Rothgeb v. The Queen, 94 DTC 6703, [1995] 1 CTC 260 (FCTD)

Gibson 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 1977, 1978, 1979, and 1980 taxation years to $5,000 per year. For the years in question, the plaintiff had deducted losses of $27,672.04, $49,101.26, $44,300.42 and $43,474.93 respectively. The plaintiff also appeals from a decision of the Minister of National Revenue regarding the deductibility of certain interest charges allegedly related to rental income of the plaintiff. This second aspect of the plaintiff’s claim was abandoned before me. Counsel for the plaintiff acknowledged during argument that the Minister’s position with respect to the interest issue was correct. The issue regarding interest will, therefore, not be dealt with further in these reasons or in my judgment.

The relief claimed by the plaintiff is as follows:

-that the appeal be allowed;

-that the matter be referred back to the Honourable Minister of National Revenue for reassessment allowing in full the farm losses of the plaintiff for the taxation years 1977, 1978, 1979 and 1980; and

-costs.

The evidence

The plaintiff was born in 1933 in Hawaii, the son of United States citizens. His father’s career was with the American military. Throughout his youth and career the plaintiffs father was active in equestrian activities. He became a very successful rider. As well, the plaintiff’s mother and he and his siblings all participated in equestrian activities but, of the children, the plaintiff was the one who was most active. In fact, the plaintiff began riding at a very early age and was competing by the age of seven. His competitive activities and interest in horsemanship centred around the three olympic competitive disciplines of jumping, dressage and combined training or "three-day events”.

The plaintiff first met the woman who became his wife through involvement in equestrian activities. She, herself, was and remains a very active equestrienne and, in fact, her competitive successes during her career outstripped those of her husband, an admission he made during the course of his evidence with obvious respect and humility.

Throughout the early years of his married life, in New Mexico, Alaska, New Mexico again and New Jersey, in the vicinity of Princeton, he and his wife were active in equestrian affairs such as competitions, shows, training, of both horses and riders, judging, stewardship and association and club work. Wherever and however they were employed, they managed to continue their involvement in equestrian affairs and spent many hours in this involvement both as a revenue producing avocation, and occasionally vocation, and as an enjoyable pastime. It was not surprising, therefore, that their two children, as well, became ardent equestrians.

While in the Princeton, New Jersey region, the plaintiff first became employed on a full-time basis in the field of data processing. He remained in this employment for five years until 1966. At that time, the family moved to Montreal, where the plaintiff took employment with Canadair Limited. He continued his involvement in the data processing field at Canadair. The family continued its equestrian interests and activities in Montreal.' Two years later, the plaintiff and his family moved to the Ottawa region where he was employed, once again in the data processing industry, with Computel. That employment lasted for approximately one year after which the plaintiff and his family moved back to Montreal where the plaintiff had secured employment with the Bank of Montreal, once again in the data processing area.

In this second sojourn in Montreal, the plaintiff and his family became very actively involved with what I will describe as an equestrian centre established by a close friend in the county of Glengarry in eastern Ontario. It was in this period that the plaintiff and his wife began to formulate dreams and then plans of establishing themselves in an equestrian business. In 1971, they bought their own farm in Glengarry; 100 acres of rolling country side with limestone based soil and good native grasses, all features which they regarded as prerequisites for a good horse farm. The purchase was only made after approximately one year of searching. The "acreage” had the advantage of being close to Montreal, thus enabling the plaintiff to continue his employment with the Bank of Montreal. The "acreage” included a log house built in 1939 on a much older foundation and 90-year- old barn adapted to serving dairy cattle. The price paid for the property was $15,000. Additional funds and a good deal of manual labour were expended on converting the barn for occupation by horses and in improving the pastures, hay fields, drainage, water supply and roadways. No significant dollar amount or time was spent on improving the house.

During this period, as more time was spent in Glengarry county, the family moved to Pointe-Claire, a western suburb of Montreal, to make access to Glengarry easier. In April 1972, the family moved to the Glengarry farm site. The plaintiff and his two children commuted to Montreal daily, the plaintiff to his work, the two children to school.

