Wilson v. The Queen, 88 DTC 6430, [1988] 2 CTC 222 (FCTD)

The Associate Chief Justice: —In these actions brought pursuant to subsection 172(2) of the Income Tax Act, S.C. 1970-71-72, c. 63, as amended, the plaintiff appeals the reassessments for the 1976 and 1977 taxation years restricting losses from the plaintiff's farming operation to $5,000 for each of those years, in accordance with subsection 31(1) of the Income Tax Act. The matter came on for hearing in London, Ontario, on April 6, 1988.

As is so often the case, the taxpayer here has been successful in one endeavour, and somewhat later in life has turned his attention to farming. As is also quite often the case, the interest in farming traces itself to an earlier era. During his youth, the plaintiff worked on farms for five consecutive summers, and spent some time on his uncle's racehorse farm. He received exposure to all aspects of farming and worked often with horses as they were more widely in use then. Reference was also made to the plaintiff's first employment following university which was with the R.C.M.P. as a member of the Musical Ride team. Out of this background, the plaintiff's interest in agriculture has heightened, with a particular emphasis on horses.

In September 1972, the plaintiff purchased 100 acres of farm land with the intention of operating a farm for the training and breeding of standardbred racehorses. At the time he purchased the farm land, the plaintiff was the chief executive officer and 100 per cent shareholder of Wilco Tubular Products Limited, a corporation situated in London, Ontario, which manufactures tubing for the automotive industry.

As often occurs in the early years of a business, losses were incurred by the plaintiff's farm in its initial years of operation. For the taxation years of 1976 and 1977 amounts of $136,415 and $105,619 respectively, were deducted from the plaintiff's income. The Minister of National Revenue reassessed the plaintiff and restricted the losses incurred from the farm to $5,000 in each year pursuant to subsection 31(1) of the Income Tax Act. The plaintiff filed notices of objection, but was later advised the notices of reassessment were confirmed.

Subsection 31(1) of the Income Tax Act provides that where farm losses are incurred by a taxpayer whose chief source of income is neither farming nor a combination of farming and some other source, he may deduct only part of the loss. The section reads as follows:

31.(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 incomes 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) $2,500.00, 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);

Counsel for Mr. Wilson argues the farm losses he is entitled to deduct should not be restricted pursuant to subsection 3(1) of the Act, as his chief source of income was from farming, or alternatively from farming and some other source of income. The plaintiff testified that when he purchased the farm he intended to establish a business which would make money for him through the racing and selling of horses. It was hoped he would retire to the farm business and let the manufacturing business run itself through the development of capable management personnel. Further, he argues that after acquiring the farm he began to implement plans for development which included renovation and construction of barns, the purchase of racehorses, and the cultivation of oats and hay. Equipment was purchased and improvements were made in order to develop a viable operation. The plaintiff maintains these factors are sufficient to show that farming was his chief source of income in combination with another source of income and accordingly he should be entitled to deduct his total losses.

The defendant maintains the plaintiff's farming operation did not constitute his chief source of income nor was it a chief source of income in combination with some other source of income within the meaning of subsection 31(1) of the Income Tax Act. It is contended by the defendant that the proper test is whether the farming, relative to other sources of income, is the chief source. As the farming activity could not reasonably be expected to provide the bulk of the plaintiff's income during the taxation years in question, it is argued the plaintiff's farming operation was a secondary pursuit to his other activities with Wilco Tubular Products Limited.

The leading case on the interpretation of section 31 is the Supreme Court of Canada decision in Moldowan v. The Queen, [1977] C.T.C. 310; 77 D.T.C. 5213. The Court concluded that the Act envisaged three classes of farmers:

1. the taxpayer, for whom farming may reasonably be expected to provide the bulk of income or the centre of work routine;

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;

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.

Taxpayers in class one are entitled to deduct their farming losses from other income without restriction; those in class two may deduct farm losses from other income but are restricted in the amount by section 31; taxpayers in class three are not entitled to deduct any farm losses from other income, as they are considered non-business losses and accordingly treated as personal living expenses.

The issue of whether a taxpayer fits into the first or second category is almost entirely factual. Moldowan provides tests, guidelines and indicia to assist the Court in making a determination, including the taxpayer’s reasonable expectation of income from other sources in comparison with the farm and his ordinary mode and habit of work. These should be examined in terms of time spent, capital committed and profitability, both actual and potential. The following language also leaves no doubt however that while a quantum comparison of all these factors including income is helpful, no single element is determinative:

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 . . . 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.

