MacRae v. The Queen, 88 DTC 6454, [1988] 2 CTC 233 (FCTD), aff'd 89 DTC 5526 (FCA)

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 1977, 1978 and 1979 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. These matters came on for hearing in Calgary, Alberta, on April 19, 1988.

Since 1971, the plaintiff has been operating a farm on land owned by himself and his wife near the town of Didsbury, Alberta. In 1973, an additional quarter section of land was purchased and in 1979, the plaintiff leased a further 480 acres that he continues to farm, for a total of 1,360 acres. From 1967 to the present, the plaintiff also carried on the practice of dentistry in Calgary, Alberta.

In the 1977, 1978 and 1979 taxation years, the plaintiff incurred certain losses in connection with the farming operation and deducted them in determining his taxable income for those years. The Minister of National Revenue reassessed the plaintiff and restricted the losses 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 later received the notices that the reassessments were confirmed. The plaintiff instituted an appeal in the Tax Court of Canada, pursuant to section 169 of the Act, but the action was dismissed when no evidence was led on behalf of the plaintiff.

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) 1/2 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.

At trial, the plaintiff put forward two arguments. First, that the defendant must fail because the pleadings make no reference to the particular assumptions made by the Minister in reassessing the plaintiff's income tax returns for the years in question. In Tobias v. The Queen, [1978] C.T.C. 113; 78 D.T.C. 6028, it was held that when no specific allegations are made as to the particular assumptions relied on by the Minister, the plaintiff is entitled to establish the assumptions that were made. From questions asked during the examination for discovery, the plaintiff contends that the Minister, in restricting the plaintiff's farm losses, relied on a comparison of the amount of time spent by the plaintiff working on the farm and at his dental practice and on the evidence of a greater income from the dental practice. It is maintained that the assumption the plaintiff was at the farm only on weekends and holidays is factually incorrect. Furthermore, the plaintiff contends the approach taken by the Minister, in simply looking at the income and loss with respect to the dental practice and the farm, is wrong in law and ignores a number of other factors which must be considered.

Second, the plaintiff argues the defendant incorrectly assumed that the plaintiff's chief source of income was neither farming, nor a combination of farming and some other source of income. The plaintiff maintains that the following factors show that farming, or a combination of farming and other sources of income are his chief source of income:

(1) he has more capital invested in the farming operation than any other undertaking;

(2) the farm is large enough that it has more than a reasonable prospect of generating an adequate return on capital invested;

(3) the plaintiff is personally, and through employees and agents, intensely involved in the day to day operation of the farming business; (4) the plaintiff plans to increase his personal involvement and investment in the farm;

(5) the farming operation is substantial in relation to other farming operations in the area.

The defendant argues the plaintiff's chief source of income during the taxation years in issue, was neither farming, nor a combination of farming and some other source of income. Accordingly, the plaintiff's farm losses should be restricted to $5,000 for each of the 1977, 1978 and 1979 taxation years, pursuant to section 31 of the Act.

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 carries 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 carries 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 essentially factual and Moldowan provides certain tests, guidelines and indicia to assist the Court. The criteria include 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, in relation to a source of income, the time spent, the capital committed and the profitability both actual and potential, but the Court was also clear in Moldowan that while a quantum measurement of all such factors, including income is useful, no single factor is determinative.

In the case at bar, the evidence is clear that the plaintiff’s dental practice has been a successful and expanding business. The plaintiff began practising dentistry in 1967 with two operatories. By 1978 these had expanded to six. That same year, the practice was closed for some months when the plaintiff's office was destroyed by fire. Insurance proceeds were used to reopen a practice with four operatories, and this number has not changed to date. Between 1971 and 1978, the plaintiff had a series of four associates working with him. The cost of a dental assistant and receptionist was paid for by the plaintiff and in turn he received 50 per cent of the associate's gross income.

In 1979, the plaintiff's wife was hired as an employee of the dental office to handle general ledger work and some reception. The number of dental assistants and receptionists doubled in 1981, and in 1983, three computer systems were placed in the dental office. As the number of employees increased, so did the gross income of the practice. In 1977, it earned $272,660, in 1978, $245,616 and in 1979, $326,432. By the mid-1980's, this figure had risen in $500,000.

The plaintiff continues to attend courses and between 1980 and 1987, invested $17,242 in professional education. He has also maintained his membership in various professional associations related to both dentistry and pharmacy.

From 1968 until the initial purchase of land for the ranch in 1971, the plaintiff was involved in a partnership raising Brown Swiss cows. When the ranch was bought in 1971,15 of these cattle were used as start-up stock. The purchase of the first 720 acres was completed by the plaintiff in partnership with another gentlemen; however, by the end of 1971 the plaintiff and his wife had bought the partner out and were the full owners of the land. In 1973 further acreage was acquired by the plaintiff, and by 1979 he was farming a total of 1,360 acres including leased land. All purchases of land for his ranch were financed by mortgage.

