Kasper v. The Queen, 82 DTC 6148, [1982] CTC 178 (FCTD)

Jerome, ACJ:—This action is brought by way of appeal from assessments made under the Income Tax Act, RSC 1952, c 148 (am SC 1970-71-72, c 63) for the plaintiff’s 1977 and 1978 taxation years, and came on for trial before me at Toronto, Ontario, on January 15, 1982. The source of dispute is a loss allegedly incurred by the plaintiff. in those years in the raising of race horses. It is well settled that horse breeding is a farming operation and the facts clearly support the conclusion that the plaintiff operated the farm as a business. The sole issue is whether the plaintiff’s farming, either alone or in combination with some other source of income, constituted the taxpayer’s chief source of income. The matter is governed by section 31 of the Income Tax Act:

(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 deductions in respect of expenditures described in section 37, from all farming businesses carried on by him exceeds the aggregate of his income 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 deductions in respect of expenditures described in section 37” 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 purpose 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.

The courts have had great difficulty in the interpretation of this rather convoluted language. The leading judgment on the forerunner, subsection 13(1), is the Supreme Court of Canada decision in William Moldowan v Her Majesty the Queen, [1977] CTC 310; 77 DTC 5213, wherein Dickson, J described it as an “awkwardly worded and intractable section and the source of much debate”. More specifically, the section appears to contain a contradiction in terms since it requires an assessment of the significance of the taxpayer’s farm income in relation to other sources, yet obviously relates only to years in which there have been losses from the farming operations. Dickson, J put the problem as follows:

The next thing to observe with respect to subsection 13(1) is that it comes into play only when the taxpayer has had a farming loss for the year. That being so, it may seem strange that the section should speak of farming as the taxpayer’s chief source of income for the taxation year; if in a taxation year the taxpayer suffers a loss on his farming operations it is manifest that farming would not make any contribution to the taxpayer’s income in that year.

On a literal reading of the section, no taxpayer could ever claim more than the maximum $5,000 deduction which the section contemplates; the only way in which the section can have meaning is to place emphasis on the words “source of income”.

Upon the facts of the Moldowan case, Dickson, J declined to upset a finding by the trial judge that farming was not the taxpayer’s principal source of income, but the language of the judgment certainly confirms that such a finding is possible, even in the face of a loss. The judgment further refers to two earlier decisions of the Federal Court of Canada, the first, The Queen v D C Matthews, [1974] CTC 230; 74 DTC 6193, where Mahoney, J concluded that start-up losses without previous profit in a tree farming operation could constitute a source of income; and Bert James v MNR, [1973] CTC 457; 73 DTC 5333, which more directly parallels the circumstances before us, where Gibson, J concluded that where a taxpayer had changed his commitment of time, attention and capital from his automobile dealership to the raising of race horses, the latter as a farming operation constituted, together with other sources, a chief source of income, notwithstanding uninterrupted start-up losses. It is obvious, therefore, that the determination of chief source of income must be based on more than a mathematical calculation of farming income in proportion to other sources which Dickson, J confirms as his judgment continues at 313 [5215]:

Although originally disputed, it is now accepted that in order to have a “source of income” the taxpayer must have a profit or a reasonable expectation of profit. Source of income, thus, is an equivalent term to business: Dorfman v MNR, [1972] CTC 151;

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:

. .. then at 314 [5215]:

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.

. . . and at 315 [5216]:

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.

Turning then to the facts in this case, during the 1960’s the plaintiff and her husband were actively engaged in the operation of their company, Motor Express Terminals Limited, which provided terminal and distribution facilities for independent truckers in the Toronto area. The plaintiff was a substantial shareholder in her own right and was also involved in decisionmaking at every level, including formation of policy, acquisition or sale of property and the day-to-day operation of the business. At one point, she formed her own subsidiary company in an attempt to profit from a potential truck leasing business, but it survived only a short time. During the mid- 1970’s the business was thriving and in 1977 was sold at its peak. Two years later, the plaintiff and her husband sold all of their interest in land which had been associated with the business and had been retained by them at the time of the sale. The total revenue was estimated at $2,500,000, and while no evidence was adduced as to the precise division between the taxpayer and her husband, it is clear that as a result of these very successful transactions, the plaintiff was left in a position to enjoy substantial investment income. Evidence disclosed the plaintiff’s income from business sources other than the farm between 1974 and 1981, as follows:

