Date:
20020725
Docket:
2000-3649-IT-G,
2000-3653-GST-I
BETWEEN:
BARRY
ENRIGHT,
Appellant,
and
HER MAJESTY
THE QUEEN,
Respondent.
Reasons
for judgment
Lamarre,
J.T.C.C.
[1]
These are appeals from assessments made
by the Minister of National Revenue ("Minister") under
the Income Tax Act ("ITA") for the 1994,
1995, 1996 and 1997 taxation years and from an assessment under
the Excise Tax Act ("ETA"), notice of
which is numbered 00000001551 and dated April 6, 1999, for the
quarterly reporting periods from January 1, 1995 to December 31,
1997.
[2]
In computing his income for the 1994 through 1997 taxation years,
the appellant deducted the amounts of $50,981, $68,206, $97,218
and $80,865 respectively as farm losses. The appellant also filed
his goods and services tax ("GST") returns for the
quarterly periods from January 1, 1995 to December 31, 1997
and claimed input tax credits ("ITCs") totalling
$17,826.20.
[3]
In assessing the appellant, the Minister disallowed expenses in
the amounts of $2,256 for 1994, $3,083 for 1995, $11,250 for 1996
and $3,651 for 1997 as being personal in nature, and ITCs in the
amount of $2,084.68 relating to those personal expenses. The
appellant does not dispute this part of the
assessments.
[4]
However, the Minister also disallowed the balance of the
appellant's farm losses (that is $48,725 in 1994, $65,123 in
1995, $85,968 in 1996 and $77,214 in 1997) and the ITCs relating
thereto (that is, an amount of $15,741.52, being the balance of
the total ITCs claimed), on the basis that the appellant had no
reasonable expectation of profit ("REOP") from the
farming activity and hence no source of income for the purpose of
claiming income tax deductions under the ITA and no
commercial activity for the purpose of claiming ITCs under the
ETA.
[5]
In an alternative argument, the respondent submitted that should
this Court be satisfied as to the existence of a REOP, the
appellant's losses should be restricted pursuant to section
31 of the ITA on the basis that he has not shown that his
chief source of income was farming or a combination of farming
and some other source of income during the 1994 through 1997
taxation years. However, the respondent has admitted that, in
that case, the ITCs claimed under the ETA should be
allowed, as section 31 has no equivalent in the
ETA.
Facts
[6]
The appellant was born and raised on a farm and his father and
grandfather were full-time farmers. He lived on his father's
farm until he was 35 years old, during which time he was
actively involved in the operation of the farm, and so were all
his brothers and sisters. Growing up, the appellant, as well as
his siblings, was involved with the 4-H Club (a youth
organization for the farming community), which taught its members
about different aspects of the farming industry. The appellant
was specifically active in the beef clubs component of the
4-H Club, through which he learned how to raise and show
cattle.
[7]
The appellant received title to his first farm property in 1975
from his father as compensation for the years of work he had put
into the family farm. In 1978, the appellant purchased a second
farm property for $55,860. He moved into the residence located on
that property in Renfrew, Ontario in 1982 when he married Jane,
who was also born and raised on a farm. The house was renovated
and the land was tile drained before they moved in. The appellant
also purchased a third farm in 1986 within walking distance of
the other two farms. The three farms have a total area of
approximately 500 acres, making Enright Farms one of the larger
farms in that area of Eastern Ontario. The farm purchased in 1978
is located approximately one kilometer from the family farm and
is also close to other family members' residences and farms.
This was an important factor in the appellant's decision to
purchase that farm because having family members close by allows
for the sharing of equipment and of labour costs and for
obtaining help in the appellant's absence.
[8]
Over the years, from 1982 to 1998, all the properties were tile
drained, the existing buildings were completely renovated and
other structures were built to store hay and house cattle. One
structure was built in 1996 to serve as a show barn and to house
an office. It is now used for special events organized for the
purpose of showing animals to potential buyers. This building was
subsequently enlarged. Another structure put up by the appellant
was a silo for the storage of grain.
