Gordon v. The Queen, 86 DTC 6426, [1986] 2 CTC 280 (FCTD), aff'd 89 DTC 5481 (FCA)

Reed, J.:—The plaintiff appeals from a decision of the Minister of National Revenue which restricted the farm losses the plaintiff can deduct from his income for the 1979, 1980, 1981 and 1982 taxation years to $5,000 per year. For the years in question the plaintiff had deducted losses of $49,153.84, $45,296.69, $87,273.58 and $58,787, respectively.

The plaintiff grew up on his parents' farm in Alberta. This was a mixed- farming operation involving beef cattle, dairy cattle, and the cultivation of grain. He worked on that farm, as many children of farmers do, having significant responsibilities therefor during a two-year period when his father worked off the farm.

In 1968 he left the family farm. He had at that time been working in construction, off the farm, for the previous five years. This work was initially as a labourer in pipeline construction. He had, by 1968 become specialized as a pipefitter and by that time had also obtained jobs with supervisory responsibilities as foreman. His pattern of work involved employment by different employers (construction companies) on a job by job basis. The jobs were of varying lengths: three weeks, six weeks, three months. In between jobs he collected unemployment insurance. The pattern of employment was irregular. On the average, as a total during a year he would spend five to seven months working. (I would indicate this was the pattern of work in the industry; it was not particular to the plaintiff). The construction jobs were located at various places in Alberta, Saskatchewan, British Columbia, one or more at least in Ontario and on one occasion he had a job in India for six months.

In 1978 he decided to buy a farm. In that year his employment income was $35,682. While referred to as modest, it was, for 1978, a reasonably handsome salary. He purchased a 162-acre farm, 40 miles north of Kamloops. The price was $120,000. A down payment of $40,000 was made, the rest of the price was financed by two mortgages, one from the bank, the other taken back by the vendor. The down payment came from the plaintiffs savings, a loan from his father-in-law and a loan (?) using his then present home in Kamloops as collateral. The Kamloops home was eventually sold and the family moved onto the farm.

The plaintiff gave as his reasons for purchasing the farm: the instability of his employment income; a desire to develop a second source of income especially for the future; a desire to be closer to his family. At the time of the purchase, he had just returned from the six-month job in India. He stated that he contemplated leaving the construction industry if, in order to obtain employment, he was forced to be so far away from his family again. I treat the last explanation with some degree of skepticism the nature of his job was such that it took him away from his family for long periods of time; the salary was handsome. I accept, however, that in purchasing the farm he was not merely seeking a way to create tax losses. The nature of his employment was such that he had time which could be devoted to the development of a second source of income. His farm background obviously made his choice a natural one. The acquisition and development of a farm, as he indicated, would create “something for the future”. It would create an option for him should the construction employment "dry up”.

Pipeline construction did not "dry up”. Wage rates in the industry increased remarkably and the plaintiff found himself during 1979, 1980, 1981 and 1982 (the taxation years in question) earning $67,479, $60,426, $129,287 and $169,560 respectively. Since that time his salary has levelled off to approximately $100,000 a year. His evidence was that during the whole time his pattern of work was not different from the earlier years, i.e. he continued to be employed on a job by job basis with significant periods of "down” time between jobs. The total time on the job was still five to seven months per year. He moved from being foreman to the position of assistant superintendent and eventually superintendent. Since 1983 he has been a permanent employee of one of the construction firms receiving a base salary whether or not he is called upon to work on a constuction job. When working on a construction job an amount additional to the base salary is paid. The time demands of this job are still no different than previously.

The plaintiff's farming operation is a cow-calf operation. This involves keeping a herd of cows, breeding them, raising the calves from the spring in which they are born through to the fall and then selling them. More attention to the farm is required, obviously, at certain times of year (e.g. for two months in the spring during calving time and then later when the hay is harvested; a week in June, another in August and a third in September). There appeared to be some flexibility whereby the plaintiff could "work” his construction jobs around these busy farm periods. If forced to choose, however, it is obvious the plaintiff would give priority to the construction work and arrange for someone else to take responsibility for the farm.

