Glass v. The Queen, 89 DTC 5497, [1989] 2 CTC 314 (FCTD)

Dubé, J.:—The issue to be resolved in this appeal of a judgment of the Tax Court of Canada is whether the plaintiff was for the 1978, 1979 and 1980 taxation years a ''class (1) farmer" and thus entitled to deduct the loss from his farming business for those years under section 31 of the Income Tax Act which reads as follows:

31. Where a taxpayer's chief soure 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 deduction under section 37 or 37.1, from all farming businesses carried on by him exceeds the aggregate of his incomes for the year, so determined from all such businesses,

and

(ii) $2,500 plus the lesser of

(A) /z 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 deduction under section 37 or 37.1” 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.

The basic judgment on the interpretation of section 31 remains Moldowan v. The Queen^ [1] as delivered by Dickson, J. (as he then was) of the Supreme Court of Canada. He described the three classes of farmers for the purposes of the Act, as follows (at page 487):

(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 carries 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.

A classification was further refined by Joyal, J. of this Court in Hadley v. The Queen [2] at page 62 (D.T.C. 5059):

. . . 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.

In the instant case, the Minister classified the plaintiff in the second category, thus limiting him to a deduction of $5,000 for each of the three taxation years in question. That decision was confirmed by the Tax Court of Canada on October 5, 1984.

The plaintiff was the only witness at the trial. He expressed himself fluently and lucidly. Now aged 49, the plaintiff was born and grew up on a mixed farm in Saskatchewan. After high school, he managed the family farm for a while, as his older brothers had to find work elsewhere. He wanted to be a farmer but saw no future on the family farm.

In 1963, he reluctantly left to take up a job as a grain elevator agent. In 1966, he married his high school friend, Rita, who also had been raised on a farm. In the ensuing years they both worked hard and saved their money hoping that some day they could afford to buy a farm and raise their family there. He remained in the employ of the grain elevator until 1975.

That year he decided to abandon his seniority, pension, and security with the Saskatchewan Wheat Pool in favour of a one-year contract to manage the Canada Farm Labour Pool Program ("the Program") for the Canada Employment and Immigration Commission. He thought that the new position would afford him more time and flexibility to return to the land and start a farm of his own. As it turned out, the contract with his new employer was renewed in 1976, 1979, 1982, 1985 and then from year to year. He is still managing the Program under a renewed contract.

According to the Program Agreement, the plaintiff agrees, as manager,

to establish and operate a non-profit agricultural manpower employment referral agency ... in a manner acceptable to the Minister and substantially in accordance with any recommendations made from time to time by the Saskatoon Local Agricultural Manpower Board.

The position required him to move to Saskatoon. By 1977, he had purchased 80 acres of undeveloped land at Vanscoy, Saskatchewan, some 20 miles from Saskatoon, and had dug a well on it. In 1978, he built a house, sold his home in Saskatoon and moved to the farm with his family. That same year, he also built a barn and some shelters, his intention being to go into sheep farming.

To finance these expenditures, he and his wife had saved about $12,000. He borrowed from the bank in order to complete the purchase of the farm, build the house and buy a flock of 150 sheep. In the spring of 1979 his first "crop" yielded 210 lambs. That year he was offered his first three-year contract of employment. He accepted, as he knew the extra cash flow would be required to finance his fledgling farm operation until he attained his target flock of about 600 ewes.

However, pastures were dry and poor in the spring of 1979 and many producers were dumping sheep and lambs because of a shortage of feed. Lamb prices began to decline. He felt this would be a good time for him to hold back his female lambs for breeding stock and expansion. That increased his stock to 210 ewes. Unfortunately, the severe drought of 1979 continued until 1980 and was followed by waves of destructive grasshoppers. Then, in early fall the interest rates began to climb and his mounting debt load was compounded by heavy grazing requirement. The flock had to be fed. From year to year, he expected the sheep farm to start showing profits, but his very limited cash flow made him unable to face prevailing severe climatic and economic conditions. In 1981, the national economic recession struck. The price of feed was going up. Sheep producers in the area were liquidating their flocks as the price of lamb was collapsing.

In 1978, he had traded in the family holiday tractor for a farm tractor. In 1981, he had sold his pleasure boat to raise some money for his farm operations. In 1982, National Revenue assessed $10,000 in income tax as his farm expenses were not allowed. That year he cashed in his RRSP retirement fund and his children lent him their savings. He put his entire stock up for sale but could only find a buyer for the higher grade White Face stock. He was left with 30 culls.

