required to qualify any opinion I provide), in my opinion, technical interpretation 2003-0039147, entitled “Dog Expenses”, dated November 20, 2003, should be victorious. The facts set out in the technical interpretation involve a taxpayer (who I will refer to as “Dick”) who incurred a number of expenses in respect of his dog, who is the subject of a book written by Dick. It is interesting to note that the CCRA has deleted the breed, name and age of the dog (who I will refer to as “Spot”) in what is clearly an unwarranted extension of the Access to Information legislation. Dick had asked the CCRA if he is entitled to deduct various expenses in respect of Spot because Spot attends book signings and speaking engagements with Dick. In this technical interpretation, the CCRA displays a brilliant understanding of the scheme of the Income Tax Act (the “Act”) by explaining that under subsection 9(1), a taxpayer's income from a business or property is the “profit” therefrom, subject to the rules in the Act, and that under paragraph 18(1)(a), no outlay or expense is deductible in computing the income of a taxpayer from a business or property, unless it was made or incurred for the purpose of gaining or producing income. The CCRA provides the careful qualification that paragraph 18(1)(b) prohibits the deduction of capital outlays except as expressly permitted in the Act, and paragraph 18(1)(h) generally denies the deduction of personal or living expenses. Finally, the CCRA notes that there is a limitation on the deduction of outlays or expenses under section 67 of the Act if the outlays or expenses are not reasonable in the circumstances. Although my extensive research has indicated that these paragraphs are referred to in other technical interpretations, the clarity and brevity of the paragraph dealing with the deductibility of expenses under the Act is breathtaking and should be read by all tax advisers who do not want to “bark up the wrong tree”. For purposes of the technical interpretation, the CCRA has assumed that Dick's activities are undertaken in pursuit of profit that results in a source of income from a business. Interestingly, the letter does not deal with the famous (or infamous) draft proposal from Finance relating to the reasonable expectation of profit (“REOP”) test which was issued on Halloween (my nominee for the “Most Important Draft Legislation Proposed During 2003” Award). Perhaps this is a discreet method by which the CCRA is advising taxpayers that the REOP test will not apply directly to dogs, or to taxpayers who write about dogs. The CCRA then states that expenditures for Spot will likely contain varying degrees of personal and business elements, and that if Dick wishes to deduct expenses and not have a “dog fight”, he will need to show that the expenses were incurred for business purposes. The CCRA points out that if there are both personal and business elements to the expenses, a reasonable basis of proration is required to determine which expenses relate to the business activity. The CCRA also notes that until the point in time that Dick began using Spot for business purposes, all of Spot's expenses would be personal expenses and no deduction would be permitted under paragraph 18(1)(h). Sadly, the CCRA does not discuss the application of the change of use rules in the Act and how one would deal with a change of use from personal use to partially personal use and partially business use of Spot. In addition, the CCRA provides its views on Spot's travel expenses, including non-refundable pet deposits. If such expenses were incurred to enable Spot to appear on television shows, at book signings or at speaking engagements with Dick, such expenses would be fully deductible. Medical expenses relating to Spot which are not capital in nature and are incurred to earn business income are also discussed. The technical interpretation makes special reference to surgery which was necessary to enable Spot to continue to make public appearances and without which Spot would have been put down and Dick's income would have been adversely affected. In my view, the issue of the deductibility of medical expenses which prolong Spot's life is a difficult one (capital vs. income) and perhaps Dick should not have asked the CCRA questions relating to medical expenses but rather let sleeping dogs lie. The CCRA also deals with a question that has been troubling taxpayers and their advisers since the introduction of section 67.1 in 1987. This is the provision which limits the deduction of amounts paid or payable in respect of the human consumption of food or beverages to 50% of the amount actually paid (originally 80%). Prior to this technical interpretation, I must admit that I did not focus on the word “human”. (The CCRA can teach old dogs new tricks.) Business meal expenses incurred for Spot were clearly contemplated by the drafters of this section and, accordingly, the deduction for the amount spent by Dick on Spot's food is not reduced by the 50% set out in the Act. The CCRA does not comment on the possible application of the general anti-avoidance rules (“GAAR”) to the human consumption of dog food or the canine consumption of human food which, in my view, may be considered to be a misuse of the provisions of the Act by a human or an abuse having regard to the provisions of the Act read as a whole. (I am showing my puppy love for the GAAR provision in the Act and would note that GAAR is a noise made by certain dogs.) The effect of this important technical interpretation cannot be underestimated and clearly the CCRA is inviting similar pet enquiries to pour down on it like cats and dogs. Although the technical interpretation is limited to dogs, one can expect aggressive tax shelter promoters to be foaming at the mouth when they market all types of animals with instructions on how to write a book about the animal (i.e., promoting tax shelters as opposed to promoting animal shelters), and in the future, the Tax Court may be faced with a multitude of cases dealing with pet deductions. In addition, the Auditor General may wish to review the activities of the CCRA to determine whether there is a conflict of interest in providing advice to Dick if the author of the technical interpretation is a dog owner or a supporter of the Ontario Society for the Prevention of Cruelty to Animals. The Auditor General may also be required to determine whether the CCRA is going to the dogs. — Jules L. Lewy is a Tax Partner with the Toronto Office of Fraser Milner Casgrain LLP and a member of the Editorial Board of the CCHCanadian Tax Reporter. He acknowledges that his family owns a dog. For reasons of privacy, he will not reveal the breed, name or age of said canine.