[9]
My understanding is that, in the period up until 1998, the
appellant expended approximately $200,000 for the construction of
those other structures and for the renovation of existing
buildings. Altogether, the Enright farms can currently house 400
to 500 head of cattle on a year-round basis. They also produce
grain, corn and hay for their own use and for other farms. In the
appellant's view, there is now no need for further capital
improvements.
[10] The
appellant had an initial mortgage of $55,000 on the farm he
purchased in 1978. His current debt on the farms is $220,000. A
real estate appraisal in November 2001 put the value of his farms
at $800,000, exclusive of equipment (that is, land and buildings
only). Except for a tractor, the appellant did not own any
equipment when he made his first purchase of a farm in 1978. In
1993, the total value of the equipment (including balers for the
hay, instead of contracting the baling out) was $137,600; it went
up to $190,200 in 1997 with the purchase of a new truck, a bigger
cattle trailer and a new tractor. The appellant calculated that
the purchase of adequate equipment would be profitable in the
long run. For example, it was cheaper to purchase machinery so
that he could bale the hay himself (a $10,000 investment) than to
contract that work out at $5,000 per year.
[11] The
appellant testified that he did not draft a business plan when he
purchased his farm in 1978. He started out with a commercial
cow-calf operation (selling from the offspring of the herd solely
for beef) because he had been raised on a cow-calf farm. He
decided to change over to a seed stock operation (production of
animals to enhance the beef industry in various genetic pools)
when he determined that, in order to make the cow-calf operation
viable, he would require at least 1,000 acres of land whereas he
had only 500 acres. The appellant explained that in a cow-calf
operation, the size of the herd is important while in a seed
stock operation, it is the quality rather than the quantity of
the herd that is important. The appellant first saw the
opportunity to enter the seed stock business with the purchase of
his first Limousin cattle (one of the major beef breeds) in 1988.
In fact, there was a need for a seed stock operation in the area
where the appellant's farm was located. The appellant
officially began to change from a cow-calf operation to a
Limousin seed stock operation in 1992. This is why, in 1996, he
built a show barn to display his cattle. A building was also
required for eventual production sales (in which a portion of the
quality herd is sold off).
[12] He and his
wife further researched the different genetic lines of Limousin
cattle, visited farms in the United States and Canada to find
genetics that would fit their breeding program and acquired
quality seed stock cattle. They mostly bought female animals in
order to enhance the herd. According to the appellant, a seed
stock animal can be sold for anywhere from $2,000 to $100,000
depending on the animal's genetics whereas a beef cow would
sell for no more than $800 to $1,200 at any local sale barn. The
appellant filed as evidence magazine articles (Limousin
World, November 1999) showing that a Limousin open heifer had
sold for US$20,000 and that a Limousin bull had fetched
US$80,000. Having consulted with different farmers who were
involved in the Limousin seed stock industry, the appellant
estimated when starting out that it would take approximately 10
years to develop a high quality herd. From their research, the
appellant and his wife concluded that they would require a herd
of 200 head of Limousin cattle in order for their operation to be
profitable. As a matter of fact, their herd grew from a total of
172 head in 1992 (with 65 crossbred cows to be sold for meat and
25 purebred cows) to a total of 250 head in 1996 (with 60
crossbred cows and 65 purebred). By 1997, more of the cattle were
purebred and the value of the herd had increased from $180,500 in
1992 to $327,510 in 1997. Today, Enright Farms no longer has any
crossbred cattle; it has 230 head of purebred animals of which 20
to 30 are available to be sold at a high price at a production
sale. Mrs. Enright stated that the herd's growth is on track
to enable them to meet their 1992 projection of breaking even in
2002. The appellant believes that currently his herd is
competitive with all other herds in Canada and the United States.
