Madronich v. The Queen, 89 DTC 5093, [1989] 1 CTC 247 (FCTD)

McNair, J.:—The plaintiff's action is an appeal from income tax reassessments disallowing the following losses claimed in respect of tree farm operations during the taxation years in question:

The broad issue of the case is whether the tree farm operations of the plaintiff constitute the carrying on of a business within the meaning of the relevant provisions of the Income Tax Act.

The plaintiff was employed in a full-time capacity as plumbing supervisor by Zentil Plumbing & Heating Co. He was born in Yugoslavia, emigrated to this country when he was 16 years of age, and by dint of perseverance and hard work eventually became qualified in his trade. He had some experience in farming acquired from his early years in Yugoslavia and while boarding at his uncle's farm near Beamsville, Ontario, after coming to Canada. The plaintiff resides with his family in Mississauga, Ontario. In April 1975 the plaintiff purchased a 20.11-acre parcel of unimproved land near Orangeville in the Township of Amaranth, Ontario. The land forming the site of the Orangeville plantation was wet and swampy and required extensive draining. The Orangeville property is about 45 minutes’ drive from the plaintiff's home in Mississauga. The plaintiff decided in or about the year 1975 to utilize the Orangeville property as a tree farm for growing red pine, white spruce, white cedar and other merchantable trees.

Initially, the plaintiff rented equipment for doing the trenching work on the Orangeville property. In 1975 the plaintiff purchased a backhoe to facilitate the construction of roads and the digging of drainage ditches. The plaintiff's employment with Zentil only left weekends and holidays free for working on the tree farm at Orangeville. He devoted about 16 hours a month to this project. In 1978 the plaintiff planted 1,000 red pines on his Orangeville plantation. This was followed in 1979 by the planting of 1,000 white spruce. In 1980 he planted 1,000 white cedar.

The Orangeville property was purchased initially as an investment but, as the plaintiff explains it, farming was in his blood and it was not long before he was looking at the possibility of growing something on it. He got informational brochures and other literature containing advice on successful tree planting and desirable nursery stock for reforestation projects from the Ontario Ministry of Natural Resources and the Midhurst Forest Station near Barrie. He also obtained Revenue Canada's Interpretation Bulletin IT-373 pertaining to farm woodlots and tree farms. The latter indicates that it may take 40 or 50 years for trees to mature.

In 1981 the plaintiff purchased a 26-acre parcel of farmland near Caledon on which he eventually plans to build his home. In the meantime, the property is being utilized for the expansion of his tree farm activities. However, the present appeal is concerned only with the expenses claimed against the Orangeville tree farm.

The defendant argues that the farming losses claimed as deductions during the taxation years in question were properly disallowed by reason that they were not outlays or expenses incurred to earn income from a business or property within the meaning of paragraph 18(1)(h) of the Act, but rather were personal or living expenses of the taxpayer, the deduction of which is prohibited by paragraph 18(1)(a) of the Act.

These paragraphs read as follows:

18(1) In computing the income of a taxpayer from a business or property no deduction shall be made in respect of

(a) 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 the business or property;

(h) 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;

Alternatively, it is argued that the plaintiff is not entitled to deduct the expenses as restricted farm losses within the meaning of subsection 31(1) of the Act and that the activities engaged in by the plaintiff on the subject property did not constitute a business carried on for profit with a reasonable expectation of profit, but were merely a hobby within the third class envisaged in Moldowan v. The Queen, [1977] C.T.C. 310; 77 D.T.C. 5213 (S.C.C.).

The whole thrust of the plaintiff's case is that he wanted eventually to have some trees to sell and the Department's Interpretation Bulletin IT-373 gave him the idea how he could turn a tree farm to profitable account in the future. He says that the bulletin illustrates what he was trying to do.

Defendant's counsel argues that there is no evidence of any reasonable expectation of profit with the result that the plaintiff's tree farm activities were nothing more than a hobby. A subjective notion connoting nothing more than a hope against hope is insufficient to bring the plaintiff within the second class of entitlement for restricted farm losses, as characterized in Moldowan. The bottom line submission is that the plaintiff's activities were merely the pursuit of a hobby in a businesslike way and failed to manifest a bona fide engagement in a business having a reasonable expectation of profit.

In Moldowan, supra, Mr. Justice Dickson said at page 313 (D.T.C. 5215):

. . . If the taxpayer in operating his farm is merely indulging in a hobby, with no reasonable expectation of profit, he is disentitled to claim any deduction at all in respect of expenses incurred.

There is a vast case literature on what reasonable expectation of profit means and it is by no means entirely consistent. In my view, whether a taxpayer has a reasonable expectation of profit is an objective determination to be made from all of the facts. The following criteria should be considered: the profit and loss experience in past years, the taxpayer's training, the taxpayer's intended course of action, the capability of the venture as capitalized to show a profit after charging capital cost allowance. The list is not intended to be exhaustive. The factors will differ with the nature and extent of the undertaking: The Queen v. Matthews, [1974] C.T.C. 230; 74 D.T.C. 6193. One would not expect a farmer who purchased a productive going operation to suffer the same start-up losses as the man who begins a tree farm on raw land.

The learned judge defined the second class of farmers entitled to claim restricted farm losses at page 315 (D.T.C. 5216):

(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.

The Queen v. Matthews, [1974] C.T.C. 230; 74 D.T.C. 6193 (F.C.T.D.) held that the operator of a tree farm was entitled to deduct his tree farming losses as restricted farm losses within the meaning of subsection 13(1) [now subsection 31(2)] on the ground that these were proper losses incurred in respect of a business carried on with a reasonable expectation of profit.

