Magee v. The Queen, 87 DTC 5282, [1987] 2 CTC 17 (FCTD)

Strayner, j.:—This is an appeal by the plaintiffs with respect to the reassessment by the Minister of their income tax in respect of 1981 and 1982. The Minister refused to allow them to deduct any of their losses with respect to the raising and management of racehorses as carried on by them on a small acreage near Saskatoon.

Prior to 1977 the plaintiffs, who are husband and wife, were in the trucking business in Saskatoon and still carry on such business today. At that time they owned no home. In 1977 they bought a racehorse which led them to look for a place in the country. They bought an 80-acre tract of land which had a three-bedroom bungalow on it. The land was largely unfenced and not broken for cultivation purposes. Since that time they have lived there. They have broken part of the land and grown crops on it. They have invested small amounts of money in the acquisition of buildings, the construction of paddocks, etc. They have also continued to operate the trucking business with which they have combined a truck repair service carried on by Mr. Magee and an accounting service for truckers carried on by Mrs. Magee.

Mrs. Magee had no farm background prior to 1977. Mr. Magee had had farm experience but a number of years before. Neither of them had any experience in breeding, raising, or racing of horses.

Their horse enterprise has remained relatively small for the past ten years since it was started and has yet to produce any profit. It would appear that they have never owned more than three or four horses at one time. They have never had more than one brood mare at a time. The first one acquired in 1979 proved to be unproductive and was disposed of in 1981. Their present brood mare was acquired in that year and produced four offspring. This year they will have two horses racing.

A summary of their farm income and expenses from 1977 to 1985 was put in, by consent, as Exhibit D-4 and is set out below:

The plaintiffs largely share their business income and share equally the losses from their racehorse operation which they have sought to deduct from their business income. Their net joint business income in 1981 was in the order of $64,000 and in 1982 was in the order of $32,000. The evidence indicates that they have made substantial investments in the business whereas their investments in the "farm" and in horse inventory have been rather limited.

The plaintiffs contend that they should have been allowed to deduct all of their "farm" expenses from other income, or at least have been allowed to claim restricted losses pursuant to subsection 31(1) of the Income Tax Act. The Minister takes the position that they should not be allowed to deduct any "farm" losses as their racehorse activities are only a hobby. In the alternative, the Minister contends that they are entitled only to restricted losses pursuant to subsection 31(1) of the Act.

For the purposes of determining deductibility of farm expenses, the decision of the Supreme Court of Canada in Moldowan v. The Queen, [1977] C.T.C. 310 at 315; 77 D.T.C. 5213 at 5216 sets out three categories of farmers. Category 1 consists of those for whom the farm is the chief source, or one of the chief sources, of income: these are people for whom farming is their main preoccupation. They are entitled to deduct all of their net farm losses from other income. Category 2 consists of those for whom the farm is a source of income, but not a “chief source". Such persons are entitled to deduct net farm losses up to $5,000 in accordance with subsection 31(1). Category 3 consists of those for whom farming is a hobby, and they are not entitled to deduct any of their net farm losses from other income.

It will be observed that to come within categories 1 or 2, it is necessary that the farm be a "source of income". That is the first hurdle which the plaintiffs must pass in this case. The Minister has in effect concluded that for these plaintiffs their farm is not a source of income and therefore they are entitled to deduct from other income neither restricted nor unrestricted farm losses.

It was confirmed in the Moldowan case that for a taxpayer to have a "source of income” he must have a reasonable expectation of profit from that "source". Such is required in order for losses in a given year to be regarded as business losses. Dickson, J. in the Moldowan case went on to say (supra at 313; D.T.C. 5215):

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. . .

After examining such factors in the present case, I am unable to conclude that the plaintiffs' racehorse venture can be viewed, in respect of taxation years 1981 and 1982, as a "source of income". It will be noted from the above table that for the nine years included therein, the farm has produced nothing but losses and I understand that to be the case also with respect to 1986. It is therefore difficult to see 1981 and 1982 as a period of temporary setbacks or even as years fraught with "start up” costs. The evidence suggests to me that as organized in 1981 and 1982, and as still organized, this is not an enterprise for which there can be a serious expectation of profit. For example, the horse operation carries a substantial mortgage-interest cost in the range of $3,000 per year. Because neither of the plaintiffs has any background in the training of horses, they have had to contract for such training which has involved, and presumably will continue to involve, substantial expenses. For what appear to be good reasons they incur substantial expenses in boarding out horses in the province of Alberta. These and many other expenses are of a continuning nature which, given the limited scale of their operation and the inevitable risks in breeding, raising, and racing horses makes it very improbable that profits can be realized. Certainly in 1981 and 1982 it would have been unreasonable to have expected a profit either at that time or in the foreseeable future. Nor am I able to see any clear plan which existed then or now for making the venture profitable. The maintenance of one brood mare on a farm, with perhaps two or three offspring of that mare racing each year, even with the sale from time to time of the latter, does not seem to me to involve such a plan. I therefore conclude that this farm is not a "source of income" and thus the plaintiffs are within category 3 as mentioned above: namely, they are engaged in hobby farming and none of their net farm losses are deductible from other income.

It should be emphasized that in most of the cases cited to me, including Moldowan itself, the Minister had conceded that the taxpayer was engaged in a business with a "source of income" because he had allowed the deduction of restricted farming losses. Instead, the present case most resembles that of Croutch v. The Queen, [1986] 2 C.T.C. 246; 86 D.T.C. 6453, where, with respect to a somewhat similar horse breeding operation, it was held that there was no reasonable expectation of profit.

The action is therefore dismissed with costs.

Action dismissed.