The appellant has advertised his successful show results. For
example, one of his cows has won several awards by virtue of its
very high quality. This cow is on a special breeding program
under which she is fertilized and the embryos are collected and
sold. Over the past two years, she has produced 19 embryos. At a
recent show and sale in Regina, a year-old heifer of the
appellant's fetched the best price at $12,000 and another
animal came in third at $8,500. The appellant's goal for his
operation is to sell very high quality animals, which he
advertises in Limousin World, a magazine with
international distribution, and by showing them at various fairs
where they have won a number of awards.
[13] The
appellant has also set his sights on a production sale. Last
year, he visited Top Meadow Farms' production sale, at which
$650,000 was brought in by the sale of 100 head of cattle. With
approximately 200-300 head, Top Meadow Farms is, according to the
appellant, the only seed stock operation in Ontario that is on
the same scale as his own. Top Meadow has been in the seed stock
business for 8 to 10 years. The appellant believes that his
operation will be ready for its first production sale in about
one year from now. He explained that you need to have between 30
and 50 animals in a production sale (he now has 20 to 30
available) to make it worthwhile for people to incur the expense
of travelling to your farm. He has already had requests to host a
production sale at which half of the cattle for sale would be his
own and the other half would be brought in by other
farmers.
[14]
With respect to the farming
statements, the appellant knew his operating expenses were going
to be significant when he first changed from a cow-calf to a seed
stock operation. The chart in Schedule A to these reasons show
the evolution of income and losses.
[15] The
appellant stated that cattle sales were lower in 1996 and 1997 -
as can be seen from the chart in Schedule A - because they were
building infrastructure in those years and therefore retained
cattle in order to increase the herd. He explained that
increasing the herd would enable them to improve sales in
subsequent years. At present, he sells 75 to 80 head of cattle a
year, of which 25 to 30 would be of high enough quality to be
part of a production sale where they could be sold at a minimum
price of $5,000 each.
[16] The
appellant was also employed with a road construction company,
Armbro Construction ("Armbro"), that operates throughout Ontario. He
began working for them in 1967. During the period from 1994 to
1997, he was a superintendent for Armbro's various work
sites. He was involved in particular with the construction of
Highway 416 between Ottawa and Highway 401. The appellant
commuted between his home and the portable office set up on the
Highway 416 site. The distance between the two locations was 65
to 70 kilometers, a 45-minute drive. The appellant stated that he
was home almost every evening, on weekends and on several
weekdays. He was also required to travel throughout Ontario for
other projects. When travelling, the appellant was in frequent
contact with his wife via cellular telephone to keep informed
about activities on the farm. The appellant explained as well
that he took the opportunity of visiting other Limousin breeders
in Ontario when travelling for Armbro.
[17] The
following breakdown was given of the time devoted by the
appellant to Armbro and to the farm. From November through
February, Armbro was closed down and the appellant could spend
all his time on the farm. In November, the cattle were brought in
from the fields for the winter, pregnancy checks were performed
and vaccinations given. In December the cattle were placed on a
feeding program and things were made ready for the calving
season.
[18] In March
and April, the appellant worked two or three days a week for
Armbro preparing project bids, and the remainder of his time was
spent working on the farm. In May and June, road construction
began again and the appellant worked five days a week for Armbro.
The remainder of his time was spent on the farm, where the crops
were put in. By July and August, the Armbro projects had been
organized and the appellant was able to spend more time on the
farm by compressing his work days at Armbro, which allowed him to
get involved in such activities as haying. In September and
October, the appellant was working five days a week for Armbro,
finishing up jobs in preparation for the winter shutdown. The
appellant's activities on the farm in those months revolved
around the show season.
[19] Overall,
the appellant calculated that he spent 140 days a year working
for Armbro and 225 days a year on the farm.
[20] The
appellant stated that he chose to work at Armbro because it was
seasonal work and as a full-time farmer he required supplemental
income to keep the farm going.
