McLaws v. The Queen, 76 DTC 6005, [1976] CTC 15 (FCTD)

Addy, J:—Counsel for both parties were in agreement that the facts were not in dispute in any material respect but that the case would turn entirely on the interpretation to be given to those facts and on the conclusions of fact to be drawn therefrom rather than on the law itself.

For many years, the plaintiff, a lawyer by profession, has owned and operated together with his wife a farm on which they live. In conjunction with the running of the farm, they race thoroughbred horses and breed thoroughbreds for the purpose of racing although they originally bred horses for show purposes. This operation of the plaintiff and his wife is not in issue in any way in the present case.

Around 1961, the plaintiff, together with others, entered into a partnership under the name of “Priddis Stock Farms” for the purpose of racing their own horses and breeding thoroughbred horses in order to improve their line of racing horses. The partnership owned no assets except the horses. Those were boarded at the plaintiff’s farm. The plaintiff in return charged the partnership for the feeding, stabling, pasturing and care of the horses as well as for any expenses for veterinarian fees, stud fees, etc involved in carrying out the operation of the partnership. The partners were entitled to share equally in the profits and in the assets and were responsible equally for all losses.

The case at Bar concerns the losses incurred by the plaintiff through this partnership. By agreement between counsel at trial and all of the other members of the partnership, counsel for the plaintiff being also the legal representative of the other partners, it is understood that the outcome of the present case will be binding on the Department of National Revenue and on all of the other individual members of the partnership as to their respective appeals.

The partnership, since its inception, had sustained losses which the Department of National Revenue had allowed the partners to claim subject to the limitations of subsection 13(1) of the Income Tax Act (RSC 1952, c 148 as amended). The Department, however, in 1973, reassessed the plaintiffs 1970 Income Tax Return by disallowing deductions from income which the plaintiff had claimed as farming losses incurred by him as a partner in the Priddis Stock Farms partnership. The amount disallowed was $1,390.70 and it was disallowed on the grounds that the expenditures were personal or living expenses within the meaning of paragraph 139(1)(ae) and were not deductible in accordance with paragraph 12(1 )(h). Counsel for the defendant also argued that the expenses incurred were for property not being maintained in connection with a business carried on for profit or with a reasonable expectation of profit.

The relevant sections are reproduced hereunder:

Sec. 12. Deductions not allowed in computing Income.

(1) In computing income, no deduction shall be made in respect of

(a) General limitation.—an outlay or expense except to the extent that it was made or incurred by the taxpayer for the purpose of gaining or producing income from property or a business of the taxpayer,

(h) Personal or living expenses.—personal or living expenses of the taxpayer except travelling expenses (including the entire amount expended for meals and lodging) incurred by the taxpayer while away from home in the course of carrying on his business, . . . .

Sec. 13. Chief source of income.

(1) Where a taxpayer’s chief source of income for a taxation year is neither farming nor a combination of farming and some other source of income, his income for the year shall be deemed to be not less than his income from all sources other than farming minus the lesser of

(a) his farming loss for the year, or

(b) $2,500 plus the lesser of

(i) one-half of the amount by which his farming loss for the year exceeds $2,500, or

(ii) $2,500.

Sec. 139. Definitions.

(1) In this Act,

(ae) “Personal or living expenses."—“personal or living expenses” include

(i) the expenses of properties maintained by any person for the use or benefit of the taxpayer or any person connected with the taxpayer by blood relationship, marriage or adoption, and not maintained in connection with a business carried on for profit or with a reasonable expectation of profit, . . .

(p) “Farming."—“farming” includes tillage of the soil, livestock raising or exhibiting, maintaining of horses for racing, raising of poultry, fur farming, dairy farming, fruit growing and the keeping of bees, but does not include an office or employment under a person engaged in the business of farming;

With regard to the type of farm losses which are contemplated by income tax legislation, the statement of my brother Cattanach, J in the case of CBA Engineering Limited v MNR, [1971] CTC 504; 71 DTC 5282, is most helpful. He states at page 510 [5286]:

Section 13 contemplates three possibilities:

(1) the farming losses of a full-time farmer where farming is the chief source of income (or a combination of farming and something else) in which event all losses are deductible,

(2) farming losses incurred in a farming operation with the expectation of profit or the eventual expectation of profit but where farming is not the taxpayer’s chief source of income, nor part of it, in which event the deductibility of losses is limited by section 13, and

(3) an operation which is in the nature of a hobby, pastime or way of life, the losses from which are not deductible being personal or living expenses.

