Hadley v. The Queen, 85 DTC 5058, [1985] 1 CTC 62 (FCTD)

Joyal, J:—The trial of this action took place in Toronto on September 18, 19, 20 and 21, 1984. The plaintiff Hadley was appealing from a decision of Mr Rolland Saint-Onge, QC, as he then was, of the Tax Review Board rendered on February 4, 1981. The Tax Review Board had ruled that any losses experienced by the plaintiff by reason of his farming operations in the course of the taxation years 1976 and 1977 were, pursuant to section 31 of the Income Tax Act, limited to $5,000 for each year.

The whole issue of the appeal revolves around the interpretation of section 31 of the Income Tax Act within the factual situation which I should wish to describe. Suffice it to say at this time that with respect to farming losses, a taxpayer may fall within any one of three classifications. In the first classification, a taxpayer is entitled to deduct all his farming losses and in that respect, such farming losses are treated no differently from losses experienced in any other endeavour. The second category is where the taxpayer is limited, in charging his farming losses, to a sum of $5,000 for any one taxation year. The third classification is where a taxpayer is not entitled to deduct any farming losses at all.

Although section 31 is drafted in the kind of arcane language characteristic of taxing statutes, there have been several judicial pronouncements to bring some clarity to its provisions and to assist any trier of facts in determining under which of the foregoing categories a taxpayer engaged in farming operations might find himself from time to time or:from year to year. The leading pronouncement in this regard is found in the Moldowan case.* [1] This is a Supreme Court decision and it appears to be the only case where the Supreme Court of Canada was called upon to rule on a section 31 issue.

At 315 [5216] of the report, Mr Justice Dickson, as he then was, found that section 31 contemplated:

(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 s 13(1) [now section 31(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 s 13(1) [now section 31(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 as a hobby. The losses sustained by such a taxpayer on his non-business farming are not deductible in any amount.

Section 31 creates no problem for the full-time farmer whose money, time and efforts are exclusively devoted to his farming operations and who has no other source of income. Treatment of farming losses for such a taxpayer is substantially in accordance with general tax rules. Neither does the section create much of a problem when dealing with a taxpayer who makes no pretence of being a farmer but, nevertheless, owns a country place with sufficient acreage to keep a couple of horses, who spends weekends and holidays there and has a neighbouring handyman look after his stock during weekdays. The public is not in the mood to subsidize the losses which might be experienced by such a taxpayer. Such losses are not business losses. They are merely the costs of maintaining a life-style.

Where the application of section 31 creates problems is in respect of a farming operation which is run as a business but where the taxpayer has other sources of income. Such a taxpayer might fit into the first category articulated by Dickson, J, in which case, any farming losses sustained may be charged against the taxpayer’s other income. In the alternative, the taxpayer might fit into the second category in which case, his farming losses are, for tax purposes, limited to $5,000 annually.

The issue of whether a taxpayer fits into the first or second category is essentially a factual one. In this regard, the judgment of the Supreme Court in the Moldowan case provides us with certain tests, guidelines and indicia to assist a trier of facts in making his determination.

For example, Mr Justice Dickson finds that a taxpayer engaged in farming need not have a “source of income’’. It is sufficient, he says, that a taxpayer have a “reasonable expectation of profit’’. In effect, an operation which suffers a loss may be found to be a source of income.

His Lordship further states, at 314 [5215], that “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 of measurement. . . .’’

In applying the test of “reasonable expectation of profit” in relation to a chief source of income, Mr Justice Dickson lists, inter alia, at 314 [5216], “. . . the time spent, the capital committed, the profitability both actual and potential . . .” And he says . 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.”

In a similar vein, Mr Justice Dickson lists, again at 314 [5215], a number of criteria which might be considered in the determination of a “reasonable expectation of profit”, such as “. . . 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.” However, “the list is not intended to be exhaustive”, warns His Lordship.