[21] The
appellant earned the following amounts at Armbro from 1994 to
1997:
1994
$ 63,413
1995
$ 87,900
1996
$138,220
1997
$123,352
[22] The
appellant has three sons, one daughter, and siblings who can help
his wife on the farm when he is away. According to him, the seed
stock operation was more compatible with his work with Armbro
than the cow-calf operation because it required a smaller
herd of cattle and therefore less time had to be spent at the
farm. Furthermore, he was able to do promotional work for the
farm when he was on the road for Armbro.
[23] The
appellant also stated that all his salary from Armbro went into
the farming operation with the exception of what he invested in
his Registered Retirement Savings Plan ("RRSP"). The appellant is
no longer with Armbro. He retired in 1999 because in 1997 he had
been promoted manager at Armbro and he found that the added
responsibilities of that position were too much to handle along
with the farming. He now devotes almost all of his time to the
farm.
Appellant's
Argument
[24] Counsel
for the appellant argued first that the appellant operated
Enright Farms in a manner that allowed him to have a REOP. He
then submitted that farming or a combination of farming and
another source of income was the appellant's chief source of
income.
[25] On the
first point (REOP), counsel reviewed the criteria referred to in
Moldowan v. The Queen, [1978] 1 S.C.R. 480, for
determining whether there is a REOP. He submitted that the
appellant had the necessary training, being a third generation
farmer who had worked on his father's farm for 35 years
before he purchased his own. With respect to the appellant's
intended course of action, counsel argued that the appellant
always knew he wanted to be a farmer. He purchased his farm close
to other members of his family so that help would be available if
necessary. The appellant realized that in order to support his
farm, he would have to engage in seasonal work. His employment
with Armbro was perfect for that purpose. Initially, the
appellant had a cow-calf operation but later changed his focus
when he determined that the seed stock industry was more
profitable. This was a carefully considered decision taken after
he and his wife had researched the matter. They were sufficiently
involved in the beef industry to have an idea of the value of
Limousin cattle and also of the desirability of getting into the
seed stock industry. Top Meadow Farms provided them with a
successful business model to follow. In order to attain their
goal, they first had to invest in the purchase of cattle to
improve the quality of their herd. They took their cattle to
various shows and fairs in order to advertise their inventory,
which made it necessary to invest in a new truck and a bigger
trailer. Also, the farm's infrastructure needed to be
improved in order to showcase the cattle and give the operation
credibility. So they invested all their capital in the farm. By
1992, improvements made to the land, buildings and equipment
allowed the farm to function as a seed stock
operation.
[26] With
respect to the history of profits and losses, counsel for the
appellant did not dispute that the appellant experienced many
years of losses, but in his view, there is a valid explanation
for those losses and they should not prevent this Court from
concluding that there was a REOP. Counsel submitted that although
the appellant started running his own farm in 1982, he changed
direction in 1992: Enright Farms began investing in the quality
of its herd and held animals back in order to improve the herd.
Therefore, there was a dip in revenue in the years at issue. The
years 1999 and 2000 and the first half of 2001 show a
profit.
[27] In
counsel's view, this is not a case of a professional moving
from the city to the country to lose there the income earned in
the city. This is not a case where the revenues are insignificant
compared to the losses. In 1998, 1999 and 2000, revenues were
over $100,000 per year. According to counsel, it has been
demonstrated that Enright Farms exhibited in the years at issue
the potential to show a profit. It had the requisite cattle and
equipment to carry on the operation. The value of the cattle,
barns and machinery altogether jumped from $498,350 in 1993 to
$824,834 in 1997 (as per Exhibit A-1, Tab 31, which is
uncontradicted). The herd growth plan prepared by the appellant
shows that they are achieving their original goal and objectives
and that the inventory is now at a level where it can produce a
profit.
