Date: 19980116
Docket: 96-4547-IT-I
BETWEEN:
YUN KAI CHAN,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
Reasons for Judgment
O’Connor, J.T.C.C.
[1] The issue is whether the Appellant in 1991 and 1992 is
entitled to deductions of the entire amounts of certain business
losses from his involvement in a business of buying and selling
Arabian horses or must his losses be restricted to the limited
amounts provided for in subsection 31(1) of the Income Tax
Act (Act), as contended by the Minister of
National Revenue (Minister).
[2] In December 1989, the Appellant and his wife purchased
fractional interests in four Arabians mares from Silver Unicorn
Inc. (Unicorn). Three other persons purchased the
remaining fractional interests in those mares.
[3] In December 1990, the Appellant and his wife converted or
swapped their said fractional interests in the two mares for a
100% interest in an Arabian stallion and an Arabian filly.
Unicorn maintained the horses at all relevant times for a
fee.
[4] The Appellant in the years 1991 and 1992 was a licensed
physician and derived substantial income from that
occupation.
[5] The horse operation produced no revenues in 1989 through
1992. The Appellant claimed as a deduction his share of the
losses incurred in 1991 being $28,753.46 which includes an amount
of $12,697.00 interest on monies borrowed to purchase the horses
and $12,882.55 in 1992 consisting entirely of interest on the
monies borrowed to purchase the horses. The Appellant paid no
horse expenses in 1992 other than the said interest because
Unicorn had defaulted in carrying out its duties.
[6] The two horses of the Appellant and his wife were moved to
Florida where litigation against Unicorn ensued. This litigation
involved other investors. The Appellant did not participate. The
litigation resulted in several horses including the two horses of
the Appellant and his wife, being ultimately included in a forced
sale. No proceeds from this sale were paid to the Appellant and
his wife. The Appellant had wanted to have the horses registered
in the names of himself and his wife but for various reasons this
never occurred and probably was the reason why the horses were
included in the forced sale notwithstanding the beneficial
ownership thereof by the Appellant and his wife.
[7] The Appellant did some research into his potential
investment in Arabian horses and concluded that it would be a
profitable investment. He derived no personal enjoyment from the
horses having visited the farm where they were kept on only one
occasion. It is clear that he was definitely a passive investor
in the horse operation.
Submissions of the Appellant
[8] The Appellant’s submissions can best be summarized
by quoting from his Notice of Appeal:
8. This was clearly a business venture with reasonable
expectation of profit for the following reasons:
a. The principal amount involved was substantial.
b. There was no involvement from the taxpayer or any of his
family members.
c. No farm land or horse racing was involved.
d. A professional horse farm was hired.
e. The horses were purchased as inventory with the intention
to sell later at a higher price.
f. The prices of the horses according to my researched
information was clearly indication that the venture was highly
profitable. (The information were previously submitted to Revenue
Canada).
g. The normal cost of this business, as quoted by the
Timberholme Arabian Farm in British Columbia (Financial Post
articles July 3, 1989) included: sale commission of 10%, boarding
fee of about $5700 a year and breeding fee of $7500. The fees
charged by the Silver Unicorn Inc. were in line with the other
Arabian horse farm.
h. The projection I used to analyze the profitability of the
business was very conservative and realistic. The projection
based from promotion of this kind of business were usually
3-4 times higher than my own estimation. (Information
previously submitted)
[9] The Respondent submits that the horse operation consisted
in “farming” as that word is defined in subsection
248(1) of the Act, that the Appellant’s chief source
of income was neither farming nor a combination of farming and
some other source of income and consequently the Appellant is
restricted to the amounts provided for in subsection 31(1) of the
Act.
Analysis and Decision
[10] Subsection 248(1) of the Act defines
“farming” as follows:
“farming” includes tillage of the soil, livestock
raising or exhibiting, maintaining of horses for racing, raising
of poultry, fur farming, dairy farming, fruit growing and the
keeping of bees, but does not include an office or employment
under a person engaged in the business of farming.
[11] Subsection 31(1) of the Act limits the deduction
of farming losses based on a formula, the result of which, if
that subsection is applicable, is that the Appellant’s
permitted deductions would be $8,715 in 1991 and $7,691 in 1992.
These are the amounts which the Minister has allowed.
[12] There is little doubt that the Appellant’s chief
source of income was not farming nor a combination of farming and
some other source of income. From his own testimony it is clear
that the Appellant’s involvement in the horse operation,
with the exception of the monies invested, was, for all intents
and purposes, nil. Further, the horse operation produced no
income whereas his physician income was considerable.
