The Queen v. Hoeft, 89 DTC 5144, [1989] 1 CTC 350 (FCTD)

Martin, J.:—The plaintiff appeals the March 13, 1984 judgment of the Tax Court of Canada allowing the defendant's appeal in respect of his farming losses, claimed for his 1977, 1978 and 1979 taxation years, portions of which losses were disallowed by the plaintiff. The learned Tax Court judge referred the matter back to the Minister of National Revenue for reconsideration and reassessment on the basis that the defendant's chief source of income for 1977, 1978 and 1979 was a combination of farming and employment.

The defendant, who is now 40 years of age, joined the Royal Canadian Mounted Police in April of 1970 and will be eligible for a pension from the force in 1990. Although he had little experience in farming as a youth he became interested in that life prior to his marriage in 1972. By helping out friends of his who operated farms he began to learn how to operate one himself.

At the time of his marriage in 1972, his wife, who was brought up on a farm and who obviously retained a genuine love of that type of life, had her own Quarter horse and was, apparently, anxious to resume the farming style of life. She apparently provided what little incentive the defendant needed to decide on adopting that lifestyle. Having made the decision, the defendant purchased his own Quarter horse the next year and rented a small ten- acre farm which he and his wife operated from 1973 to 1976.

During those years the defendant claimed restricted farm losses i.e. to a maximum fo $5,000 per year, as allowed by subsection 31(1) of the Income Tax Act. No amounts were introduced in evidence indicating the defendant's income and expenses for that period but I can assume there must have been losses because the provisions of subsection 31(1) are only engaged when there are losses.

In 1976 the defendant bought a 160-acre farm in the Estevan District of Saskatchewan. The farm consisted of 80 acres of crop land, 60 acres of pasture and 20 acres of hay together with a 105-year-old residence, a barn and some outbuildings. The defendant rented the 80 acres of crop land for a three-year period on a 1/3-2/3 split on the crop. The property was acquired for $53,000. The defendant put up as collateral for the full $53,000 loan his and his wife's horse plus one other horse together with three cows and five calves and, presumably, the farm.

By 1977, the defendant considered that his farming activities had increased to such an extent that he could claim full farming losses rather than the restricted annual loss of $5,000. It was during that year that the defendant had a serious accident which rendered him incapable of doing any work around the farm for a period of about six and one half months. During that period what farm work was done was done by his pregnant wife.

During the three-year period that he operated the farm at Estevan the defendant purchased a small farm tractor, a cultivator, a pick-up truck, a few cattle and one or two horses. His statements of farming income and expenses for the 1977 to 1979 taxation years indicated that he also purchased four or five calves for feeding and subsequent sale and that he bought an additional horse.

In April of 1979 the defendant was transferred to Southey, a community about 155 miles south of Estevan. The defendant actually moved to Southey on July 6 with a view to finding another farm. That he did on September 8, 1979. It consisted of a 320-acre farm with a house, barn, outbuildings and farming machinery which he purchased for $115,000. He had some difficulty in disposing of his Estevan farm but he finally sold it by the end of the September 1979 for $75,000.

As the new farm was not set up for raising cattle and training horses no new cattle were purchased to feed over the winter although one Quarter horse filly was purchased in that year.

Over the years from 1973 to 1988 the defendant tried his hand at selling eggs, raising chickens, growing alfalfa, raising calves for sale, raising turkeys and other aspects of farming but his main interest appears to have been establishing himself and his wife as Quarter horse breeders. He explained that in order to establish a horse as a quality Quarter horse it is necessary to enter it in accredited competitions with a view to obtaining points towards the horse’s qualification as a champion Quarter horse. Given a horse of fair quality it seems to follow that the more shows or competitions in which the horse competes the greater the chances are that it will be awarded points. This explains why so much of the defendant's time was taken up preparing for, going to and from and attending horse shows.