[28] While the
herd may not have increased in number, it has however appreciated
in value. An animal having been sold last year for $12,000, it is
reasonable to expect that other animals from the herd, with
similar genetics, would likewise command high prices on the
market. Furthermore, two other revenue streams, namely embryo and
semen straw sales, have been introduced.
[29] Based on
the above, the appellant submitted that Enright Farms did have a
REOP.
[30] On the
second issue, that of the chief source of income, counsel for the
appellant reviewed the three criteria established in the case law
for determining a taxpayer's chief source of income, namely:
capital committed, time spent on the activity and profitability,
both actual and potential (see Canada v. Donnelly (C.A.),
[1998] 1 F.C. 513).
[31] Counsel
relied on The Queen v. Poirier, 92 DTC 6335 (F.C.A.),
where it was stated that when a court considers the three factors
listed above, they must be considered cumulatively and not
disjunctively. He also relied on Hover v. M.N.R., 93 DTC
98 (T.C.C.), a decision in which the concept of adjunct income in
cases involving farmers was recognized. In other words, without
the off-farm income, the farming operation could not have been
commenced nor could the substantial capital expenditures and
start-up costs have been made or incurred. In this sense, the
off-farm income formed an integral part of the combination of
farming and some other source of income. Here, the income from
Armbro was an essential element in the business plan for the
farm.
[32] Counsel
also submitted that having a farming background is an important
consideration in the determination of a taxpayer's chief
source of income. There is a distinction to be drawn between a
country person who goes to the city and a city person who goes to
the country (see Donnelly, supra).
[33] Counsel
relied as well on cases in which the courts did not apply the
section 31 restriction to taxpayers who had been raised on farms
and who had been incurring losses for periods ranging from 12 to
19 years (see Miller v. The
Queen, 2000 DTC 1502 (T.C.C.);
Rich v. Canada,
[1995] T.C.J. No. 1623 (Q.L.); Paquette v. Canada, [2000]
T.C.J. No. 412 (Q.L.)).
[34] In
counsel's view, the appellant's seasonal off-farm job did
not interfere with the significant time he spent on his farm. As
for the capital committed, almost all of the appellant's
income was invested in the farm and he had sufficient buildings
and equipment to succeed with his business plan. With regard to
profitability, the appellant expected during the period from 1994
to 1997 that the bulk of his income would be from farming by
2002, that is, once they reached the production sale stage. This
is shown by the financial projections they made at the time,
which, according to the appellant's wife's testimony, are
on the verge of being borne out (as per the non-reconciled
financial statements filed for the first six months of 2002). In
counsel's view, there is evidence of potential profitability
in the relevant years and confirmed evidence that the farm was in
fact profitable in subsequent years.
[35] Counsel
finally submitted that if not convinced that, in the years in
question, the potential profitability of Enright Farms exceeded
the income from Armbro, the Court should consider the fact that
no one factor, such as profitability, should be determinative in
a chief source of income analysis. The lack of profitability in
the relevant years cannot be ignored but it should not overshadow
the other relevant facts of this case.
Respondent's
Argument
[36] Counsel
for the respondent did not dispute the sufficiency of the
appellant's knowledge and expertise with regard to the
farming operation. Counsel relied mainly on the size of the
losses incurred over a period of 20 years in submitting that the
appellant did not have a REOP in the taxation years at issue. In
counsel's view, that is too many years for those losses to be
able to be considered as start-up costs. He submitted that
the losses over the 20 years are to be seen as a continuum and
that the change in business from a cow-calf operation to a
seed stock operation is not significant enough for the Court to
close its eyes to the losses in the years prior to that change.
Basically, counsel did not accept the appellant's submission
that a new start-up period began in 1992. In his view, the
appellant has not shown that there was a REOP in the years at
issue.