In 1974, the plaintiff enrolled in a course of study in horse breeding at York University in Toronto, and together with some others there, formed an association under the name of Punjabi Stables. Before the end of that year, however, the plaintiff felt she would be more comfortable operating on her own and left the partnership. Near the end of 1974, she purchased her first horse and I accept her evidence that she had decided at that time to get into horse breeding as a business, with bloodlines as the key to success. In early 1975, she had a brief preliminary discussion with Mr Conn Smythe, whom she considered to be one of the most successful horse breeders in the country. This led to an extended meeting at the Smythe stables in early 1977, as a result of which the plaintiff introduced some of Mr Smythe’s operational techniques into her own farms, although, obviously, on a more modest scale. More significantly, the meeting confirmed the plaintiff's convictions about the importance of bloodlines and, in fact, her next purchase, Supper Club, was very much on the Smythe recommendation, on the basis of the sire, New Providence.

Later in 1977, the plaintiff was in a financial position to take advantage of a growing rift in a then existing partnership and made her most substantial capital investment to that date. In that same year, the plaintiff enjoyed her first sign of success in getting two yearlings in the annual sale. One was actually sold for $82,000, and the second horse, Vice Regal, which had to be withdrawn from the sale because of a temperature problem, was sold shortly thereafter for over $100,000. I also note that in 1980, her best horse, Swiss Kin, was entered into one of Canada’s premier racing events, The Oaks, and was ridden by Avalino Gomez, clearly the dean of the Canadian jockey corps. History sadly records that it was in this race that Gomez suffered the loss of his life when the horse fell and broke a leg. The enormity of that tragedy cannot, however, detract from the significance of entry into such an event as it relates to the intention of the plaintiff in carrying this operation on as a business. It also leaves very little doubt that, but for the accident, the plaintiff's farming operation in 1980 would have shown an even more sub- stantial profit than the $100,000 it actually recorded. From the point of view of time and attention, I am satisfied that the plaintiff was totally absorbed in the operation of the horse breeding farm by 1978, and that during the years from 1974 to 1978, she was systematically transferring her attention from the previous business to the farm. In terms of commitment of capital, her initial expenditure in 1974 was modest, but over the intervening years, she expended $250,000 to purchase the farm and stable facilities and over $1,100,000 for acquisition of inventory and operating cost. During those years, her gross revenue exceeded $700,000. By way of comparison with her income from other sources, which I listed earlier, the figures for the farm are as follows:

This evidence strongly supports the plaintiff’s contention that when she disassociated herself from the Punjabi partnership and purchased her first horse in 1974, she had formed the intention of raising race horses as a business. From the beginning, she managed the operation and maintained records on a business-like basis. She pursued her initial commitment to the importance of breeding by emulating the obvious successful example of the Smythe farm and when the propitious moment arrived, backed that commitment with a substantial capital investment. Her behaviour was, at all times, more consistent with a view toward long-term rather than short-term involvement, and with the reasonable expectation of profit and income from the farm in the not too distant future. Subsequent events have vindicated that confidence and, of course, assist the Court in confirming these early intentions of the plaintiff in a way that was obviously not available to the Minister’s officials at the time of their initial assessment of the plaintiff’s 1977 and 1978 returns. Finally, the plaintiff gradually increased her commitment of time and money until both were so substantial as to leave no doubt in my mind that during 1977 and 1978, she had changed her mode and habit of work to the management of her horse breeding farm from her previous active participation in the operation of Motor Express Terminals Limited.

I find, therefore, that in the 1977 and 1978 taxation years, the plaintiff’s farming operation provided her with a source of income which, in combination with her income from the operation or disposition of Motor Express Terminals Limited, constituted the taxpayer’s chief source of income, within the terms of subsection 31 (1 ) of the Income Tax Act so that the plaintiff was not, in those years, restricted to the loss limitation contained in subparagraph 31 (1 )(a)(ii). Accordingly, the appeal is allowed, with costs, and the matter is referred back to the Minister of National Revenue for the appropriate reassessment.