Although the defendant has been farming continuously since 1973 his operations have never shown a profit. The following table, although not complete for every year since 1973, indicates some of the financial aspects of his farming operations and his employment income:

The defendant said that after he purchased the farm in 1976 he intended to bring the operation ahead on a conservative basis anticipating that it would be showing a profit within five years. No evidence was given to support this statement and, in fact, in the subsequent five-year period his farming operations sustained losses in each year and had a cumulative loss over the five-year period of about $67,000. Notwithstanding that record the defendant claims that his Estevan farm would have shown a profit in 1980 had he not moved to Southey.

In December of 1981 the defendant said, in his brief to the Tax Court, that it generally takes a three or four year period for a farming operation to show a profit but that the Southey operation, being a new one and having high start-up costs and being done in a period of high interest rates, would require five or six years to turn a profit.

For some unexplainable reason there accompanied his brief to the Tax Court a detailed statement of his projected farm income and expenses for the next five years (1981 to 1985) in which he projected substantial profits for each of the five years and a cumulative profit over the five-year period of $86,925. In fact, as the record indicates, he had substantial losses in each of the five years and a cumulative loss over the period of $79,005. He also had further losses of $40,000 over the next two years.

The defendant accounted for his losses by reason of poor markets, bad weather and high interest rates and, at the hearing before me, once again predicted that within five years he would have a profitable farming operation. However he gave no estimates or projections or supporting data to warrant his optimism, perhaps wisely so in the light of his other projections.

Pursuant to subsection 31(1) of the Income Tax Act a taxpayer is limited to a $5,000 annual deduction for farming losses

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, . . .

In Moldowan v. The Queen, [1978] 1 S.C.R. 480; [1977] C.T.C. 310; 77 D.T.C. 5213, the Supreme Court of Canada set out the basis for determining whether a taxpayer's chief source of income is either farming or a combination of farming and some other source of income. The Court found that one should have regard to the taxpayer's reasonable expectation of income from his various revenue sources and his ordinary mode and habit of work and, with respect with each revenue source, one should have regard to the time spent, the capital committed and the profitability, both actual and potential.

Until recently it has generally been held that the two tests, "reasonable expectation of income" and “ordinary mode and habit of work" should be read disjunctively so that if a taxpayer can qualify under either test he would be entitled to claim that his farming revenue formed a portion of his chief source of income. In the recent case of Canada v. R. Morrissey, [1989] 1 C.T.C. 235; 89 D.T.C. 5080, the Court refused to accept the disjunctive application of the tests suggested by the trial judge on facts remarkably similar to the facts in this case and found, commencing at page 241, as follows:

With respect, I do not agree that Moldowan suggests disjunctive consideration of pertinent factors in quite the way the learned trial judge has dealt with them. The discussion in Moldowan begins as follows:

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.

Moldowan also says, dealing with the difference between classes 1 and 2, “while a quantum measurement of farming income is relevant, it is not alone decisive". 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.

The appellant has admitted that the respondent was farming with a reasonable expectation of profit. That means he was farming as a business and is conclusive that he was not a class 3 farmer. 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 subsection 31(1), it seems to me that potentially, 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.

Moldwan 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 defining the test as relative and not one of pure quantum measurement, Moldowan teaches that all three factors are to be weighed. It does not, with respect, merely require that farming be the taxpayer's major preoccupation in terms of available time and capital.

On a proper application of the test propounded in Moldowan, when, as here, it is found that profitability is improbable notwithstanding all the time and capital the taxpayer is able and willing to devote to farming, the conclusion based on the civil burden of proof must be that farming is not a chief source of that taxpayer's income. To be income in the context of the Income Tax Act that which is received must be money or money's worth. Absent actual or potential profitability, farming cannot be a chief source of his income even though the admission that he was farming with a reasonable expectation of profit is tantamount to an admission which itself may not be borne out by the evidence, namely that it is at least a source of income.

In this matter the defendant has made out a strong case for time spent and capital invested in his farming operations. He submits that he and his wife jointly devote some 4000 hours each year to the farming operation and that all the money which he manages to save out of his income from his employment as a full-time RCMP officer is invested in his farming operation.