[37] With
respect to the chief source of income argument, counsel for the
respondent did not dispute that the appellant invested all his
capital in the farming operation. He submitted, however, that the
evidence discloses that the appellant spent half his time on the
farm and the other half on his employment with Armbro, and that
he did not devote more time to the farm than to Armbro. Counsel
relied on the case of Sartori v. The
Queen, 2002 DTC 1252, [2001] T.C.J.
No. 855 (Q.L.), in which Judge Bowman stated that the
determination of chief source of income is not a pure quantum
measurement, however, the fact that a source of income besides
farming provides a taxpayer's livelihood while farming
consistently yields a loss cannot be ignored. Counsel said that
the Minister believed the average price that could be obtained
for the Limousin cattle owned by the appellant to be more in the
vicinity of the $3,000 per head indicated in the documents
adduced in evidence than the $5,000 to $10,000 claimed by the
appellant and his wife in their testimony. Using a $3,000 value
for the cattle, counsel submitted that the potential
profitability of the farm is much less than the appellant
testified that it is. Therefore, the potential income from the
farm was not comparable to the income received from Armbro.
Counsel was accordingly of the view that farming was not, either
alone or in combination with the income from Armbro, the
appellant's chief source of income. He therefore asks that
the losses be restricted pursuant to section 31 of the
ITA.
Analysis
[38] As
mentioned at the beginning of these reasons, the parties argued
this case before the decisions of the Supreme Court of Canada
in Stewart, supra,and Walls, supra, were
rendered.
[39] In those
decisions, the Supreme Court of Canada considers the appropriate
use of the REOP test under the ITA and, in Stewart, summarizes as
follows how that test has been broadly used over the years, in
paragraph 47:
47. To
summarize, in recent years the Moldowan REOP test has become a
broad-based tool used by both the Minister and courts in any
manner of situation where the view is taken that the taxpayer
does not have a reasonable expectation of profiting from the
activity in question. From this it is inferred that the taxpayer
has no source of income, and thus no basis from which to deduct
losses and expenses relating to the activity. The REOP test has
been applied independently of provisions of the Act to
second-guess bona fide commercial decisions of the taxpayer and
therefore runs afoul of the principle that courts should avoid
judicial rule-making in tax law: see Ludco, supra; Royal Bank of
Canada v. Sparrow Electric Corp., [1997] 1 S.C.R. 411; Canderel,
supra; Shell Canada Ltd. v. Canada, [1999] 3 S.C.R. 622. As well,
the REOP test is problematic owing to its vagueness and
uncertainty of application; this results in unfair and arbitrary
treatment of taxpayers. As a result, "reasonable expectation
of profit" should not be accepted as the test to determine
whether a taxpayer's activities constitute a source of
income.
[40] The
Supreme Court of Canada concludes in the following terms at
paragraph 60:
60. In
summary, the issue of whether or not a taxpayer has a source of
income is to be determined by looking at the commerciality of the
activity in question. Where the activity contains no personal
element and is clearly commercial, no further inquiry is
necessary. Where the activity could be classified as a personal
pursuit, then it must be determined whether or not the activity
is being carried on in a sufficiently commercial manner to
constitute a source of income. However, to deny the deduction of
losses on the simple ground that the losses signify that no
business (or property) source exists is contrary to the words and
scheme of the Act. Whether or not a business exists is a separate
question from the deductibility of expenses. As suggested by the
appellant, to disallow deductions based on a reasonable
expectation of profit analysis would amount to a case law
stop-loss rule which would be contrary to established principles
of interpretation, mentioned above, which are applicable to the
Act. As well, unlike many statutory stop-loss rules, once
deductions are disallowed under the REOP test, the taxpayer
cannot carry forward such losses to apply to future income in the
event the activity becomes profitable.
[41]
In the present case, it is obvious that the respondent initially
denied the deductibility of the losses under the ITA based on a REOP
analysis.
[42]
It is clear now that sole reliance on such a restricted analysis
is no longer valid. However, where a personal element is present,
the REOP test is one objective factor, although not a conclusive
one, to be considered in determining whether the taxpayer is
carrying on the activity in a commercial manner.