Mr. Justice Mahoney had this to say of tree farming at page 236 (D.T.C. 6197):

It is apparent that "tree farming” on the scale in question involves relatively few revenue years over a long period of time, perhaps much longer than normal human life expectancy. Equally, it may be inferred that, given a number of "tree farms" or a very large one with a number of plots in varying stages of maturity, a more or less frequent recurrence of revenue years could be achieved, after, of course, a rather lengthy initial waiting period if the undertaking were started from scratch. Accepting, as I do, the proposition that "tree farming” is capable of being a business, I cannot agree with the Plaintiff's argument that these essential characteristics of the business, when it is carried on in a small way, somehow alter its nature so that it is no longer a business. It is important to note that in subparagraph 139(1)(ae)(i) the word “reasonable” modifies "expectation" not "profit" and that the term “reasonable expectation of profit" is not synonymous with "expectation of reasonable profit”.

Each case where the realization of profit is so postponed will have to be examined on its own merits to ascertain that the profit is not merely notional and that the expectation of profit is indeed reasonable.

It is true that in Matthews three expert witnesses with university degrees in forestry were called with a view to establishing, inter alia, that the taxpayer's operation was reasonably likely to produce an operating profit, although there was no guarantee of that. In my view, it would be wrong to conclude that expert evidence is required in any and all cases to establish a reasonable expectation of profit for a tree farming venture. In other words, the particular facts of each case must be examined objectively on their merits with a view to determining whether the expectation of profit is reasonable in the circumstances, and is not something founded merely on whimsical expectations.

Nor is it necessary, in my view, for the taxpayer to show that he undertook his reforestation project pursuant to some government-sponsored program. The scheme of this type of program was alluded to in Matthews. As the plaintiff explained on cross-examination, he did not want to become tied to the Ministry of Natural Resources under such an agreement, but preferred to manage his tree farm operation in his own way. As he aptly put it: “Oh, no, I got advice in their brochures, but I did not ask them for help”.

The brochure of Midhurst Forest Station (Exhibit P-6) confirms that they have supplied nursery stock for reforestation projects for over five decades and that about half the annual output goes for planting on Crown land and Agreement Forests. The brochure states that the rest is purchased by private landowners who must first qualify by obtaining approval of their planting plan. The evidence is clear that the seedlings for the Orangeville plantation were purchased from the Midhurst Forest Station at an initial price of $10 per thousand, which has since gone up to a price of $110 for two thousand seedlings. Exhibit P-9 is the plaintiff's plan of the Orangeville plantation indicating where he planted his red pine, white spruce and white cedar seedlings during the years 1978, 1979 and 1980. He was cross-examined about this and his evidence was entirely consistent with what was portrayed in Exhibit P-9.

He was queried on cross-examination about spraying to eliminate the weeds in his plantation. His answer was that the seedlings could survive without it and that he wanted to keep away from spraying.

Based on his analysis of the information available to him, the plaintiff anticipated that the Orangeville plantation could be expected to yield merchantable lumber in 30 to 40 years. In the meantime, he planned to periodically thin out the plantation and sell the resultant crop as nursery stock or Christmas trees. To date, he had only been able to make a few sporadic sales of firewood. The plaintiff had also conceived the scheme of selling live, harvested trees in the ornamental or landscaping market for which he could obtain a price of $4.50 for white cedar and $35 for a Christmas tree. This innovative project was delayed in the execution because of problems encountered in rebuilding a barn on the Caledon property.

The plaintiff’s overall objective for his Orangeville tree farm is perhaps best illustrated by the following passage from his testimony:

The only thing I can say, that when you spend money to create something, like in any business you have to put money up first, and that money should create income and profits at a later date, which in my case — like the pamphlet says there, I didn't go strictly by the pamphlet, but it explains there that it takes 34 [sic] years before you can have a big sale of trees. Thirty to forty years it says . . . to have them for timber. But, meantime, I will be thinning them out, and I think it says there also thinning out, and that could be sold for nurseries or Christmas trees, or whatever.

The underlying factual assumptions on which the Minister relied in making his reassessments were that the losses claimed in respect of the Orangeville property were personal or living expenses and not outlays or expenses incurred to earn income from a business or property and that the farming activity conducted thereon was nothing more than a hobby.

Paragraph 248(1)(a) describes personal or living expenses as follows:

248. (1) In this Act,

"personal or living expenses" includes

(a) 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,

Considering the evidence in its entirety, I find that the plaintiff's tree farm operation on the Orangeville property was a sideline business for which there was a reasonable expectation of profit realization in the future. The evidence establishes that the operation was undertaken in a systematic way and in accordance with accepted reforestation practices. The fact that the ultimate harvest from the anticipated crop was some 30 or 40 years removed does not operate, in my view, to make the operation less of a business and more of a hobby. Moreover, I consider that the expectation of profit was reasonable in the circumstances and not merely notional. In my opinion, the whole purpose of the plaintiff's undertaking was directed to profit realization in the foreseeable future. In the result, I must conclude that the Minister was wrong in disallowing the expenses claimed for the taxation years in question Within the limitations of subsection 31(1) of the Income Tax Act.

The plaintiff's appeal is therefore allowed and the matter is referred back to the Minister for reconsideration and reassessment in accordance with these reasons. The plaintiff shall have his taxable costs of the action.

Appeal allowed.