The plaintiff runs a cow/calf operation, selling marketable calves in the fall, along with any cows that cannot be bred that winter. His tasks on the ranch involve acquisition of cattle with a view to upgrading the quality of calves produced, feeding and care of cattle, breeding of marketable calves, clearing and developing unbroken land, and construction and improvement of the feedlot, fencing, corrals, watering systems and buildings.

When the land was purchased it was not a full scale ranching operation and though it had been fenced and partially broken, portions of it were covered in bush and there was much work to be done to bring enough under cultivation to build a self-sufficient ranch. Existing buildings included a house and a few barns and sheds. Though there was a residence on the ranch the plaintiff and his family chose to maintain their principal residence in Calgary.

A number of improvements were made from 1971 to the present including preparation of unproductive acreage for cultivation, the cultivation of crops, maintenance and installation of fencing, construction of buildings and equipment acquisitions. Further purchases of cattle combined with the natural growth of the herd increased the cattle inventory, so that in 1977, 1978, and 1979 the average closing inventory was 143 cattle. During the years in question, work on the farm was carried out by the plaintiff, a hired consultant/manager and the plaintiff's son. From time to time, contractors were hired to do the initial clearing and breaking of the land. Presently, the plaintiff and his son, Allan MacRae, are the principal workers with extra labour being hired during the haying season. In 1979, Allan MacRae began to reside full-time at the ranch and to receive a salary for his work there. A second home has been constructed for the plaintiff and his wife, which they plan to occupy on a full-time basis when the plaintiff retires from his dental practice.

For the 1977, 1978 and 1979 taxation years, the gross income for the farm was $10,004, $30,103 and $31,553 respectively, with net losses for the same three years of $53,986, $46,719 and $72,184. At the time of trial, the ranch had never shown a profit. During the hearing, the plaintiff called an expert witness, Mr. Lore, qualified to give opinion evidence on farming and agricultural matters. In his report, Mr. Lore compared figures taken from the plaintiff's operation to consensus data taken from ranches throughout the Province of Alberta. The result of that comparison showed the interest charges on the MacRae ranch almost six times higher than the comparable ranch, labour costs almost three times higher and the miscellaneous overhead five times higher. Mr. Lore further testified that though the plaintiff was fairly knowledgeable in farming techniques and quite innovative with regards to improving crop production through chemical fertilization, the ranch would not be capable of earning a profit until the interest, labour and other expenses were reduced. He believed that if these three problem areas could be brought into line with the comparable farm, the MacRae ranch would be profitable. It was pointed out, however, that in the ten years from 1976 to 1986 there has been no reduction of costs and the problem of undercapitalization continues.

The plaintiff testified that he expects to eliminate the interest charges by clearing the farm debt in seven years from the time of trial. Because of the cyclical nature of the cattle business, prices for beef are expected to drop in approximately four years, and the plaintiff acknowledged that if this occurred, chances are he will not meet his seven year objective. These factors indicate that the ranch will remain unprofitable for at lease seven more years and, very likely, longer.

The plaintiff gave evidence that during the taxation years in question it was, and in fact still is, his routine to work on the ranch Friday afternoons and weekends, and take vacation from the dental practice during the busy times on the ranch (approximately 4 to 6 weeks annually). Office hours in the dental practice require his presence Monday to Thursday 8:30 a.m. to 5:00 p.m. and Friday mornings. Occasionally, the plaintiff is required to work on the farm in the evenings. In more detail, in 1977 he spent 1,890 hours on the ranch and 1,557 hours in the dental practice. In 1978, because of the fire in the dental office, only 1,067 hours were spent there and 2,062 hours on the ranch. In 1979, 1,959 hours were estimated for the ranch and 1,396 for the dental practice. In following years the estimation of the division of hours was generally the same, with between 300 and 600 more hours annually being devoted to the ranch. Given the plaintiff's evidence that he practises dentistry 4.5 days weekly and is on the ranch 2.5 days weekly plus vacation time, these hourly calculations are unrealistic. At best, the time spent at each operation is evenly divided.

At trial, figures were presented related to the capital committed to the dental practice and the farm. The capital committed to the dental practice includes amounts for the cost of leases for required dental equipment, the leasing of a dental computer system, and computer software and a printer. From 1971 to 1988 total capital committed to the plaintiff's dental practice amounts to $285,640.

The figures presented by the plaintiff relating to capital committed to the ranch include the cost of the land, buildings, machinery and interest on the farm debt. However, in Gordon v. The Queen, [1986] 2 C.T.C. 280; 86 D.T.C. 6426, Madame Justice Reed suggested that where the cost of the farm is calculated in the capital committed, the annual mortgage costs should not be included in the calculation as well. When the interest on the farm debt is excluded, the total capital committed to the farm from 1971 to 1988 amounts to $511,527.