[43]
With respect to the right to claim ITCs under the ETA, these may only be
claimed on tax paid on property or services acquired in the
course of a commercial activity. Commercial activity is defined
as follows in subsection 123(1) of the ETA:
"commercial
activity" of a person
means
(a) a
business carried on by the person (other than a business carried
on without a reasonable expectation of profit by an individual, a
personal trust or a partnership, all of the members of which are
individuals), except to the extent to which the business involves
the making of exempt supplies by the person,
(b) an
adventure or concern of the person in the nature of trade (other
than an adventure or concern engaged in without a reasonable
expectation of profit by an individual, a personal trust or a
partnership, all of the members of which are individuals), except
to the extent to which the adventure or concern involves the
making of exempt supplies by the person, and
(c) the
making of a supply (other than an exempt supply) by the person of
real property of the person, including anything done by the
person in the course of or in connection with the making of the
supply.
[44]
Thus, the REOP test is specifically included in the legislative
provision which defines commercial activity. A taxpayer must
therefore demonstrate that he or she is carrying on a business
other than a business carried on without a REOP if that taxpayer
is to be able to claim that he or she is engaged in a commercial
activity.
[45]
In the present case, the appellant is claiming ITCs under
the ETA.
It should be added that he lives on his farm with his family and,
although the scale of his farming activities is quite large, it
cannot be denied that there is a personal element involved here.
Consequently, an analysis of the REOP test in the context of the
facts of this case is not superfluous in the circumstances, and I
will deal with this aspect first.
REOP
[46]
The Supreme Court of Canada noted in Stewart, supra, that in order for an
activity to be classified as being commercial in nature, a
variety of objective factors should also be looked at. The Court
states at paragraphs 54, 55 and 58:
54. It
should also be noted that the source of income assessment is not
a purely subjective inquiry. Although in order for an activity to
be classified as commercial in nature, the taxpayer must have the
subjective intention to profit, in addition, as stated in
Moldowan, this determination should be made by looking at a
variety of objective factors. Thus, in expanded form, the first
stage of the above test can be restated as follows: "Does
the taxpayer intend to carry on an activity for profit and is
there evidence to support that intention?" This requires the
taxpayer to establish that his or her predominant intention is to
make a profit from the activity and that the activity has been
carried out in accordance with objective standards of
businesslike behaviour.
55. The
objective factors listed by Dickson J. in Moldowan at p. 486
were: (1) the profit and loss experience in past years; (2) the
taxpayer's training; (3) the taxpayer's intended course
of action; and (4) the capability of the venture to show a
profit. As we conclude below, it is not necessary for the
purposes of this appeal to expand on this list of factors. As
such, we decline to do so; however, we would reiterate Dickson
J.'s caution that this list is not intended to be exhaustive,
and that the factors will differ with the nature and extent of
the undertaking. We would also emphasize that although the
reasonable expectation of profit is a factor to be considered at
this stage, it is not the only factor, nor is it conclusive. The
overall assessment to be made is whether or not the taxpayer is
carrying on the activity in a commercial manner. However, this
assessment should not be used to second-guess the business
judgment of the taxpayer. It is the commercial nature of the
taxpayer's activity which must be evaluated, not his or her
business acumen.
. . .
58. In
addition to the fact that the deductibility, or otherwise, of an
expense is a separate question from the existence of the
underlying source of income, it is also true that the
profitability of the activity to which the expense relates does
not affect the deductibility of the expense. In particular, there
have been a number of cases where a taxpayer's large interest
expenses have resulted in net losses, which in turn have caused
the Minister to conclude that there is no reasonable expectation
of profit, and therefore no source of income from which the
interest expenses can be deducted. However, as stated above,
reasonable expectation of profit is but one factor to consider in
determining whether an activity has a sufficient degree of
commerciality to be considered a source of income. . .