Nevertheless, he managed to start up again in 1983, while maintaining his job as manager of the Program. He purchased additional young ewes in 1985, realizing an adult stock of cull sheep would not improve his situation. The price of sheep went up in 1983 and 1984, following a strong demand. At present, he continues to operate the farm with a current inventory of 160 ewes.

Throughout this entire period, the plaintiff was deeply involved in local and provincial sheep breeders' associations. In 1982, he became chairman of the Commercial Committee of the Saskatchewan Sheep Breeders Association. In 1983, he became vice president. He was also a founding member of the Prairie Shepherds Cooperative Ltd.

As to the hours of work during the three taxation years in issue, the plaintiff testified that he worked about 30 hours per week at the Program. However, being the manager, he enjoyed considerable flexibility and could take complete weeks off four or five times a year. As he worked for a set fee, his contract was not affected by the amount of time spent at the office. The rest of the time he spent on the farm, where he worked long hours with his wife. He estimates he worked 40 to 50 hours per week on farm chores. He rarely took any holidays and had no other hobbies.

It appears the plaintiff purchased that particular parcel of land because it was marginal and therefore affordable. When he moved there in 1978 the surrounding farms were used for poultry, or dairy, or hog, or semi-confined beef operations. There were no immediate residential neighbours but now some newly-arrived rural residents commute to Saskatoon. Adjacent to the plaintiff's farm are three full-time farming concerns.

As the plaintiff testified at the trial, he expected some growth after the first year but profits only after two or three years. If he could reach a plateau of a flock of 600, the farm would become profitable and self-sustaining. He would then be able to leave his job at the Program and live entirely off the farm. Of course, that was before he was confronted with the devastating drought of 1979 and 1980, and the economic recession of 1981. His insufficient cash flow and the high rates of interest compounded his problems. The plaintiff admits that he also made some mistakes in the early years, mainly in the purchase of stock and his overestimating production.

In reporting his income for the taxation years in question the plaintiff inter alia reported as follows:

In the aforementioned landmark Moldowan decision, Dickson, J. pointed out that section 31 of the Act includes the combination of farming and some other source of income as the chief source of income. He said as follows (at page 488) :

The reference in s. 13(1) [now section 31(1)] to a taxpayer whose source of income is a combination of farming and some other source of income is a reference to class (1). It contemplates a man whose major preoccupation is farming. But it recognizes that such a man may have other pecuniary interests as well, such as income from investments, or income from a sideline employment or business. The section provides that these subsidiary interests will not place the taxpayer in class (2) and thereby limit the deductibility of any loss which may be suffered to $5,000. 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 farms as a main expectation of income is not disentitled to deduct the full impact of start-up costs. [Emphasis added.]

In other words, to succeed in this appeal the plaintiff must show that his major preoccupation for the three years in question was farming. He may have other pecuniary interests and income from other sources, but the chief source of income must be farming or a combination of farming and some other source of revenue. Dickson, J. also held that a man who changes his occupational direction from his previous profession and occupation and commits himself to farming as a "main expectation of income" would then qualify as a "class (1) farmer". It follows from that pronouncement that a taxpayer does not have to be successful in his new farming venture, as long as he looks to farming as a main expectation of income.

In the case at bar, if the plaintiff really considered farming as his major preoccupation and he looked to farming as a main expectation of income, his managerial job at the Program would not disentitle him from a “class (I)" treatment. If he can establish a change of occupational direction in 1978, 1979 and 1980, he may deduct his start up costs. Dickson, J. continued at page 466:

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.

[Emphasis added.]

As I mentioned in my decision of Eldon U. Richardson v. Canada, [1989] 1 C.T.C. 10; 89 D.T.C. 5001, released on November 15, 1988, there are additional criteria arising from the jurisprudence: the amount of time devoted to the farm; [3] the income from farming as compared to the taxpayer's professional income; [4] the phase-out of the taxpayer's involvement in his prior profession; [5] the importance of the capital invested in the farm. [6]

In Charles H. Roney v. M.N.R., [7] the taxpayer was an executive who derived over $220,000 from employment and dividends and deducted $73,238 for farming losses for his 1975 taxation year. My colleague Denault, J. found as a fact that the defendant changed his occupational direction from that of an executive to that of a farmer as a main expectation of income. At page 13 of his decision, the learned judge relied on five specific elements which militated in favour of the taxpayer:

In the present case, the following facts have to be retained in favour of a deduction of full farm losses. Firstly, the size of the farming operation, some 711 acres, is one that is commensurate with an ability to generate large profits over a period of time. Secondly, the evidence showed that the farm was a well equipped operation with a good number of purebred and half-bred cattle and that this was a viable ongoing business. Thirdly, there was a large amount of capital injected by the defendant. Fourthly, the defendant moved his family on the farm where he had a view over the general operation of the farm and he obtained the services of a farm manager and a herdsman to help operate the farm and to make it a successful business enterprise. Fifthly, the defendant applied his considerable business experience to his farming business with a view to deriving substantial income therefrom. He later had to close down the operations due to special circumstances which were out of his control. [Emphasis added.]