The family had, for many years, had their own horses. They too, were installed at the farm and more horses were acquired. By 1974, the plaintiff had invested approximately a further $20,000 in the farm, which included the purchase of adjoining acreage with a second barn.

By 1972 or 1973, the plaintiff and his wife had settled their ambition to get into the horse farming business on a full-time basis. At the same time, while they were content that they knew about riding, coaching, teaching and training, they were not satisfied that they knew enough about horse farming and breeding. They concluded that the best place to expand their knowledge was in Europe. The plaintiff engaged in a job search. He found employment in Kuwait, in the banking area, and once again, in the data processing field. While in terms of location, it was not exactly what he had been looking for, he was satisfied that the nature of the employment would provide him a range of opportunity to spend time in Europe. He therefore accepted the Kuwaiti offer on the basis of a three-year full-time contract.

The plaintiff moved to Kuwait. His wife remained behind for a number of months to wind up their affairs in Glengarry county and to make arrangements for the care of those horses that they decided not to sell. One child was in university, the other followed to Kuwait where he spent one term in school and subsequently transferred to a school in Rome. Once the plaintiffs wife followed him to Kuwait, the two became very active in equestrian affairs in Kuwait. The opportunities to travel to Europe materialized. Every opportunity was exercised to visit equestrian facilities and farms and to talk with those knowledgeable in equestrian affairs and horse breeding and farming in association with the trips. On October 30, 1975, the plaintiff purchased a two-year-old Trakehner stallion. On July 5, 1976, he purchased a Trakehner mare. The plaintiff determined that these horses would constitute the base of the breeding operation on return to Canada with the objective of breeding, raising, training and marketing a superior class of animals for the jumping, dressage and combined training disciplines in North America.

The plaintiffs three-year contract in Kuwait expired early in 1977. He was offered an extension but was determined to return to Canada to commence his farm operation in earnest. By this stage, he estimated he had some $50,000 to $55,000 invested in the farm, the two Trakehner horses and their transportation to Canada, and farm buildings and equipment. He had approximately $20,000 in savings and his credit was good. He needed proper stables and an indoor riding hall. He was satisfied that his savings would be sufficient to provide for the stables and riding hall.

He returned to Canada on March 3, 1977. He worked exclusively on establishing his farm in the second quarter of that year. In recognition that the farm would not support itself and his family in the early years, he relied upon his 17 years of experience in data processing to establish himself as a freelance consultant, operating from his home.

His forecast of expenditures in connection with the farm proved to be low. His forecasts in income from stud fees, boarding of mares and sale of horses proved to be high. Costs were influenced by higher than expected energy costs and interest rates. Revenues reflected the difficult economic climate into which he had returned. He was fortunate that he had entered into a field of freelance consultancy at a time when his particular knowledge and skills were in demand. He was able to carry on his consulting work, commuting primarily to Ottawa and to Montreal and working at the farmhouse. He turned down contracts for consulting that would keep him away from the farm for too much time. According to his own estimates, he spent more time on his farm work than on consulting. However, on a more conservative estimate, the time spent in his two areas of work was most likely about equal in 1978 and 1979.

The plaintiff and his wife continued to operate the farm until 1988 when operations ceased. The plaintiff continued, until at least the end of 1992, to operate his consulting business on a very successful basis.

Two independent witnesses, a Glengarry veterinarian who first provided services to the plaintiff in 1978, and the director of dressage for the Canadian Equestrian Federation, a resident of Kars, Ontario, a national and international judge for dressage and a family friend of the plaintiff and his family, testified as to the commitment and work ethic of the plaintiff and his professionalism and, in the case of the latter, as to the success of some of the horses bred at the plaintiff’s farm and the fine reputation of the plaintiff and his wife throughout the relevant element of the equestrian community.

The law

The relevant provision of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the ’'Act"), as it read for the 1978 to 1980 taxation years of the plaintiff, was section 31. It was in the following terms:

31(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, for the purposes of sections 3 and 111 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) 1/2 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 subparagraph (a)(i) exceeds the amount determined under subparagraph (a)(ii) is the taxpayer’s "restricted farm loss" for the year.

