What do racehorses and the stock market have in common? Gambling might come to mind. But, for at least one stockbroker, tax deductions would be the right answer.
In an unusual case, the Tax Court of Canada found that expenses incurred while breeding and racing thoroughbred horses could be claimed as deductions against the stockbroker's substantial commission income. The most unusual aspect of this case was that it was heard 13 years earlier by another judge who denied the same stockbroker's claim.
The stockbroker's argument was that his horse racing activities resulted in promotional expenses that should be deductible for people like himself who earned commission income.
In 1992, the judge hearing the case agreed with Canada Revenue Agency that thoroughbred horse racing was more accurately classified as a farming activity and that there was no significant connection between the stockbroker's racing activities and the sale of securities.
Since farming was not the stockbroker's main source of income, he could only claim restricted farm losses rather than all of his losses reported in the 1980, 1981 and 1983 tax years.
CRA had also argued successfully that the type of promotional expenses that are deductible under the Tax Act are items such as meals and entertainment, not horse-related expenses such as stable fees or horse transportation costs.
Because the stockbroker could not adequately demonstrate how his horse racing activities supported his ability to earn commission income as a stockbroker, he lost the case.
Jump forward 13 years and the same situation is presented to a new judge. This time, the stockbroker was able to demonstrate that 25 to 50% of his commission income was directly related to client contacts he had made through horse racing.
The judge in the current case also took a far more expansive view of what might be considered legitimate promotional expenses. His interpretation was that the act permitted the deduction of any reasonable expense that was incurred for the purpose of gaining or producing income from employment.
The judge also found the horse racing expenses to be more closely related to earning income in an area other than farming and, therefore, the restricted farm loss provisions of the act did not apply.
However, even after the second ruling, the stockbroker was still not fully in the clear. Although the judge allowed the deductibility of the expenses in principle, the stockbroker was still required to submit to a CRA audit to establish the actual amounts to be deducted.
No attempt was made in this decision to explain why horse racing expenses should get a more favourable treatment under the Act than other promotional expenses such as golf course memberships, yachts, club dues, meals and entertainment. Those expenses are either severely restricted or are not deductible at all.
One more unusual twist to this situation is that the judge who found against the stockbroker initially is now the boss of the judge who later found in favour of the stockbroker.