The Moldowan decision has purified the air. It has provided us with legal principles and guidelines which narrow considerably the field of inquiry in determining under which of the three heads enunciated by Mr Justice Dickson farming losses might be treated. The decision, of course, is also of a nature where both devil and saint may quote it with equal impunity and immunity.

I should now review the findings of facts in the case before me. It is fair to say that between the parties there is not much conflict on the evidence. The difference between the plaintiff and the defendant is substantially one of weight and one of inferences.

The plaintiff is an entrepreneur. He is also by training a chartered accountant. In 1960, he engaged in the business of selling cars for an automobile agency in Toronto. He showed talent. By 1966, he had become general manager of his employer’s operations.

In that same year, he stepped on the first rung of the entrepreneurial ladder. He succeeded in obtaining his own dealership, Northtown Ford Sales in Willowdale, Ontario. His equity in that venture was limited. Most of the money was Ford money and Ford effectively controlled the dealership. A year later, however, the plaintiff was able to borrow $120,000 and pay off Ford.

The business generated enough income so that some two years later, in 1969, the plaintiff bought another dealership. In 1970, he joined together those two dealerships and their car-leasing operations. He made more money. In 1971, he added a London dealership to his chain and made more money again. At this time, the plaintiff had three car-sale agencies and a leasing operation going for him.

In that same year of 1971, the plaintiff bought a building in Toronto and consolidated his leasing business there. It was about this time that Linblasco Investments Limited and HOJ National Leasing Company, later to become HOJ Industries Limited, were established as holding companies for the plaintiff’s several operations and investments.

The business conducted by the plaintiff continued to prosper. By 1973, net earnings from his operations totalled some $200,000. A year later, in 1974, the businesses were reporting net earnings of some $440,000. By the year 1974, the plaintiffs net equity in the companies had grown over the years and now exceeded $900,000.

It is a proper inference to make from the foregoing that the plaintiff was bringing remarkable talent to his enterprises, specifically in bringing together financial and management resources to assure a successful and profit-making operation. He was making the right decisions and the right choices. He was getting good managers, giving them a relatively free hand and compensating them handsomely.

I conclude from the evidence that by 1971, the plaintiffs businesses had stabilized. He was thereafter able to conduct his operations from an office in a small commercial building in Willowdale and appeared to have been able to do so with the administrative support of one financial controller and one secretary. His own controlling functions consisted mainly in keeping his finger on the financial pulse of his operations by monitoring their constant or erratic heartbeats through a system of daily operations controls provided to him.

In 1972, the plaintiff decided to buy a farm. He did a lot of research on it. He applied his analytical skills to choosing the right farm at the right place and at the right price. He had no experience in farming but his family roots were rural and he acknowledged a sort of atavistic yearning to get into it. The plaintiffs father, on whom he counted for assistance, had a professional degree in agriculture but had not been engaged in the business of farming during his professional life.

The plaintiff looked upon farming as an area where his proven skills as an entrepreneur, an accountant and a manager would meet the kind of challenge he had faced many years earlier when he had first entered the car business. His entrepreneurial enthusiasm was directed towards making his farming adventure a going concern.

He picked a farm about an hour’s drive from Toronto. It became known as Ancona Pharm No 1. It consisted of 190 acres formerly owned by Windsweep Farms and 100 acres formerly owned by one Beatty. It contained an old house, an old horse barn and an older cattle barn. His initial efforts were to make the house liveable. He painted the house, put up some wallpaper, fixed the upstairs bathroom and replaced the windows.

On May 15, 1973, the plaintiff bought the Thompson farm containing 200 acres. On the same date, he bought the Fox farm with 100 acres. This new acreage, with attendant farm buildings and situated some ten miles away from his original farm property, became known as Ancona Pharm No 2. The plaintiff continued to acquire acreage so that by the winter of 1975-76, he occupied a total of 756 gross acres and owned a total of some 698 net acres.