(2) For the purposes of this section, the Minister may determine that 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. [1]

The guiding principles in the interpretation and application of the foregoing provision were enunciated by Dickson J. (as he then was) in Moldowan v. The Queen, [1978] 1 S.C.R. 480, [1977] C.T.C. 310, 77 D.T.C. 5213. Dickson J. was there dealing with section 13 of the Income Tax Act as it related to the 1968 and 1969 taxation years of the appellant in that case. It was common ground between Counsel before me that, for all purposes relevant to this appeal, the substance of section 31 as quoted above was the same as its predecessor provisions including section 13 as it was before the Supreme Court of Canada in the Moldowan case. In the opening paragraphs of his reasons in Moldowan, Dickson J. described the then subsection 13(1) as “an awkwardly worded and intractable section and the source of much debate." He summarized its substance on the facts of the case before him, in the following terms at page 482 (C.T.C. 311, D.T.C. 5214):

The effect of subsection 13(1) is to limit to $5,000 the farming losses which a taxpayer may claim as a deduction in a taxation year. The appellant’s farming losses exceeded this amount in the years 1968 and 1969. He contends that his chief source of income for those taxation years was either farming or a combination of farming and some other source of income, and therefore the constraint of the subsection does not apply to him.

The plaintiff here presented precisely the same contention in respect of his 1977 to 1980 taxation years inclusive. The defendant, by contrast, contends that the constraint of the section does apply to the plaintiff and therefore the plaintiff is limited to a deduction of $5,000 in respect of farming losses for each of the taxation years in question.

In Graham v. The Queen, [1983] C.T.C. 370, 83 D.T.C. 5399 (F.C.T.D.) affirmed on appeal at [1985] 1 C.T.C. 380, 85 D.T.C. 5256 (F.C.A.), Cattanach J., referring to Mr. Justice Dickson in Moldowan, stated at page 371 (D.T.C. 5401):

he made the valiant effort to make sense out of language where no sense existed.

Section 13 is now section 31 but the material language thereof is unchanged.

The issue here then, paraphrased from Moldowan, is whether the farming business carried on by the plaintiff in the years 1977 to 1980 was his chief source of income or whether it, in combination with another source, was his chief source of income. Mr. Justice Dickson went on at page 486 (C.T.C. 314, D.T.C. 5215-16) of Moldowan to state:

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 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.

At page 487-88 (C.T.C. 315, D.T.C. 5216), Mr. Justice Dickson continued in the following terms:

In my opinion, the Income Tax Act as a whole envisages three classes of farmers:

1. a taxpayer, for whom farming may reasonably be expected to provide the bulk of income or the centre of work routine. Such a taxpayer, who looks to farming for his livelihood, is free of the limitation of subsection 13(1) in those years in which he sustains a farming loss.

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. Such a taxpayer is entitled to the deductions spelled out in subsection 13(1) in respect of farming losses.

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 a hobby. The losses sustained by such a taxpayer on his non-business farming are not deductible in any amount.

The reference in subsection 13(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). It 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 side-line 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. While a quantum measurement of farming income is relevant, it is not alone decisive. The test is again both relative and objective, and one may employ the criteria indicative of "chief source" to distinguish whether or not the interest is auxiliary. A man who has farmed all of his life does not become disentitled to class (1) classification simply because he comes into an inheritance. On the other hand, a man who changes occupational direction and commits his energies and capital to farming as a main expectation of income is not disentitled to deduct the full impact of start-up costs.

Analysis

It was not disputed before me that, in the taxation years here at issue, the plaintiff was engaged in farming. Nor was it disputed that, for each of those taxation years, the plaintiff incurred a loss in his farming business. Finally, it was not disputed before me that the plaintiff’s farming operations were "a” source of income in the taxation years in question.

