The Queen v. Twigg, 96 DTC 6297, [1996] 3 CTC 135 (FCTD)

Wetston J.: — This is an appeal by way of trial de novo from a decision of the Tax Court of Canada, dated April 5, 1991, which allowed the defendant’s appeal from reassessments for the taxation years 1980, 1981, 1982, 1983, 1984, and 1985. The defendant, an accountant by profession, sought to deduct the full extent of the losses which he had incurred from his horse racing operation, known as River Ridge Farms. The Minister of National Revenue restricted to $5,000 per year the defendant’s losses from farming, in accordance with subsection 31(1) of the Income Tax Act (the “Act”), R.S.C. 1952, c. 148, as amended by S.C. 1970-71-72, c. 63, section 1, and subsequently. That provision reads as follows:

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 [the amount calculated according to a formula which, in effect, places a limit of $5,000 per year on the deductible farm losses].

Any loss in excess of the $5,000 limit becomes the taxpayer’s restricted farm losses for the year.

The plaintiff admits that the defendant had a reasonable expectation of profit from the operation of his farm. In essence, then, the plaintiff concedes that the defendant carried on a farming business, and was not a hobby farmer: Moldowan v. R., (sub nom. Moldowan v. Minister of National Revenue) [1978] 1 S.C.R. 480, [1977] C.T.C. 310, 77 D.T.C. 5213. The plaintiff submits that, at all relevant times, the defendant’s chief source of income for the taxation years in question was neither farming nor a combination of farming and accountancy. In this regard, the plaintiff argues that the defendant’s accounting business could not be viewed as subordinate or auxiliary to his farming operation.

The plaintiff further submits that this is not a “combination” case because subsection 31(1) of the Act requires that there be a connection between farming and the taxpayer’s other source of income; the two sources of income cannot simply be adjuncts to one another. According to the plaintiff, the accounting practice places very different demands on the defendant than does the farming operation. The absence of any connection between the two sources of income therefore precludes any consideration of them in combination. The plaintiff argues that the two businesses must be compared in order to determine which is the chief source of the defendant’s income. Nevertheless, the plaintiff does rely upon the assumption, inter alia, that farming was neither the centre of the defendant’s work routine, nor his major preoccupation, during the taxation years in question.

The defendant does not contend that farming was his chief source of income; rather, he argues that his chief source of income was a combination of farming and accountancy. In this respect, the defendant asserts that, at all relevant times, farming was the centre of his attention, and his major preoccupation.

Both parties agree that the leading case concerning farm losses continues to be Moldowan v. The Queen, supra. In that case, Dickson J. concluded that the Act as a whole envisages three classes of farmers. A taxpayer for whom farming may reasonably be expected to provide the bulk of his income, or form the centre of his work routine, is categorized as a Class I farmer. Such a taxpayer looks to farming for his livelihood. Even if he carries on a sideline business, it is subordinate to the farming operation, which must be his major preoccupation. A Class I farmer may deduct all of the farm losses which he has sustained in a year. A Class IT farmer, according to Moldowan, supra, is a taxpayer who does not look to farming, or to a combination of farming and some subordinate income source, for his livelihood or chief source of income; rather, such a taxpayer carries on farming as a sideline business, and not as a major preoccupation. Subsection 31(1) of the Act restricts the amount of farm losses which a Class II farmer may deduct. A Class III farmer is a hobby farmer, and is not at issue in the present case.

The defendant argues that he is a Class I farmer on the basis that farm- ing, in combination with his accounting practice, comprises his chief source of income. The plaintiff argues that the defendant is a Class II farmer because his accounting practice cannot be considered to be a sideline business or a subordinate source of income.