In the Richardson case aforementioned, I held that similar findings could be made in favour of the taxpayer, except that he did not leave his home, did not change his lifestyle and continued to operate in his milieu as an accountant.

In the instant case, I find that the plaintiff generally meets all the above criteria, including the fact that he did sell his house in Saskatoon and moved to the farm. From his evidence, which stands uncontradicted, his mode and habit of work changed drastically in the sense that he became more of a farmer and less of a Program manager. From all the evidence available, his lifestyle and his main interest in life became those of a sheep farmer.

In a more recent case, Morrissey v. Canada [8] the Federal Court of Appeal dealt with the case of a taxpayer who operated a farm and was a freighter engineer during his 1977, 1978 and 1979 taxation years. The Court determined that there was no reasonable expectation of profit from the taxpayer's farm. The Court said that actual or potential profit must be demonstrated; the taxpayer's mere intention to earn a profit was not sufficient. The majority of the Court found that farming was not a chief source of the taxpayer's income.

Mahoney, J., on behalf of the majority, said as follows at pages 241-42 (D.T.C. 5084):

. . . While the determination that farming is a chief source of income is not a pure quantum measurement, it is equally not a determination in which quantum can be ignored.

. . . It also implies that farming was a potential source of income and calls for an enquiry whether it was potentially a chief source of income either alone or in combination with another source. In considering s. 31(1), it seems to me that potentiality, rather than actuality, is the question in all cases since the provision applies only where there is a loss in a taxation year. That is not, of course, to say that actual profitability in other years may not be evidence of the potential for profit in years of losses.

Moldowan suggests that there may be a number of factors to be considered but we are here concerned only with three: time spent, capital committed and profitability.

In a still more recent decision, Mohl v. Canada, [9] my colleague Strayer, J. examined the case of a taxpayer who throughout the 1978 to 1982 taxation years was involved in a variety of businesses, through his family corporation, as well as being involved in the business of acquiring, breeding, racing and reselling horses. He found that the taxpayer had no reasonable expectation of profit from farming for the years in question and could demonstrate no reasonable basis for his belief that such expectation ever did exist. He analysed as follows the decision in Moldowan as interpreted in the Morrissey case at page 428 (D.T.C. 5238-5239):

It now appears clear from the Supreme Court decision in Moldowan as recently interpreted by the Federal Court of Appeal in Canada v. Morrissey, [1989] 1 C.T.C. 235; 89 D.T.C. 5080 that, for a person to claim that farming is a chief source of income, he must show not only a substantial commitment to it in terms of the time he spends and the capital invested, but also must demonstrate that there is a reasonable expectation of it being significantly profitable. I use the term "significantly profitable” because it appears from the Morrissey decision that the quantum of expected profit cannot be ignored and I take this to mean that one must have regard to the relative amounts expected to be earned from farming and from other sources. Unless the amount reasonably expected to be earned from farming is substantial in relation to other sources of income then farming will at best be regarded as a “sideline business" to which the restriction on losses will apply in accordance with subsection 31(1).

Applying the three criteria of time spent, capital committed and profitability, I find in the instant case that the taxpayer was not carrying on farming merely as a “sideline business". He had truly changed his mode and habit of work and centred the bulk of his energy on sheep farming. The capital involved was modest but he gave all he had, and more, cashing in his RRSP and overextending himself into debt. His uncontradicted evidence is to the effect that he spent much more time on the farm than he did at the Program. His stated intention, and I found him to be very credible, was that he only maintained his job at the Program so as to bring in some desperately needed cash flow while he was in the process of launching his farm operations. He, of course, expected to succeed at this venture. Unfortunately, because of the severe economic and weather conditions experienced during the early years, he was not successful. It appears that farming was potentially his chief source of income, at first in combination with another source, and then all by itself. As indicated by Mahoney, J., in the Morrissey decision, "potentiality, rather than actuality, is the question in all cases since the provision applies only where there is a loss in a taxation year".

Consequently, I find that for the taxation years 1978, 1979 and 1980 the taxpayer was a “class (I) farmer" entitled to deduct all his farming losses. Thus, the reassessment for those taxation years shall be vacated.

Judgment in favour of the plaintiff with costs.

Appeal allowed.