The various exhibits filed by the plaintiffs counsel indicate fairly conclusively the extent and thrust of the taxpayer’s operations on Ancona Pharm No 1 and Ancona Pharm No 2. He initially bought a dozen cows in order to start a cowcalf operation. By the end of 1973, he had a carry-over of 19 head of cattle and he bought an additional 209 head. He sold 167 head for $38,000 and finished the year with 230 head.

In 1973, the plaintiff made substantial improvements to Ancona Pharm No 2. He built a huge barn attached to which was a calving barn. It became a show barn with cement base, heating system, feeders, and other equipment to feed and clean his show cattle. He extended the bulk silo, built a roof over a culling area, made substantial repairs to another barn, subdivided and completely fenced the 200-acre Thompson farm into four 50-acre lots and used them for pasture.

Concurrently, the plaintiff went into the purebred-cattle business. He settled on the Charolais breed. This required major investments in prize bulls and purebred Charolais cows. The plaintiff went into this program in a big way. He hired good management, studied all available material on the purebred-cattle business, and so organized his affairs that in some three years of operation, he had one of the largest cow-calf and purebred cattle farms in the area. More than that, he had become recognized as a prime breeder of Charolais cattle in Eastern Canada and his success, at least to the measure of the quality of his stock, seemed assured.

The evidence is conclusive that throughout those formative years, the plaintiff committed to his venture substantial amounts of capital. As disclosed in the exhibits filed, the plaintiffs capital commitment in his farming operations totalled over $200,000 in 1972, increased to $700,000 in 1973 and had exceeded $1,000,000 by 1974 and 1975.

It was in the year 1975, as disclosed in the exhibits, that the plaintiffs net investments or equity between his “city” operations and his “country” operations were just about in balance. By that year, the amount of dollars put into his farming venture was as much as what he had accumulated in some eight or nine years in his car business.

In spite of the taxpayer’s strong commitment of time and capital, he suffered financial losses. He had started his farming business when the market was bullish. Purebreds which had cost an average of some $3,500 in 1974-1975 were worth barely $1,045 in 1976. A prize bull turned out a dud. Some purebreds were found to suffer from brucellosis in 1975 and had to be destroyed.

Furthermore, as the cattle prices plunged from their high of 1972-1973, the prices of feed kept climbing and thus stacking increasing outlay to decreasing income. The resulting losses were very high. They totalled $449,909 in 1976 and $138,136 in 1977.

In 1977, in order to cushion the loss, the taxpayer started to scale down his operations. This required time. The taxpayer entered into a partnership arrangement on one of his farms and proceeded to cut down on his herd. His 1977 loss of $138,136 added to his previous losses were more than he could reasonably bear. He finally disposed of everything in July 1978.

If it should otherwise be regarded as self-serving for a taxpayer to state retrospectively that he wished to effect “a change in occupational direction” or make of farming “a new centre of work routine” or “make of it a new livelihood”, as enunciated in the Moldowan case, the test, in my view, is whether the taxpayer’s actions are in conformity with his later-stated intentions.

In this regard, it should be said that the plaintiff, to use colloquial language, put his money where his mouth was. He put more than his money. He put substantially all of his entrepreneurial skills into the venture and applied to its operation the management experience and expertise he had previously acquired.

The “capital committed” is one of the tests suggested by Dickson, J in the Moldowan case. The plaintiff certainly meets that test. I will go further. I find that he meets other tests as well, most of them reflecting the composite of several pertinent facts which I find rather convincing.

(1) The plaintiff, although not experienced in cattle farming, let alone purebred cattle raising, learned quickly the rules of the game. More than this, he acquired the services of an experienced manager who looked after the day-to-day operations and counselled the plaintiff on the risks and pitfalls of the business and on the art and science of farming.

(2) Most of the plaintiffs exhibits, some thirty of them, indicate to me an intensive and extensive approach to full-scale, high level operations. This re- quired planning, cash flow projections, organization of cattle auctions, attendances at purebred cattle sales both in Canada and abroad and the supervision of his several construction and improvement programs. The plaintiffs physical presence on his farm was usually over weekends and holidays. The intellectual input, however, was a daily affair.