The plaintiff has, since purchasing the farm in 1978, made improvements to it: cross fencing, new corrals, garages, workshops; more land has been cleared doubling the amount of pasture land available and increasing by ten acres that available for hay; some extra land in recent years has been leased to provide additional pasture and hay.

The plaintiff in 1978 purchased 45 head of cattle. The size of the basic herd has increased somewhat over the years (in 1982 it numbered 51; in 1985 it numbered 56). While starting in 1978 with grade cattle and a Hereford bull, the plaintiff in 1981 decided to work towards the development of a purebred Charolais herd. He purchased a Charolais bull in that year and subsequently some Charolais cows. He states that he hopes to have converted his herd to purebred Charolais in another couple of years.

The capital requirements of any farming operation, as is well known, are considerable. A schedule indicates that the total funds invested in the farm operations as a percentage of the plaintiff’s total cash receipts over the 1978 to 1985 period is 54 per cent. The “total funds invested” figure set out in the schedule is composed of the $120,000 cost of the farm (consequently the annual mortgage costs are not included), annual farm expenses, capital additions and livestock purchases. Counsel for the plaintiff notes that this constitutes a significant capital commitment by the taxpayer. The farm, of course, is also the family’s home.

Subsection 31(1) of the Income Tax Act provides:

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, for the purposes of sections 3 and 11 his loss, if any, for the year from all farming businesses carried on by him shall be deemed to be the aggregate of

(a) the lesser of

(i) the amount by which the aggregate of his losses for the year, determined without reference to this section and before making any deduction under section 37 or 37.1, from all farming businesses carried on by him exceeds the aggregate of his incomes for the year, so determined from all such businesses, and

(ii) $2,500 plus the lesser of

(A) /2 of the amount by which the amount determined under subparagraph (i) exceeds $2,500, and

(B) $2,500, and

(b) the amount, if any, by which

(i) the amount that would be determined under subparagraph (a)(i) if it were read as though the words “and before making any deduction under section 37 or 37.1” were deleted,

exceeds

(ii) the amount determined under subparagraph (a)(i);

and for the purposes of this Act the amount, if any, by which the amount determined under the subparagraph (a)(i) exceeds the amount determined under subparagraph (a)(ii) is the taxpayer's “restricted farm loss” for the year.

As has often been noted this section is frustratingly convoluted in its wording. I cannot conceal a considerable degree of rage at being required to apply this section to the circumstances of a taxpayer. How can a taxpayer be expected to know what his tax liability is by reference to subsection 31(1). Surely, there is an obligation to frame taxing laws, despite all their complexity, in clearer terms than this.

In any event, other Courts have had less difficulty than I and have managed to apply the section. I take as the starting point the decision of the Supreme Court in Moldowan v. The Queen, [1977] C.T.C. 310; 77 D.T.C. 5213. In that case it was noted that the Income Tax Act envisages three classes of farmers:

(1) a taxpayer, from whom farming may reasonably be expected to provide the bulk of income or the centre of work routine . . .

(2) the taxpayer who does not look to farming, or to farming and some subordinate source of income, for his livelihood but carried on farming as a sideline business . . .

(3) the taxpayer who does not look to farming, or to farming and some subordinate source of income, for his livelihood and who carried on some farming activities as a hobby . . .

The third category is not relevant for the purposes of this case. To determine whether a person falls within the full loss category (category 1) or the restricted loss category (category 2), the Moldowan decision indicates that it is necessary to determine whether the taxpayer's “chief source of income" is farming. Thus the words “nor a combination of farming and some other source" in subsection 31(1) would appear to be superfluous; one looks in either case to the “chief source of income". At 315 (D.T.C. 5216) of the Moldowan decision it is stated:

The reference in subsection 13(1) [now s. 31(1)] to a taxpayer whose source of income is a combination of farming and some other source of income is a reference to class (1). /t contemplates a man whose major preoccupation is farming, but it recognizes that such a man may have other pecuniary interests as well, such

as income from investments, or income from a sideline employment or business. The section provides that these subsidiary interests will not place the taxpayer in class (2) and thereby limit the deductibility of any loss which may be suffered to $5,000.

[Emphasis added.]

