REOP tax ruling: Impact is big

Make no mistake about it. The recent Supreme Court ruling that struck down the “reasonable expectation of profit” (REOP) rule is a landmark decision.Tax lawyers are rejoicing. Over at the Canada Customs and Revenue Agency (CCRA), they’re tearing their hair and trying to figure out what to do in the face of this stunning setback.What’s at stake
This is not one of those “only affects a few people” kind of decisions. Many Canadians of all income groups will be able to take advantage of this new situation at some point in their tax-paying lives.

The REOP standard has been at the core of the tax department’s approach to interest and business loss deductibility for as long as anyone can remember.

It has touched a wide spectrum of Canadians, from multi-millionaires seeking tax shelters to self-employed home workers trying to earn a few extra bucks to make ends meet.

When looked at under a microscope, as the Supreme Court did, it was a completely arbitrary approach.

Can’t disallow expenses
The CCRA assumed that it knew better than anyone else whi business ventures had a chance of eventually making money and which did not. Auditors who had spent their entire careers in the public service could peremptorily disallow expense claims because, in their view, the taxpayer never had a genuine expectation of making money.

The amazing thing is that no one ever seriously challenged the standard before.

Just think about it. How is a tax officer supposed to judge whether the money a garage band lays out for equipment is deductible? Are these just kids fooling around, or the next Bare Naked Ladies?

Harry Potter example
If J.K. Rowling lived in this country and tried to claim deductions relating to her writing materials while she was scribbling on the kitchen table, they probably would have been disallowed.

After all, she had never published anything. Where’s the reasonable expectation of profit?

The Supreme Court took the position that business decisions should be left to entrepreneurs and business people, and the CCRA should butt out. Hooray for the justices.

Next page: Ruling has downside

Ruling has downside
Unfortunately, there is a downside to this. The tax shelter market is likely to be revitalized.

Look for all kinds of sweet-sounding deals to be floated in the next few months as aggressive promoters take advantage of the new situation.

Many of these deals will end up being losers, so be on your guard. Remember that there is no point in saving $0.45 in taxes just to lose $1 in investments.

Make future claims
After the ruling came down, I chatted about it with a tax consultant who spent the more than a decade as a senior officer with CCRA before retiring a couple of years ago. He described the judgement as a “landmark decision”.

However, he suggests that anyone thinking about amending a 2001 tax return or trying to re-open previous years should consult a professional advisor first.

“Such requests are going to attract attention and may trigger an audit,” he warns. “Even if you’re squeaky clean, audits can be time-consuming and expensive. I would only consider doing this if the amount of money involved is very significant.”

Going forward, however, his advice is quite different.

If you have any expense that is in any way business-related, claim it. Be aggressive. You are not committing a crime, as long as the expense is legitimate.

Unless it can be clearly demonstrated that the charges related to personal matters (you still can’t claim mortgage interest on your home, for example), the CCRA will be very reluctant to challenge them in the light of the slap-down they’ve received from the Supreme Court.

From the Internet Wealth Builder.