(3) It is true that the plaintiff was not spending full-time at the farm culling the herd, cleaning the barns, feeding the stock or sowing and reaping his harvest. I find as a fact that the plaintiff was not running a cottage industry where that element of “time spent or devoted’’ has been most appropriately applied. The plaintiff was engaged in large-scale operations requiring commitment of large and risky expenditures. The decision-making process and the nature of the involvement must perforce be measured qualitatively as well as quantitatively. I fail to see any substantial difference in law between time spent thinking, planning, organizing and deciding, and time spent putting up split-rail fences. Although the plaintiff did do all of the usual farming chores on a continuing basis during the whole history of his farming operation, I think that the test is substantially met in the intellectual direction he provided to the business and in the constant attention he had to give his large investment.

(4) It was also true, as argued by counsel for the defendant, that the plaintiff was at the same time enjoying substantial income from his automobile operations. I was urged to find that the plaintiff could not “look to farming for his livelihood’’ or to find that he carried on his farm operations as a “‘sideline business”. This conclusion, however, is based on hindsight. The plaintiff did not have the benefit of a crystal ball during the years in question. His ambition and expectations of becoming the prime breeder of purebred cattle in Eastern Canada and gaining from it substantial income are not, in my view, vaporized by subsequent events which proved him wrong.

(5) I also find that during those same years, the plaintiffs earlier operations had become much more a source of investment income than employment income. I find it thoroughly plausible, given the talent and skills of the plaintiff, that he should have so organized his car business that it was practically running itself. As a consequence, he could devote the same talent and the same skills in a new venture hoping or expecting throughout that it would ultimately provide the bulk of his earned income.

(6) I also find that the reversals the taxpayer suffered were substantially beyond his control. I accept the evidence of his expert witness, Dr L J Martin, who traced the history of a depressed market beginning shortly after the taxpayer had entered into his venture. On the evidence, there is nothing to indicate incompetence, lack of care or foolhardiness. Dr Martin’s evidence is clear on the fact that all breeders went through an extremely difficult financial squeeze during that period of time. In retrospect, there is no doubt that the plaintiff should have pulled in his horns sooner, so to speak. Had he done so, he would have cut his losses considerably.

As stated in the Moldowan case, an objective determination from all the facts must be made as to whether or not a taxpayer had a reasonable expectation of profit. The list provided by Dickson, J ‘‘. . . is not intended to be exhaustive. The factors will differ with the nature and extent of the undertaking . . .” In my view, there is necessarily included in the genus of the factors suggested by Dickson, J the sheer magnitude of the plaintiffs capital commitment as compared with the capital on hand.

This factor also applies to the “chief source” test. As has already been noted, the determination of “chief source” involves both “a relative and objective test”, and it is decidedly not “a pure quantum measurement”. It is suggested in the Moldowan case that 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. It may also be suggested that a taxpayer who intends to make of farming his “chief source” should not be denied unexpected losses if he has already won his lottery, or already succeeded formidably in the auto dealership business.

The decision of the Tax Review Board in 1981 stresses the high income yield which the plaintiffs auto business was providing to him, as against the income- /loss experiences of his farming operation. The Board found it ludicrous for the taxpayer to expect that his farming operations would achieve similar results. It seems to me that the intention and purpose of the taxpayer, as made evident by his resource commitments, large-scale land, buildings and equipment purchases at that time, are also material to the determination of the issue. They constitute a positive response to at least some of the indicia suggested in the Moldowan case.

Furthermore, if the plaintiff was experiencing rough times with his farming operations, it was his decision, as losses mounted, that the harsh and inexorable threshold had not yet been reached. It was his judgment call. If he suffered losses before giving up, it is evidence to me that he was still hoping to “‘turn the business around”. Hindsight might be precise but it is not helpful in this respect. Indeed, the fact that there were losses is prologue in the context of the plaintiffs total experience.

