Richardson v. The Queen, 89 DTC 5001, [1989] 1 CTC 10 (FCTD)

Dubé, J.:—The central issue in this income tax case is whether the plaintiff was for the taxation year 1978 a “class (1) farmer" and thus entitled to deduct the loss from his farming business for that year under section 31 of the Income Tax Act. The section reads:

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 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) /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 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 was delivered by Dickson, J. (as he then was) of the Supreme Court of Canada in Moldowan v. The Queen, [1978] 1 S.C.R. 480; [1977] C.T.C. 310. 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.

The classification was further refined by Joyal, J. of this Court in Hadley v. The Queen, [1985] 1 C.T.C. 62; 85 D.T.C. 5058 at 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 the 1978 taxation year. The Tax Court of Canada confirmed that decision. The action before me is therefore an appeal by the taxpayer of that decision.

The plaintiff is a successful accountant operating a main office at Chatham, Ontario, and a secondary office at St. Mary's, Ontario in the area where he was born and raised on a farm. In 1944 at the age of 17 he was an apprentice in an accounting firm and at 21 a partner. He is presently 61 years old. In the course of the relevant years, he was a 50 per cent partner in the firm of Richardson & Laken in 1978, a 47 per cent partner in 1979 and 1980 and a 48 per cent partner in 1981.

He also took an active part in other business ventures being involved with corporations carrying on business under the names of Wildwood Trailer Park, Import and Export Products Limited., Poke's Bait Shop, B. & C. Storage and Leading Limited, Nabco Lumber, Inc. and Richlake Services Limited.

In the the summer of 1978 he and a minority partner purchased two farms consisting of 91 acres with a specialized building for raising horses along with a regulation training track. The total investment in the start-up farming operations was $276,000, $174,000 of which represented his own investment. He employed a full-time farm manager and six employees as well as outside trainers, veterinaries and horse breeders. There was a three bedroom home in excellent condition on the farm. The plaintiff did not live there himself, but his farm managers did (a second manager was retained to replace the first one who turned out not be satisfactory to the plaintiff). At the start, the plaintiff and his partner purchased ten mares and nine horses. The purpose of the farm was to breed suitable studs, to provide artificial breeding, to offer horse training for prospective customers and to raise and to race horses. The partners later purchased 60 head of cattle. The farm operations turned out not to be a success and the plaintiff claimed these losses:

1978: $37,826.10

1979: $16,579.95

1980: $56,475.00

1981: $54,851.98

On the other hand, the plaintiff reported the following income from his accounting practice:

1978: $45,463.25

1979: $46,143.60

1980: $58,189.21

1981: $60,465.78

The plaintiff testified at the hearing that he wanted to retire from the accounting business which he found to be more and more stressful and to move gradually, within three to four years, to the farm business, which he thought would be an “easier profession", a more relaxed lifestyle. In August 1978, the accounting business claimed less of his presence so he spent more and more time on the farm. The accounting practice is feverishly busy during the income tax return preparation period from January to the end of April, but there is more freedom during the summer months. In 1978, the plaintiff had two accountant partners, two trainees and three secretaries. He also retained the services of an additional part-time trainee at income tax time.

Before 1978, the plaintiff would spend his summer leisure time golfing and boating. He dropped those recreational activities to spend more time on his farm business and sold his two yachts. He would leave the Chatham office on Thursday afternoons and drive to the farm some 100 miles away and return on Mondays. In 1979, he would spend about a day a week at the office, except at busy income tax time where he would spend four days at the office each week. His “billable hours" of work were reduced from 1645 hours in 1977 to 1270 in 1978.

By consent, the plaintiff filed a letter from his physician dated September 23, 1988. Dr. T. L. Walker has been the plaintiff's physician for almost 30 years. He writes that the plaintiff had "severe high blood pressure since before 1950”. Vascular surgery was performed in 1958, but there remains an "essential" component of hypertension. He was placed and has remained constantly on medication. The year 1978 was a particularly stressful year. He was overworked with long hours and excessive demands for his services. The plaintiff is a "hard-working, hard-driving man who pushes himself excesively". The doctor concludes that "the situation described above has been a year-in and year-out situation, however my notes and memory indicate that 1977,1978 and 1979 were particularly 'bad' years”.