The fact that the capital committed to the ranch exceeds the amount committed to the dental practice is not sufficient for a finding that the plaintiff's chief source of income is the farm. As was emphasized in Mold- owan at page 314 (D.T.C. 5215),

Whether a source of income is a taxpayer's “chief source" is both a relative and objective test. It is decidedly not a pure quantum measurement.

This same problem was considered in two recent cases before the Tax Court of Canada in McCulloch v. M.N.R., [1988] 1 C.T.C. 2284; 88 D.T.C. 1183 and White v. M.N.R., [1987] 1 C.T.C. 2178; 87 D.T.C. 122. Both involved professionals who took up farming as this plaintiff has done. Both involved cases where the professional income exceeded the farm income and both involved cases where it appeared likely that the farm income would remain unprofitable for some time. The analysis and ultimate determinations were expressed by A.C.J. Christie in terms that appear to me to be precise and unimpeachable. I do not propose to quote extensively upon the facts of the cases, but the similarity is striking even from the headnotes which I quote as follows in McCulloch:

The taxpayer was a medical doctor specializing in spine surgery. He had a very successful career, and was a world-renowned expert in one particular procedure. In 1971, the taxpayer started a Christmas tree farming business but by 1974 had sold the farm and purchased a feed-lot operation. The taxpayer familiarized himself with various aspects of farming, associated himself with an advisor whom he considered an expert in the area and eventually operated the farm as a partnership with the advisor's company. The operation grew to over 1900 acres, and the taxpayer took a central supervisory role. The taxpayer devoted one full day and several evenings a week to farming, and started related grain farming and abattoir businesses, which proved financially unsuccessful. The Minister disallowed the taxpayer's deduction of full farming losses from other income for the 1978 to 1982 taxation years. The taxpayer appealed to the Tax Court of Canada.

and in White:

The taxpayer was a medical doctor who, after developing an interest in farming, purchased a ten-acre farm in 1975. He acquired a few cattle, pigs and other animals but suffered small but consistent losses from his operation. Between 1976 and 1980, the taxpayer devoted approximately 80 hours per week to his medical practice. In the spring of 1979, the taxpayer decided to focus on raising purebred Simmental cattle for the production of beef. He purchased a herd later that year and, in 1980, he began to reduce the time devoted to farming: Wednesdays and weekends were allocated to farming. In order to expand, the taxpayer purchased an 80-acre parcel of land in 1984 and disposed of his original 10-acre parcel as part of the purchase price. The taxpayer, however, continued to suffer losses from his farming operation from 1980 to 1985, inclusive, ranging from about $15,000 to about $126,000. At the same time, he continued to earn substantial income from his medical practice. In fact, such income continued to rise over the years. The Minister restricted the taxpayer's farming losses in respect of his 1980 to 1983 taxation years and the taxpayer appealed to the Tax Court of Canada.

I also quote from page 2290 (D.T.C. 1187) of the more recent decision in McCulloch:

While I am satisfied that the appellant was thoroughly devoted to his farming enterprise and that the generously committed his physical, intellectual and finan- cial resources to it this, of itself, cannot resolve the dispute in his favour. This commitment must be considered in relation to his dedication to medicine which obviously was very substantial. His income from this source, the volume of surgery he performed, his teaching activities and his authorship and presentation of learned papers all speak, and speak emphatically, for themselves. A comparison between the appellant's medical income and the financial results of his farming activities is cogent. The whole of the evidence leads me to conclude that the appellant falls considerably short of discharging the onus that rests upon him to establish that the respondent erred in his reassessments. I go even further and say that, when regard is had to what realistically must have been his commitment to farming as opposed to his commitment to medicine and the economic results of each, I am affirmatively satisfied that the appellant falls within the second class of farmers described in Moldowan.

During the times relevant to the appeal he did not look to farming, or to farming and a subordinate source of income, for his living. The business of farming was in a sideline position with respect to his medical business. It follows that this appeal cannot succeed.

Simple justice and consistency prohibits me from reaching any different conclusion in the present case.

In my opinion the amount of time devoted by the plaintiff here to his dental practice, his continuing education in that area and his membership in numerous associations, combined with the continued growth and financial success of the practice indicate a very substantial commitment. The facts clearly show that the plaintiff cannot realistically or objectively be regarded as being other than a taxpayer who looked to dentistry as his chief source of income. When the commitment to the farming operation is compared with the commitment to the dental practice and the financial results of each are considered, it is apparent that the ranch was a sideline operation.

Though the plaintiff has made significant investments of time and money in the ranch, it is clear that there existed no reasonable expectation of profit from the operation, and the plaintiff's ordinary mode and habit of work, during the taxation years in question, centred around his dental practice.

These appeals are therefore dismissed, with costs.

Appeals dismissed.