I am satisfied that if the plaintiff had foreseen that his operations would have shown sustained losses through most of the years in question, he would certainly have cut bait sooner and minimized the continuing erosion of his personal net worth. No person is happy to suffer that kind of loss. No person will throw good money after bad when he knows or should reasonably be satisfied that his venture holds no hope of success. On the evidence, it would appear that the plaintiff reached that conclusion in July of 1978. I do not find, however, that it had become his state of mind in the course of the taxation years in question.

I also find in the considerations and factors outlined in the Moldowan case that they do not need all to be of equal value. Their individual importance depends on all the circumstances of an individual case. One such factor which might predominate over the others is the amount of capital the plaintiff committed to his farming venture. If the plaintiff argues new direction, new orientation, or new commitments to bring himself within the first category defined in the Moldowan case, the quantum element alone of his capital investment provides the plaintiff with pretty good credibility. It gives force to the several arguments advanced by the plaintiff's counsel and overcomes the incredulity which an ex post facto analysis of actual performance attracts to the case.

The findings I have made with respect to the plaintiff's farming operations must be viewed within the framework of intentions and expectations. While it is true that the operations, as financially unsuccessful as they were, might indicate prima facie that the plaintiff should come within the second category of “sideline” operators as articulated by Dickson, J in the Moldowan case, the plaintiffs intentions and expectations are, in my view, material to the conclusions I have drawn. To a great extent, in reviewing past history, a trier of facts must adopt something akin to an armchair approach as that expression is used in the interpretation of testamentary instruments. The intentions and expectations must be analyzed in the light of the taxpayer’s activities and of the economic situation relating to beef farming which existed at that time.

Expert evidence by Dr Martin is conclusive that in 1973, the profitability of the beef market was buoyant. Cattle prices in 1973 were high and indeed, the industry had enjoyed an experience of rising prices over six or seven earlier years. It appears in retrospect that the plaintiff was unfortunate enough to enter the business when beef prices were at their peak. Economic analysis discloses that in the first quarter of 1973, steer prices exceeded feed costs by $23.12 per hundredweight. The price decline during that period coincided with a rising prices trend in feed costs, so much so that by the end of 1976, the market price per hundredweight of steers was then $5.52 /ess than the cost of feeding them.

The plaintiff was facing an economically depressed industry, a situation which, over the years 1975, 1976 and 1977, saw cow-calf operators lose in excess of $83 million. Breeding stock operators, according to the evidence, were even larger losers.

In the circumstances, one must guard against the normal conclusion that the substantial investment made by the plaintiff could not possibly have been with a serious intention of achieving profitability. Furthermore, as I have found earlier in these reasons, the plaintiff is not the type of person who would gladly risk a million dollars in an operation on the simple expectation that in the event of losses, half of them would be absorbed by deductions from his other income.

One must also guard against adapting a statutory interpretation to the guidelines articulated by Dickson, J in the Moldowan case. The words used by His Lordship in simplifying the wording of section 31 of the Act do not, a priori, fit every taxpayer into a procrustean bed of someone else’s choosing. Indeed, His Lordship, in suggesting tests which might be applied from case to case, is careful to point out that such tests are “not exhaustive”, that some of them are both relative and objective, or that some of them are not to be measured purely in quantum terms. In a few words, His Lordship was not attempting to draft legislation.

It is my view therefore that the conclusion I have reached is on the basis of a factual situation which has unique and distinguishing features. Numerous precedents cited to me by counsel on both sides might be relevant or persuasive but I would doubt that any one of them would be conclusive. I prefer to be guided by the principles enunciated in the Moldowan decision. I think that my conclusion is in conformity with these principles and in keeping with the legislative intent of section 31.

The appeal is therefore allowed and the Minister of National Revenue is requested to reassess the taxpayer accordingly and to allow full deduction of the plaintiffs farming losses for the taxation years 1976 and 1977.

Costs to the plaintiff.