According to Dickson J. in Moldowan, supra, a taxpayer’s chief source of income is to be determined on a relative and objective basis. The analysis involves more than a purely quantitative measurement. The Court must consider the taxpayer’s ordinary mode and habit of work, and the reasonable expectation of income from among the various income sources. Such a consideration requires a comparison of three factors, namely, the time spent, the capital committed, and the actual and potential profitability, in relation to each of the taxpayer’s sources of income. It is clear that these factors are to be considered cumulatively, not disjunctively: Morrissey v. R., (sub nom. Canada v. Morrissey) (sub nom. Morrissey v. The Queen) [1989] 1 C.T.C. 235, (sub nom. R. v. Morrissey) 89 D.T.C. 5080 (F.C.A.) refusing leave to appeal Morrissey v. R. (sub nom. Morrissey v. Minister of National Revenue), 100 N.R. 157 (note) (S.C.C.), at pages 241-2 (D.T.C. 5084).

Where a taxpayer’s chief source of income is neither farming nor another revenue source, then it must be determined whether a combination of these sources constitutes the taxpayer’s chief source of income, so that he may be considered a Class I farmer. Such a determination requires more than a mere addition of the two or more income sources. As Dickson J. noted in Moldowan, supra, at C.T.C. page 488, farm losses in a combination case will not be fully deductible unless farming represents the taxpayer’s “major preoccupation”. Subsidiary interests will not restrict the Class I losses in a combination case; therefore, income from a sideline business is also permitted. However, where farming is not the taxpayer’s major preoccupation, or where the other business is not subsidiary or auxiliary to farming, the taxpayer’s chief source of income cannot be viewed as a combination of farming and another revenue source.

The taxpayer’s auxiliary interest, like his or her chief source of income, is also distinguished on a relative and objective basis by comparing the time spent, the capital committed, and the actual and potential profitability of the various income sources: Moldowan, supra. Thus, while quantitative measurements of farming income alone are not decisive, they are relevant, and cannot be ignored: Moldowan, supra', Morrissey, supra.

Prior to my analysis of the issues, I will deal with the plaintiff’s argument that a connection between the taxpayer’s various sources of income is required in a combination case before the taxpayer may be considered to be a Class I farmer. The plaintiff contends that the investment in the farm operation of income from a subsidiary business is insufficient to establish a connection between the two revenue sources. Stated somewhat differently, if the sources of income are competing for the taxpayer’s time and capital, they cannot constitute a combination within the meaning of subsection 31(1) of the Act. I see no basis, within either the provision or the case law, that would support such an approach. Justice Dickson was clear in Moldowan, supra, wherein he stated, at C.T.C. page 487, that “[t]he word connected is not found in section 13 [now section 31] of the present Act. ...[T]here is no reason why there must be such a limitation.” Indeed, Dickson J. noted that combination cases often involve a change in the taxpayer’s mode and habit of work, which may signify an imminent switch in his chief source of income, from one business or profession to another.

In the present case, the main issue is whether a combination of farming and accountancy can be considered to be the defendant’s chief source of income for the taxation years 1980 to 1985. Such a determination requires a relative and objective comparison of the criteria outlined in Moldowan, supra. If farming was not the defendant’s major preoccupation, in the sense that his accounting practice was not a mere sideline business, the farming and accounting businesses will not, in combination, be sufficient to establish the defendant as a Class I farmer within the meaning of subsection 31(1) of the Act. In addition to the case of Moldowan, supra, I have also considered the following decisions: Graham v. R., (sub nom. Graham v. The Queen), [1983] C.T.C. 370, 83 D.T.C. 5399 (F.C.T.D.), affirmed (sub nom. R. v. Graham), [1985] 1 C.T.C. 380, 85 D.T.C. 5256 (F.C.A.); Hadley v. R. (sub nom. Hadley v. The Queen), [1985] 1 C.T.C. 62, 85 D.T.C. 5058 (F.C.T.D.); Morrissey [supra]; Mohl v. R. (sub nom. Mohl v. Minister of National Revenue), [1989] 1 C.T.C. 425, 89 D.T.C. 5236 (F.C.T.D.); Cocks v. Minister of National Revenue, [1991] 2 C.T.C. 2023, 91 D.T.C. 688 (T.C.C.); Roney v. Minister of National Revenue, [1991] 1 C.T.C. 280 (sub nom. KR. v. Roney), 91 D.T.C. 5148 (F.C.A.); White v. Minister of National Revenue, [1991] 2 C.T.C. 331 (sub nom. White v. R.), 91 D.T.C. 5598 (F.C.T.D.); Poirier (Trustee of) v. Canada (sub nom. Poirier Estate v. R.), [1992] 2 C.T.C. 9, 92 D.T.C. 6335 (F.C.A.); Hover v. Minister of National Revenue, [1993] 1 C.T.C. 2585, 93 D.T.C. 98 (T.C.C.); and Timpson v. Minister of National Revenue, [1993] 2 C.T.C. 55 (sub nom. R. v. Timpson) 93 D.T.C. 5281 (F.C.A), leave to appeal refused (1994), 167 N.R. 240n (S.C.C.).