I have some reservations about the time the defendant claims to have spent on his farming operations. For a six-month period during the three years in question, when the defendant was unable to do any physical work, he claims to have spent from six to ten hours a day "managing" the farming operation. As well he made no allowance for the time which he must have spent in caring for his own horse, in making repairs and attending to the general maintenance of his home, in maintaining the garden area around his home and other such personal matters. He also included as time spent in his farming operation the time he and his wife spent visiting neighbourhood friends for a social evening because, during these visits, he talked about farming.

I have no doubt that the defendant and his wife spend a great deal of time in the actual operation of their farm. However the defendant appears to have characterized as actual time spent in his farming operation any time he was on the farm and not sleeping or eating. Indeed he even adds to that time the time when he was not on the farm but discussing farming in general with his friends.

I do not have to make a finding with respect to the time spent or mode of life of the defendant because, like Mr. Morrissey, he cannot bring himself within the test of potential profitability. Since 1973 the defendant has been carrying on a farming operation and has not made a profit any single year. Originally, after acquiring his own farm, he says he expected to make a profit in five years but came nowhere near that mark. After that, in 1981, he predicted immediate and substantial profits over the next five-year period, according to his detailed projections, or a profit within five or six years, according to his brief. In fact over that period he sustained continual losses which appear to have settled down to an annual loss of $20,000. Notwithstanding these uninterrupted losses over a sixteen-year period the defendant continues to predict the imminent profitability of his farming operation.

In another remarkably similar case, The Queen v. J. Peter Connell, [1988] 1 C.T.C. 247; 88 D.T.C. 6166, Strayer, J. made the following observations:

Looking at the criterion of the "taxpayer's reasonable expectation of income from his various revenue sources" I find it difficult to see in the present case that the taxpayer has established a reasonable expectation of his farm income becoming his chief source, or one of his chief sources, of income. He testified that when he commenced building his herd in 1973 he expected it would take about ten years to make the operation profitable. The basis for that belief was demonstrated. In any event, it has proven to be overly optimistic as the farm is not yet profitable some fifteen years later. The taxpayer blames this in part on depressed meat prices and, for part of the period after the tax years in question, on extraordinarily high interest rates. To a certain degree these and similar problems seem to arise frequently in agriculture and any realistic forecast of profitability must take them into account. While the taxpayer says he is optimistic for the future and expects his herd to become profitable, as mentioned earlier no data and no corroborating evidence was presented on this point. While the Minister has, by applying subsection 31(1), conceded that the taxpayer's farming is “a source of income" and this implies some expectation of ultimate profitability, this is not determinative of whether the taxpayer could have a reasonable expectation that his farm income would be his chief source of income either alone or in combination with another source of income. It is hard to see how such an expectation could be entertained in the circumstances of 1979 and 1980 when he was earning a salary of respectively $61,199 and $69,510. Mr. Connell himself confirmed in his testimony that he could not conceive of his farm income exceeding his employment income. On the facts it is difficult to see how he could have had a reasonable expectation of his farm income even being significant in relation to his employment income so as to constitute one of his chief sources of income.

In my view, bearing in mind the defendant's farm losses and employment income over the three-year period in question, his prior record of losses and his subsequent losses over the following ten years, Mr. Justice Strayer's remarks are equally applicable to the defendant in this case and I find that the defendant could not, in the years in question, have had a reasonable expectation that his farm income would be his chief source of income either alone or in combination with another source of income.

Having found the profitability of his farming operations to be improbable then, in the words of Mahoney J. in Morrissey, at page 242:

. . . notwithstanding all the time and capital the taxpayer is able and willing to devote to farming, the conclusion based on the civil burden of proof must be that farming is not a chief source of that taxpayer's income.

Accordingly, I will allow the appeal with costs and direct that the Minister's assessments for the 1977, 1978 and 1979 taxation years of the defendant be confirmed.

Appeal allowed.