There can be no doubt on the evidence before me that the plaintiff’s preoccupation was farming. Though the evidence as to time spent, as between his consultancy business and farming was disputed and inconclusive, I conclude that he spent at least equal time on his farming business. He committed all of his capital and his credit, with what some might describe as reckless abandon, to his farming business. He relied on his consultancy business as a "cash cow" to help support the farm. The profitability of his consultancy business far exceeded that of his farm business and events subsequent to the taxation years here in question established that that con- tinned to be the case. [2] Despite the evidence of the plaintiff, the credibility of which was not questioned and which I certainly do not question, that he would have spent more time, to the point of all of his time, on the farming business if he could have afforded it, there was no evidence before me on which I could possibly have concluded that an expectation of profit from the farm for the years in question or for those within a reasonable time thereafter was realistic.

In Poirier Estate v. The Queen, [1992] 2 C.T.C. 9, 92 D.T.C. 6335 (F.C.A.), Mr. Justice MacGuigan speaking for the Court stated at page 10 (D.T.C. 6336):

The learned judge here seems to suggest that farming income can be combined with, in the sense of supplemented by, another source of income in order to constitute a chief source of income. It is clear from Moldowan v. The Queen, [1978] 1 S.C.R. 480, [1977] C.T.C. 310, 77 D.T.C. 5213, at page 487 (C.T.C. 314, D.T.C. 5216), that the word "combination" in subsection 31(1) is not to be read in that sense. It is also now clear that what is required for a determination that farming is a chief source of income is a favourable comparison of farming with the other source of income as to such matters as the time spent, the capital committed, and the profitability, both actual and potential: The Queen v. Connell, [1988] 1 C.T.C. 247, 88 D.T.C. 6166 (Strayer J.), approved on that point by this Court in A-341-88 (decided January 16, 1992). Court of Appeal decision reported at [1992] 1 C.T.C. 182, 92 D.T.C. 6134.

In The Queen v. Timpson, [1993] 2 C.T.C. 55, 93 D.T.C. 5281 (F.C.A.), once again, Mr. Justice MacGuigan, speaking for the Federal Court of Appeal, stated at page 56 (D.T.C. 5282):

The trial judge limited his examination solely to the question of the taxpayer’s reasonable expectation of profit....

I am satisfied on the evidence here that the plaintiff had a "reasonable expectation of profit". Most assuredly this profit did not arise as soon as the plaintiff predicted but the market, the high interest rates and the time required to gain credibility all conspired to delay what he had every right to expect-a profit.

But this consideration gets, at best, only to a finding that farming is "a source of income", not that it is "a chief source of income," as required by subsection 31(1) of the Income Tax Act.

It is now beyond question that the tripartite test established in Mo Ido wan is conjunctive, not disjunctive. Further, a reasonable expectation of profit alone is only sufficient to support a finding that farming is "a source of income” rather than "a chief source of income".

On the facts before me, the actual profitability of the plaintiffs farming business was clearly in a subordinate position to that of his consulting business. Time has proven, unfortunately, that the same was true of the potential profitability of the two businesses. Time invested was roughly equal. Capital invested in the farming business far exceeded that which was invested in the consulting business. However, I feel compelled not to disregard the fact that while the plaintiff had invested considerable time throughout his life to developing his expertise in relation to horses and equestrian affairs and later in relation to horse farming, he had also devoted considerable time and effort, over a period of some 17 years, to developing an expertise in data processing, an expertise which proved to be considerably more marketable in the taxation years here in question and subsequent taxation years than his expertise in horses and horse farming. I am satisfied that these elements of relative "investment” must be considered.

On the basis of the foregoing analysis, I conclude, with some regret because I cannot help but have great sympathy for the earnestness and commitment that the plaintiff demonstrated throughout his testimony before me, that this appeal must fail. Against the test as stated in Mo Ido wan, the plaintiff has failed to establish that, for the taxation years at issue, he was a taxpayer for whom farming might reasonably be expected to provide the bulk of income or the centre of work routine.

While costs would normally follow the event I am not satisfied that is an appropriate disposition on the basis of the facts and argument before me. There will be no order as to costs.

Appeal dismissed.