The factors to be considered in determining chief source of income were discussed at 314 (D.T.C. 5215-16):

Whether a source of income is a taxpayer's “chief source” of income is both a relative and objective test. It is decidedly not a pure quantum measurement. A man who has farmed all of his life does not cease to have his chief source of income from farming because he unexpectedly wins a lottery. The distinguishing features of “chief source” are the taxpayer's reasonable expectation of income from his various revenue sources and his ordinary mode and habit of work. These may be tested by considering, inter alia in relation to a source of income, the time spent, the capital committed, the profitability both actual and potential. A change in the taxpayer's mode and habit of work or reasonable expectations may signify a change in the chief source, but that is a question of fact in the circumstances.

[Emphasis added.]

In considering these factors in the present case, I discount first of all the quantum difference between the plaintiffs employment income and his farm revenue (there was of course no net farm income). The comparison of time spent on the two endeavours in this case is somewhat difficult to make, since the farm was also the taxpayer's home. Not all the time spent there would be spent on farm business. While the winter months would neither require nor allow extensive farm work, at other periods of the year (calving, haying) more than an eight-hour day would be put in. When the plaintiff was away from home on a construction job he would not be available for farm work at all, although he gave evidence that the practice was to return home on long weekends when possible. In so far as time spent is concerned I conclude that the plaintiff spent almost equal amounts of time in the two endeavours.

Obviously, there was a much greater capital commitment to the farm than to the construction work. But this factor, as a factor of comparison, is not useful in the present case; employment income by its nature does not usually require much capital commitment. The capital commitment has some significance, as it pertains to the plaintiff's intentions or expectations.

With respect to profitability both actual and potential there is, of course, no actual profitability. Indeed the losses have been more or less consistent over an eight-year period. One cannot see a steady decline as one would expect if the taxpayer were making a concerted effort to make the farming operation profitable. One cannot classify a significant proportion of the expenses as what might be called “start-up” expenses — many are of an ongoing nature.

Evidence was given that part of the unprofitability of the farming operation was due to an unexpected decline in beef prices through the years in question. I cannot accept that the decline in beef prices between 1980 and 1984 was something that should have been totally unexpected and unanticipated. I note that there was no independent evidence called concerning the state of the market in 1978. There was no independent evidence as to what would have been the reasonable expectations of a farmer with respect to beef prices in 1978. This is not a case such as Hadley v. The Queen, [1985] 1 C.T.C. 62; 85 D.T.C. 5058 (F.C.T.D.) where evidence was led demonstrating that at the time the taxpayer purchased his farm (1972) the profitability of the beef market was buoyant with prices having risen continually during the previous six or seven years.

A table of projected profitability was prepared by the plaintiff. It projects a profit for 1986 of between $13,936 to $17,000. A continued profit is projected for the years following in the order of $30,000 for each year. These projections are based on three modifications to the plaintiff’s existing operation: (1) no amount is included in the computation of expenses, for depreciation; (2) it is assumed that the mortgages on the farm will be paid off (the plaintiff asserts that this could be accomplished by applying the tax refunds which would become available if he is successful in this case);

(3) no amount is deducted as management fee to his father-in-law or wife (it is assumed the plaintiff will be on the farm full time and not need to make those expenditures).

I cannot give this projection of profitability much weight. In the first place, it assumes the taxpayer will forfeit an employment income of approximately $100,000 a year for a farm income in the neighborhood of $30,000. In the second place, there is no independent evidence supporting it. There is no independent evidence before me that a cow-calf operation of the size and nature of that carried on by the plantiff should be expected to be economically viable or profitable.

What then of the evidence respecting “a change in mode or habit of work or reasonable expectations”. The Moldowan decision indicates that these may demonstrate a change in the taxpayer's chief source of income. There was obviously a change in the plaintiff’s mode and habit of work from pre-farm days to post-farm days. But, this is not one of those cases in which a taxpayer has retained his employment income in order to acquire the capital to build up a farm*. [1] I can find no crystallized intention in this case on the part of the taxpayer to change his chief source of income from employment to farming. In my view, the plaintiff's acquisition and subsequent development of the farm was in the nature of creating an option for the future. I can conclude no more than that the taxpayer created for himself the possibility of moving into farming, as his chief source of income “some time down the road”, should construction employment not be avail- able, or, should some other eventuality occur which would make this an attractive course of action.