In 1988, the plaintiff sold the farm to another farmer but maintained his other operations, including the accounting practice which had become more profitable yearly during that period. The partnership earned the following income for those years:

1978: $275,078

1979: $316,279

1980: $369,765

1981: $392,074

The narrow issue to be resolved is whether or not the plaintiff's chief source of income for the year 1978 was farming. The jurisprudence in the matter has provided several useful criteria.

In the aforementioned Moldowan decision, Dickson, J. points out that section 31 of the Act includes a combination of farming and some other source of income as the chief source of income. He speaks as follows (at page 488; C.T.C. 315):

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 farming as a main expectation of income is not disentitled to deduct the full impact of start-up costs.

[My emphasis.]

In other words, so as to succeed the plaintiff must show that his major preoccupation in 1978 was farming and not accounting. If farming was indeed his major preoccupation, the other pecuniary interests, such as his accounting practice and his other businesses would not disentitle him from a class (1) treatment. Moreover, if the taxpayer can establish a change of occupational direction in 1978 he may deduct his start-up costs. In order to do so, he must show that he looked at farming as his main expectation of income. Dickson, J. continues (at page 486; C.T.C. 314.):

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.

[My emphasis.]

Additional criteria as to the chief source of income may be obtained from the jurisprudence: the amount of time devoted to the farm; [1] the income from farming as compared to the taxpayer's professional income; [2] the phase-out of the taxpayer's involvement in his prior profession; [3] the importance of the capital invested in the farm. [4]

In Charles H. Roney v. M.N.R., [1984] C.T.C. 2701; 84 D.T.C. 1431 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. The Minister limited his farming loss to $5,000 on the basis that the taxpayer's chief source of income was neither farming nor a combination of farming and some other source. The Tax Court of Canada allowed the taxpayer's appeal. It found that the taxpayer carried on the farming activities as a sideline business, that he was not yet a full-time farmer but was starting up the farm business and changing the course of his occupation. It held that it was sufficient that the taxpayer incurred the start-up costs in anticipation of a career change but was prevented from making the actual change due to an unforeseen drop in the price of beef cattle. That decision was very recently confirmed by Denault, J. [5] In his judgment he reviewed the authorities and the facts of the case. He found as a fact that the defendant had changed his occupational direction from that of an executive to that of a farmer as a main expectation of income. He said (at page 12 [C.T.C. 364]):

. . . Although the taxpayer did not perform physical labour on the farm but put his organizational and analytical skills to the business, while getting substantial income from his other business operations, his expectations were that his purebred farming operation would provide the substantial bulk of his income in the future. But he suffered financial losses and finally had to dispose of his herd.

The learned judge also made the following findings (at page 13 [C.T.C. 364]):

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.

[My emphasis.]

Similar findings could be made in the instant case, except the fourth one, as Mr. Richardson did not move to the farm. He did not leave his home, did not change his lifestyle, continued as an accountant (albeit with a reduced workload) and attended yearly chartered accountant conventions throughout the period.

In the case at bar, the plaintiff testified that his farming adventure was not successful, partly because his managers did not produce as expected and also because the interest rate shot up dramatically during that period (from 9 / per cent in 1978 to 21 per cent in 1981). His partners wanted out. The plaintiff, however, made no efforts to liquidate any of his other sideline interests, (and obviously did not dispose of his main source of revenue, the accounting business) so as to salvage the farm operation.

My view of the situation is that the chief source of income of the plaintiff was and remains his accounting practice. He had several other businesses, of which the farm operation was an important one, considering the capital and time invested in it. It seems to me that if the plaintiff had reached a turning point in his life in 1978 (he was then 51 years old) because he found the accounting business to be too stressful, he would have moved to the farmhouse, which admittedly was in excellent condition, so as to enjoy fully the calm of the countryside and to rediscover the serenity of his boyhood days. His role in the farm venture consisted mostly in keeping the books and completing the financial arrangements. He was not personally involved in the actual day to day management of the farm. He had no particular knowledge or experience in the breeding, raising or racing of horses. The purchase of the farm did not really change his mode or habit of work: it was merely the extension of his profession to yet another business venture.

I must therefore conclude that in 1978 the plaintiff's chief source of income was not farming, nor a combination of farming and some other source of income, but his accounting practice. Neither can I find that there was a change in occupational direction during that year.

Consequently, the action is dismissed with costs.

Action dismissed.