Firstly, with respect to the relative amounts of time which the defendant devoted to his farming operation and his accounting practice from 1980 to 1985, the evidence indicates a 60:40 ratio in favour of farming. The defendant clearly spent a large portion of his time at his farm. Although the exact hours which he dedicated to his farming business varied throughout the year, it appears that he generally spent four hours each morning at the farm, before beginning his work day at the accounting firm. For most of the taxation years in question, the plaintiff was totally involved in all aspects of his farming operation. He raced, bred, boarded, trained, bought, sold, and transported horses, while participating in the general upkeep of the farm. He also belonged to numerous horse-related associations, occupying executive positions therein, as well as a number of syndicates.

According to the testimony of Mr. Larry Safinuk, the defendant regularly arrived at the accounting firm in the late morning, around 11:00

a.m., and left later in the afternoon, around 4:00 p.m., on average. While the defendant did not put in full work days at his accounting practice, he nevertheless derived significant revenue from this source of income. The evidence suggests that this is a result of the experienced and competent employees who worked on a large portion of the defendant’s files. Apparently, the majority of the defendant’s work at the accounting firm involved attracting clients and overseeing the files that he delegated to his employees. The plaintiff did not belong to any accounting organizations, apart from the Institute of Chartered Accountants.

Although it appears that the defendant spent approximately sixty percent of his time at his farm, over the years 1980 to 1985, he still devoted a significant portion of his time to his accountancy. For example, there were greater demands placed upon the defendant’s farming operation in the spring, the season when foals are generally born. This was also a demanding time at the accounting firm, though, because of the coinciding income tax season. A comparison between relative time and energy spent on each income source does weigh in favour of the farming operation; however, there is no suggestion that virtually all of the defendant’s working hours were devoted to his farming operation. Time spent is obviously more than a quantitative matter. The defendant gave the impression, throughout his testimony, that accountancy was not paramount, from the perspective of both his time and his efforts. Despite the defendant’s dedication to farming, though, he clearly did not abandon his accounting practice.

Secondly, in regards to capital committed, the defendant clearly invested a great deal of money in his farming business in the years 1980 to 1985. During that time, the defendant acquired numerous items necessary for the operation of his farm, including farmland, paddocks, a barn, a tractor, a hay shelter, a mare’s shelter, a horse trailer, a water wagon, trucks, and a training track. Although unclear, the evidence suggests that the defendant had invested about $400,000 in his horse racing operation. In contrast, from 1980 to 1983, the defendant’s partnership equity in his accounting business was in a negative position. The defendant’s capital investment in the accounting practice was considerably less than his capital investment in the farm. Furthermore, much of the income which the defendant derived from accountancy was subsequently invested in his farming operation. Hence, there can be little doubt that the defendant’s accountancy income supplemented his farming business.

The plaintiff has suggested that the present case is not one in which a comparison of the amount of capital which the defendant committed to his various revenue sources is necessarily appropriate, as farming is a capital- intensive business, while accountancy is not. I do not accept this argument. The defendant could have operated a more highly capitalized accounting practice, had he wished to do so. The defendant clearly committed a great deal of capital to his farming operation, and invested much smaller amounts in his accounting business. On a relative and objective basis, the majority of the defendant’s capital commitments were made to his farming operation.