In the case at bar, the evidence is clear that although the plaintiff's farm operation began on a small scale, it quickly became successful due to the plaintiff's significant investment of time and capital. The business began with the purchase of 100 acres of farm land in 1972. During the next two years, the plaintiff purchased horses and equipment, converted the already existing barn to one suitable for his purposes, fenced in the property, converted the land to pasture and grew crops of oats and hay. In addition, the plaintiff constructed a family home on the property so he would be on the farm for management purposes and for continual involvement in farming activities. During the early years, the majority of the labour involved in the enterprise was effected by the plaintiff himself with the occasional assistance of part-time hired laborers.

Before the plaintiff actually began to acquire racehorses, he went to Kentucky, met with a number of people in the business and did a good deal of reading to educate himself about the breeding and training of stand- ardbred racehorses. The first racehorse was purchased in 1974, and this number increased from four or five in 1976, to approximately 75 horses in later years.

As the business expanded and the number of horses increased, the plaintiff acquired more land and equipment and constructed additional facilities including a number of barns, runins, living quarters for grooms and a race track for training. In terms of the total capital committed, the plaintiff spent $218,500 for the purchase of farm land, and $463,000 for the purchase of horses. Additional staffing was necessary as operations increased. From 1974 to 1984, there was one full-time manager, and between 1976 and 1984, the number of full-time people increased at the rate of almost one a year until there were nine full-time employees by 1984.

The plaintiff has always managed the farm business personally. He hired and fired all personnel, set up the business plan and delegated day to day activities. Extensive records of the farming operation were maintained. These included files of breeding programmes for each of the brood mares, shoeing standards, expense records, vehicle maintenance, training records and histories of the foals born on the farm.

The plaintiff’s evidence is that his days were spent at the office of his manufacturing business, but mornings, evenings, weekends and vacation periods were spent working on the farm. On the average, 32 hours weekly were spent working on the farm, and ten hours weekly were spent dealing with farm business in the office at Wilco Tubular Products Limited. Work on the farm included managing, directing, labouring (fencing, cutting hay), foaling and training racehorses. Farm matters dealt with at the office included talking to breeding farms, race tracks and the farm manager as well as all financial aspects of the farming operations. In addition, the plaintiff often travelled to attend at races and sales involving his horses. Calls regarding farm business were frequently received at the office and the plaintiff was free to leave the office if required.

As previously noted, during the years he owned and operated the farm, including the taxation years in question, the plaintiff held the position of Chief Executive Officer of Wilco Tubular Products Limited. In this role of entrepreneur, he would seek out the customers and make all major decisions regarding the running of the business, then leave the day to day details to management personnel. His presence was not required in any of the plants and when he did visit them, it was more to boost employee morale than to scrutinize company operations.

The evidence is clear that the plaintiff's company has been quite successful. In 1976, Wilco U.S. was formed, and another factory was opened in Glencoe, Ontario in 1979. Between 1970 and 1980, the number of employees increased from 100 to 450. Assets went from $1.6 million in 1974 to $14 million in 1982 and during the same period of time retained earnings increased from $67,000 to $5 million. Not unexpectedly, plant capacity and the customer base also expanded during the 1970's. In the taxation years in issue, 1976 and 1977, the net incomes of the manufacturing enterprise were $453,000 and $540,000, respectively. The plaintiff's personal income from the manufacturing business during these two years totalled $382,000.

Though the plaintiff was very successful in his manufacturing business, he made a decision to commit substantial time, effort and capital to a new business venture. The plaintiff's efforts to educate himself on horse breeding and racing and his planning, investment and consistent input of time indicates a long term commitment to the business of farming. There is abundant evidence to show that from the beginning of the farm operation, the plaintiff had changed his ordinary work habits so as to centre it equally between the farm and the manufacturing business. The evidence also convinces me that there was a reasonable expectation of profit from the farm almost from the very beginning.

I also consider it significant that unlike the majority of disputes under section 31 where several years of uninterrupted losses lend support to the Minister's contention that farming does not constitute a present or potential source of significant income, in this case success came relatively early. One of the first horses purchased by the taxpayer was an immediate winner and as a result, the farm operation showed profit within three years of start-up. It has continued to do so ever since. Furthermore, when interest rates rose to entirely unexpected levels in the 1980’s, the manufacturing business, not surprisingly, encountered severe difficulties. Indeed, the assets of the farm were pledged to save it. This unexpected turn of events also brought about very quickly a situation in which the income from farming compared favourably with the taxpayer's other source of income.

For the foregoing reasons, I find that the plaintiff is entitled to deduct the total losses incurred in his farming business. Accordingly, these appeals are allowed.

Appeals allowed.