I agree with this classification as did Collier, J in Oscar Dorfman v MNR, [1972] CTC 151 at 154; 72 DTC 6131 at 6135.

It is clear that the present situation does not fit into the first category since the plaintiff, as a member of the partnership, was certainly not engaged in full-time farming and if the operation of the partnership is one of farming it must fit intc either the second or the third category.

As to whether the partnership is engaged in an endeavour of a farming nature as contemplated in the Act seems to be clearly estab- lished on a fair reading of paragraph 139(1)(p). The breeding and keeping of horses for racing purposes falls squarely within the meaning of “maintaining horses for racing” and therefore constitutes farming. In the case of R v Fred Juster, [1973] CTC 410; 73 DTC 5325, Cattanach, J again held that where a partnership was in the business of buying, selling and racing race-horses, it was farming within the meaning of paragraph 139(1)(p) even where it owned no other assets and did not actually care for the horses but had them cared for by others. The Juster decision, supra, was upheld by the Court of Appeal, the decision being reported in [1974] CTC 681 and 74 DTC 6540. The Court of Appeal there made it quite clear that the term “maintaining of horses for racing” was to be given a broad interpretation and, in the circumstances of that case, constituted farming. In the case at Bar, in addition to acquiring, keeping and disposing of horses by means of claim races, the partnership was also breeding horses and I therefore find no difficulty whatsoever in coming to the conclusion that the plaintiff was engaged with his other partners in a farming operation.

The only remaining point to decide is whether it was an operation being carried on with a reasonable expectation of profit. In other words, whether it falls in the second or in the third of the three categories mentioned in the CBA Engineering case, supra. Whether or not there was a reasonable expectation of profit is to be determined by an objective test and for that reason the actual performance of the partnership from a profit and loss standpoint over a period of years is a very important consideration. However, the status, capacity, experience, interest and actions of the partners are also to be taken into account especially in trying to establish whether the undertaking is a hobby or a commercial venture. As to its financial success, the partnership, since its inception, never showed a profit. This is illustrated by Exhibit 1 filed at trial. Yet, having regard to the total income and expenditures of the partnership, the losses were not unreasonable and very little additional luck in the various races by the partnership horses would have resulted in a favourable balance sheet. It is also important to note that the evidence established that the partnership was breeding horses in an attempt to build up its stable and improve the breed in order to attain greater success in racing, with resulting profits. There was also evidence adduced, which I accept, to the effect that the partnership broke up subsequently, in 1972, because there was a difference of opinion between the plaintiff and the other partners as to the amount of money which should be invested to immediately increase the number of racing horses held and thereby apparently improve the chances of the operation being a profitable one. The mere fact that the horse-racing enterprise was not an immediately profitable one is not too important if there is a prospect of profits being produced eventually as the operation improves. The question is whether there is a reasonable expectation of profits and the expectation need not relate to the immediate future. As to this, see R v Douglas C Matthews, [1974] CTC 230; 74 DTC 6193. In this respect the case at Bar is quite distinguishable on the facts from the case of Donald A Holley v MNR, [1973] CTC 539; 73 DTC 5417, where it was held that the operation did not have any commercial characteristics. The taxpayer who was living on the farm had expended some $50,000 during six years with a total return of only some $4,500. It was held that the expenditures were living expenses as the racing and selling of horses in this case constituted solely a hobby and formed in no way an enterprise with profit as one of the motivating factors.

In the case of MNR v Dr Jean Beaudin, [1964] CTC 70; 64 DTC 5077, where a medical practitioner who [sic] owned a horse and made considerable profit from it, Dumoulin, J accepted the doctor’s testimony that it was merely a hobby and not an adventure in the nature of trade and found that the income from the winning of races was not taxable. It is clear that this case, as often happens, turns entirely on its facts, the deciding factor being that the trial Judge accepted the taxpayer’s testimony and stated at page 5078 of the report:

l have discovered nothing in the evidence given before me which would allow me to question the witness’ (the taxpayer’s)* [1] testimony . . . .