Counsel for the plaintiff argues, however, that it is not the change from one chief source (employment) to another chief source (farming) that is required in order to be entitled to full farm losses. She argues that in this case the change evidenced the creation of a second chief source of income and that this fits within the holding of the Moldowan case and the subsequent jurisprudence. It is argued that the taxpayer in this case had two equal chief sources of income. It is argued that this is evidenced by his mode and habit of work and reasonable expectations.

I accept the argument made by counsel for the plaintiff that the tests set out in the Moldowan case were not expressed to be exhaustive (page 314 (D.T.C. 5215) of that decision) and that one should not treat the text of the Moldowan decision as legislation. I refer, in this regard, to the comments of my colleague, Mr. Justice Joyal, in the Hadley case (supra) at 69 (D.T.C. 5064). I have considered the recent jurisprudence on the issue of farm losses cited to me by counsel: Graham v. The Queen, (supra) confirmed on appeal [1985] 1 C.T.C. 380; 85 D.T.C. 5257 (F.C.A.); Hadley v. The Queen, (supra); Poirier Estate v. The Queen, [1986] 1 C.T.C. 308; 86 D.T.C. 6124 (F.C.T.D.); McCambridge v. M.N.R., [1981] C.T.C. 2314; 81 D.T.C. 251 (T.R.B.), Auffrey v. M.N.R., [1984] C.T.C. 3002; 84 D.T.C. 1808 (T.C.C.); Knaak v. M.N.R., [1984] C.T.C. 2460; 84 D.T.C. 1397 (T.C.C.); Rivers v. M.N.R., [1984] C.T.C. 2933; 84 D.T.C. 1802 (T.C.C.); Hunter v. M.N.R., [1985] 1 C.T.C. 2440; 85 D.T.C. 404 (T.C.C.); Laufer v. M.N.R., [1984] C.T.C. 3052; 85 D.T.C. 16 (T.C.C.); and Bender v. M.N.R., [1986] 1 C.T.C. 2437; 86 D.T.C. 1291 (T.C.C.). I quote from some of them.

In the Graham case the taxpayer worked full time for Ontario Hydro but he also worked full time on his farm. Mr. Justice Urie, writing the majority decision, stated, at 383 (D.T.C. 5259):

. . . It seems to me, therefore, that one of the issues with which the Court must deal in this appeal is whether or not it is possible, in the rather unusual circumstances of this case, for a person to have employment in two full-time occupations at the same time, . . .

[Emphasis added]

Implicit in the Court's decision is an affirmative answer. In the Hadley decision, at 69 (D.T.C. 5064), Mr. Justice Joyal noted that in the circumstances of that case:

The substantial investment made by the Plaintiff could not possible have been made with[out] a serious intention of achieving profitability.

[Emphasis added]

In the Poirier case, the Associate Chief Justice said at 312 (D.T.C. 6127):

The facts satisfy me that Poirier’s investment of time and money was of such a magnitude that his operation was stamped from the start as a business. Furthermore, a business not only with a reasonable expectation of profit in the near future, but a profit that would compare with his other sources of income. . . .

[Emphasis added]

In Auffrey at 3004 (D.T.C. 1810):

. . . it can fairly be said that the Appellant has established that his cattle farming was not a sideline business or a subsidiary interest for 1979. . . .

In the Rivers case it was said, at 2934 (D.T.C. 1804):

The appellant’s planning, statistical and evident business-like approach to his sheep farming business (Exhibits A-3, A-7 and A-8) are indicative of his keen ana- lytical abilities and knowledge in relation thereto and were reflective of his position that farming was not just a sideline or subsidiary business.

[Emphasis added]

With this jurisprudence in mind, I have come to the conclusion that even if I accept counsel's argument, that it is possible for a taxpayer to have two chief sources of income, I could not classify the plaintiff's farming activity as having the requisite characteristics. In my view, the plaintiff's farming activity does not have the characteristics which would allow it to be considered anything other than a sideline or subsidiary business.