Thirdly, the defendant argued that his horse racing operation was potentially profitable. Initially, when he and his wife entered the business, in 1979 or 1980, they were only involved in the racing aspect of the industry ; they were not, at that time, interested in breeding horses. In 1981, the defendant determined that there was little chance of him succeeding in the horse racing industry by focussing solely on the racing side of the business. As a result, the defendant, in 1982, became involved in all three facets of the industry, i.e., breeding, boarding, and racing.

By 1984, the defendant’s full-service horse racing operation was well underway. The defendant experienced some success in 1984, with an increased income from racing. Although the defendant appears to be clearly knowledgable and proficient with respect to the horse racing industry, his counsel noted that his farming operation has frequently met with bad luck. In the opinion of the defendant’s counsel, this has prevented the defendant from generating many of the profits which his horse racing business could potentially have produced. As I indicated during the trial, however, I believe that it is less a question of luck; rather, it is a matter of the risky nature of the horse racing business, which is perhaps even riskier than other types of farming operations.

While the defendant acknowledged that horse racing is a risky business, he indicated that he took contingencies into account when developing his farming operation. He also argued that, in light of the risks inherent in the horse racing business, a comparison of the actual amount of profit generated by his farming and accountancy should not bear primary importance in the present case. In my view, however, the uncertain nature of the farming operation should be taken into account when determining the likelihood that the defendant will eventually look to farming for his livelihood: Mo Ido wan, supra, at pages 488-89 (C.T.C. 315-16).

The plaintiff argues that a comparison of the profit from the taxpayer’s various sources of income, though not determinative, cannot be ignored. In fact, according to the plaintiff, such a quantum comparison is a very important factor in the present case.

The defendant’s gross and net incomes from his various revenue sources, for the taxation years in issue, are contained in the following table:

As the above table illustrates, the defendant’s gross income from farming did increase, for the most part, over the period from 1980 to 1985; however, his farm losses increased at a much higher rate. While it may be useful to consider gross income in some situations, I am of the opinion that, for tax purposes, net income is a more appropriate barometer, particularly in cases dealing with chief source of income.

The defendant’s total losses from his farming operation, from 1976 to 1988, were in excess of $500,000; yet, there is no evidence to suggest that the defendant had any plans concerning how those losses would be absorbed. The defendant did indicate that he prepared financial projections; however, it seems that these were undertaken in order to obtain bank loans, apparently for the purpose of consolidating his debts.

Due to more than just start-up costs, the defendant was unable to realize a profit from farming during the taxation years in question. In fact, the defendant has achieved profitability only once: in 1992, a horse of his own breeding at River Ridge Farms-Josh’s Hero-was a winner at the Canadian Derby. This success was obviously the result of a skilful development program. The defendant contends that he would have had another profitable year, in 1986, but for an election taken under section 28 of the Act. While only Saskatchewan-bred horses can run in certain lucrative races in that province, it is clear that the purses in Saskatchewan are smaller than in other provinces, such as Alberta. The defendant testified that his objective was to earn $200,000 gross annually from his farm operation. Although he does race in other provinces, the evidence suggests that this expectation is unlikely. For example, of the approximately 1500 race horses running in Alberta, only five made over $100,000 in 1995. In Saskatoon, over 400 horses race, and no horse has ever made over $100,000. In contrast, the defendant’s net income from accountancy was consistent and, for various reasons, remained stable during the taxation years in question.

As noted earlier, the relevant criteria must be weighed objectively, and on a cumulative basis. The defendant clearly devoted a great deal of time and energy to his horse racing business, and invested considerable capital in his farming operation. However, he continued to rely on accountancy for the bulk of his income. In addition, it cannot be said that he was able to look to farming for his livelihood. The amount of time which the defendant continued to devote to his accounting practice, and its consistent and stable profitability, clearly suggest that accountancy could not be viewed as a sideline business, subordinate to the defendant’s farming operation, over the years 1980 to 1985.

In conclusion, the combination of farming and accountancy did not constitute the defendant’s chief source of income for the taxation years in question. Therefore, the appeal shall be allowed, and the reassessments for the years 1980, 1981, 1982, 1983, 1984, and 1985 shall be restored. There shall be no order as to costs.

Appeal allowed.