Similarly in the case of Ernest C Hammond v MNR, [1971] CTC 663; 71 DTC 5389, Pratte, J came to the conclusion, where the taxpayer owned and raced a horse, that his winnings were not income. In that case, the taxpayer, who was 68 years of age, had suffered a stroke and had disposed of his very considerable business interests: He was dabbling in horses and by good fortune purchased a winner who very rapidly netted him some $335,000 in prize money. It was held that this was not taxable as the taxpayer was not engaged in a venture in the nature of a business; the learned Judge stated at page 667 [5392]:

The fact of purchasing and racing a horse is not, in Itself, a trading venture because it is not normally made with a view to profit.

But he was careful to add subsequently:

For this reason, purses won by a race horse cannot be considered as income from a business except In exceptional circumstances showing that the owner of the horse had so organized his activities that he was in fact conducting an enterprise of a commercial character.

He was also careful to insert at the beginning of his judgment (refer page 665 [5390] of the report) the following statement:

Counsel for the appellant and the respondent agreed that the question whether or not prize money won by horse racing Is taxable income admits different answers, depending on the facts of each case; more precisely, counsel for both parties agreed that such prize money is income only Inasmuch as the taxpayer’s racing activities are such that they can be considered as a business.

It is also of some importance in that case that the taxpayer was not breeding horses.

As I have previously stated, the status, capacity, experience, interests and actions of the partners are quite relevant in determining the issue of whether the operation constituted a business or a hobby.

The plaintiff is quite active in his law practice which involves chiefly corporation law. He is also a businessman, having been involved, throughout the years, with considerable financial success, in several commercial undertakings of various types. One of the other partners, George Crawford, has for some time, been interested in the oil business. He is also a lawyer engaged in a small way in a practice in partnership with another lawyer and also has various other business interests which have proven to be quite lucrative. He owns a large farm. The third partner, J Edward O’Connar, also owns a farm on which he raises cattle and standardbred horses. He is very interested in the Calgary Stampede and also has had and continues to have a wide range of financial interests. His principal occupation is that of business manager of a Calgary clinic. The fourth partner, one LC Blackburn, is semi-retired. He is also financially secure, having made his money in real estate. He is the only one of the partners who does not own a farm but he has, for some time, been actively interested in the Calgary Exhibition.

The partners in the case at Bar were not gamblers; there is undisputed evidence that they seldom bet and when they did it would be a matter of placing a $5 or a $10 bet. One of the partners, before he entered into the partnership, did not even know how to place a bet on a horse-race. Except for the plaintiff himself, who was charged generally with the administration and supervision of the undertaking, the partners did not make a habit of attending the races in which their horses were entered. Some of them rarely attended any such meets. lt is therefore difficult to understand how this undertaking could be classified as a hobby or as a source of amusement or entertainment for the partners. It would be reasonable to conclude that the partners, as very successful businessmen, would not be prone to spend their moneys without reason and the only possible motivation remaining for them to take part in the activities of the partnership would have been to make a profit.

I do not wish to imply that one cannot or must not find satisfaction, enjoyment, amusement or even intense pleasure from a trade, profession, calling or occupation which is clearly income-producing, for, wherever possible, every wise man should do his utmost to ensure that he will find these rewards in his daily work. But an absence or a near absence of any such reward would seem to point to another governing motive. It might even be said that, in the circumstances of the present case, the conclusion is obvious that the raison d’être of the partnership could be nothing else but the expectation of making a profit. As to its reasonableness, to hold that the expectation of future profits combined with the possibility of large purses, from what the partners must consider to be relatively small expenditures, does not constitute a reasonable expectation, would involve substituting my own business judgment to that of four extremely successful businessmen, without any real evidence to justify such a finding.

Having regard to the evidence as a whole, which substantiates the oral evidence of the plaintiff to the effect that the partners entered into and continued in their partnership for the purpose of making a profit from their race-horses, I must conclude that the expenditures were not personal or living expenses of the taxpayer as defined in paragraph 12(1 )(a) or 139(1)(ae) but were in fact incurred in connection with a business carried on with a reasonable expectation of profit and that the facts of the case place it squarely within the second category mentioned in the CBA Engineering case, supra.

The appeal is therefore allowed with costs and the whole is referred back to the Minister for reassessment to allow the deduction of the taxpayer’s proportion of the loss of the partnership in 1970 in accordance with subsection 13(1) of the Act.