In response to may request, counsel for the defendant provided me with the following sources as giving some indication of the history and purpose behind the restricted loss provision: Bert James v. M.N.R., [1973] C.T.C. 457 at 465-70; 73 D.T.C. 5333 at 5338-42; the Report of the Royal Commission on Taxation, Vol. 4 (1966) (Carter Commission Report) with respect to “hobby farming" at pages 446-48 of that report; Report of the Royal Commission on Taxation of Profits and Income, Final Report (Cmnd. 9474, 1955) (Radcliffe Commission Report) at pages 148-50. What emerges from those sources is a concern that taxpayers (especially those who enjoy a substantial income from other sources) may be prepared to carry on a farming business with a certain degree of indifference towards the losses incurred. This indifference arises out of, for example, the fact that the farm losses may be carried at the marginal rate of tax on other income; the recreational and personal life style provided by the farm environment is attractive; farm land often carries with it potential for future land development; an asset is often created out of what would otherwise be a highly taxed income. It seems to me a significant factor, whether one be talking about the hobby farmer or the part- time farmer, is a consideration of whether or not the business is being carried on on a commercial basis with a determination to make the business profitable as soon as possible.

I return to the Moldowan case. Mr. Justice Dickson indicated that indicia of a “chief source” were the taxpayer's reasonable expectations and his ordinary mode and habit of life. The plaintiff’s mode of life, in this case, is to give priority, if he has to, to his employment income. However, by virtue of the nature of that employment he had extensive time available for farming. In this case “mode and habit of life” is a neutral factor. But, I cannot find that his “reasonable expectations” were anything other than to treat the farming business as a sideline. I cannot find, in the words of the Hadley decision “a serious intention of achieving profitability”. The evidence demonstrates that the business was marking time; one year's losses were much like the next. There is no independent evidence that the farm in its conception and operation was economically viable. And, a crucial fact, to which I have not heretofore made reference, demonstrates, in my view, the taxpayer's reasonable expectations. This fact is his entry, in 1982, into the business of breeding and running race horses. This was a significant. factor in the farm losses claimed for that year. He chose to embark on this risky business endeavour which, as is well known, is loss prone. He indicated in evidence that he did so because he had some extra cash available. He chose not to pay down the debt load on his cow-calf operation. This, in my view, demonstrates an intention to treat the farm operation as a sideline business. I conclude, from the size and scale of the operation, the actual profit and loss experience, the projected profit and loss experience and the intention of the taxpayer as demonstrated by his conduct that the operation was a sideline business.

An alternative argument is put forward with respect to the plaintiffs horse-race breeding and racing interests. These were undertaken in partnership with a Mr. Bishop. Counsel argues that: the sole business of that partnership was the breeding and running of racehorses; paragraph 96(1 )(a) of the Income Tax Act provides that a partner's income from a partnership is to be “computed as if the partnership were a separate person’; thus subsection 31(1) of the Act is to be applied in computing income at the partnership level; since the only business of the partnership, in this case, was the racehorse business all losses arising from that business are brought into the computation and flow through to the plaintiff (i.e. the plaintiffs one-half of the losses). It is argued that if it had been intended to exclude subsection 31(1) from the computation of income detailed in section 96 this would have been expressly so provided. Express exclusions are found, for example, in paragraphs 96(1 )(d) and (e) and subparagraph 53(2)(c)(i).

I think the preferable interpretation is that argued by counsel for the defendant. The partnership loss or income flows through to the individual, retaining its characteristics in respect of its sources. The total income of each partner individually then determines whether or not subsection 31(1) is applicable to them. The partnership is not a taxpayer. The income is not taxed in the partnership's hands; it is taxed in the hands of the partners. Subsection 31(1) applies to a “taxpayer".

It is obvious from the foregoing that the plaintiff's action must be dismissed. I come to this conclusion with some degree of regret. If I did not have the Moldowan decision and decisions of the Federal Court of Appeal binding upon me, I would be tempted to interpret subsection 31(1) as too convoluted, vague and imprecise to be capable of application.

Action dismissed.