[13] The question thus becomes, was the operation
“farming”? The definition in subsection 248(1) is an
inclusive one, i.e. it extends the normal meaning of farming to
certain activities that might be borderline, such as maintaining
of horses for racing. That is not an issue here as the horses
were not maintained for racing purposes. However, the definition
does include the words “livestock raising”. I have
little doubt that the normal meaning of the word
“farming” would include the operations carried on by
Unicorn on behalf of the Appellant. Any such little doubt is
moreover removed because the operation surely consisted of
“livestock raising”.
[14] The Appellant argues that his was a mere passive
investment and therefore he was not carrying on personally a
farming operation.
[15] A similar argument was advanced in a very similar case,
namely Levy v. The Queen, 90 DTC 6346. The taxpayer in
that case had used an argument similar to that of the Appellant
in this case. Rouleau, J. of the Federal Court - Trial Division
stated as follows at page 6350:
The words “carried on by him” cannot be said to
have the same meaning as “actively engaged”. In fact,
I am confident in saying that an investment of capital, plus
contributions towards expenses and a fee for care and
maintenance, does constitute carrying on business.
The jurisprudence is clear that business may be said to be
“carried on” by a taxpayer, even though the actual
work is undertaken by another, when the taxpayer invests capital
only with a view to sharing the proceeds...
[16] It may seem unfair to certain taxpayers that farming
losses must be restricted as provided in subsection 31(1) whereas
the restrictions do not apply to any other business. Moreover, it
may seem unfair because perhaps if the Appellant had acquired
shares in a corporation carrying on a farming business, he would
not be restricted by subsection 31(1) if the shares suffered a
loss. Notwithstanding these concerns, parliament has enacted the
subsection and it must be applied where its conditions are
satisfied. In my opinion the subsection clearly applies in the
present case.
[17] This result will not please the Appellant. However, I
would point out that the Appellant may have been fortunate in
that the Minister at least allowed him the restricted farm losses
contemplated in section 31. The following general commentary
contained in CCH Canadian Tax Reports, Vol. 2 p.7703/4 bears this
out.
The Department, in Interpretation Bulletin IT-322R
( ¶ 5675), and the Supreme Court of Canada in Moldowan v.
The Queen, 77 DTC 5213, recognize that a taxpayer
who is engaged in farming operations may fall into one of three
classes. These are as follows.
(1) The taxpayer for whom farming may reasonably be expected
to provide the bulk of his income or the centre of his work
routine. Such a taxpayer who looks to farming for his livelihood
is free of the limitation in section 31 and may deduct the full
amount of a farming loss from other income.
(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. Such a taxpayer must
operate the farm with a reasonable expectation of profit but
devote the major part of his time and effort to other business or
employment. Such a taxpayer is entitled to the deduction of farm
losses subject to the limitations set out in section 31.
(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 farming activities with no reasonable expectation or
profit. The losses sustained by such a taxpayer are considered to
be personal or living expenses as defined in subsection 248(1)
and not deductible.
Whether a taxpayer has a reasonable expectation of profit from
his farming operations is an objective determination to be made
from all of the facts. Some of the criteria to be considered are
the extent of activity in relation to businesses of comparable
nature and size, the amount of gross revenue from farming in
relation to the relevant expenses, time spent in the operation as
compared to other income earning activities, the profit and loss
experience in the past years, the taxpayer’s training, the
taxpayer’s intended course of action, the capability of the
venture as capitalized to show a profit after charging capital
cost allowance.
Once it is determined that a taxpayer has a reasonable
expectation of profit from farming and thus is carrying on a
farming business, it is necessary to determine whether farming
either alone or in combination with another source of income,
constitutes the taxpayer’s chief source of income. It has
been determined in the decided cases that the use of the word
“combination” in subsection 31(1) does not require
any connection by way of physical relationship or integration or
interconnection between farming and the subordinate activity
which provides another source of income. However, it has also
been indicated that “combination” does not mean the
simple addition of two sources of income for any taxpayer. In the
Moldowan case, Dickson, J. indicated that this is both a
relative and objective test:
It is decidedly not a pure quantum measurement. A man who has
farmed all 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.
Similarly, the reference in section 31 to a taxpayer whose
source of income is a combination of farming and some other
source of income was interpreted as contemplating a man whose
major preoccupation is farming but recognizing that such a man
may have other pecuniary interests as well, such as income from
investments, or income from a sideline employment or business.
For example, a full-time farmer may obtain employment during the
winter months when farming does not demand a significant portion
of his time. Such subsidiary or auxiliary interests do not
necessarily make section 31 applicable to the taxpayer.
[18] In conclusion, for the above reasons the appeals are
dismissed.
Signed at Ottawa, Canada, this 16th day of January 1998.
"T.P. O’Connor"
J.T.C.C.