.
[47]
The criteria set out in Moldowan, supra, are the taxpayer's
training, the taxpayer's intended course of action, the
history of profits and losses and the capability of the venture
to show a profit. Those objective criteria are not disputed by
the Supreme Court of Canada in Stewart, supra, for cases where the REOP
test may be a useful tool in the determination of the
commerciality of a venture. Each counsel, in his argument, has
analyzed those criteria in light of the facts in the present
case.
[48]
The respondent did not challenge the fact that the appellant and
his wife had the required training to operate a farming
business.
[49]
With respect to the appellant's intended course of action, it
is true that he did not have a formal business plan. However,
when he determined that the cow-calf operation was unstable
and that he would require another 500 acres in order to make it
profitable, he decided to look for other options. He and his wife
did research in magazines and spoke with various breeders before
determining that a seed stock operation with Limousin cattle
would be a good investment. The appellant followed the model used
at Top Meadow Farms - a now profitable enterprise as I understand
it - in bringing along his operation. First, he invested in his
herd in order to improve its quality. Second, he invested in the
physical infrastructure required to operate a seed stock farm.
Third, he sought to develop a strong reputation in the industry
by showing his animals at fairs. Finally, the appellant is now
focusing on the sale of his cattle through a production sale that
he intends to hold in the near future. The appellant has also
opened up new avenues of revenue such as embryo and semen straw
sales.
[50]
With respect to the history of profits and losses, it is
understandable that the respondent would challenge the existence
of a REOP when the appellant has shown losses for 20 years.
However, I also agree with counsel for the appellant that the
gross farming revenue was significant in the years in question
and much of it was from cattle sales. The appellant's losses
between 1994 and 1997 were large but not excessive compared to
gross income. In 1996 and 1997, revenues were lower due to the
appellant's decision to retain cattle in order to increase
the herd with a view to improved sales in the future.
Furthermore, expenses were greater in those years because of the
addition of a show barn and the purchase of new equipment to
transport animals to shows and fairs. The appellant testified
that all the required physical infrastructure is now in place and
that yearly expenses will consequently decrease. The appellant
further testified that he will soon be in a position to hold a
production sale that he expects should be quite profitable. As
well, one must be careful in reading the farm expenses chart. The
greatest expenses consist of the purchase of cattle. A mandatory
inventory adjustment has to be taken into account in the
computation of farm expenses. This adjustment is designed to
decrease or eliminate cash method losses resulting from purchased
inventory (see Interpretation Bulletin IT-526, Farming - Cash
Method Inventory Adjustments, May 28, 1993). If we take into
account the mandatory adjustment, the appellant's losses are
far lower than they appear to be on the chart.
[51]
Finally, although the appellant lives on the farm with his
family, this is not a case where a professional from the city
sets up a hobby farm in the country and incurs substantial losses
in doing so.
[52]
I therefore conclude that the operation of the farm has shown
numerous indicia of commerciality, and I am satisfied that the
appellant did have a REOP in the taxation years at
issue.
Chief Source of
Income
[53]
The respondent is of the opinion that the farm losses should be
restricted to $8,750 for each of the taxation years at issue in
accordance with the formula set out in section 31 of the
ITA. Losses will
be restricted under section 31 if it is determined that the
appellant's chief source of income was neither farming nor a
combination of farming and some other source of income in the
taxation years at issue.
[54]
The cumulative factors of capital committed, time spent and
profitability will determine whether farming will be regarded as
a "sideline business" to which the restricted farm loss
provisions apply. No one factor is decisive (see Donnelly,
supra).
[55]
In the present case, there is no doubt that the appellant has
committed significant time and capital to his farm.
[56]
With respect to profitability, both actual and potential, the
appellant knew he would incur losses during the taxation years at
issue because of the new orientation given to the farm. The
appellant and his wife had, however, expected at that time that
the seed stock operation would break even in 2000. Indeed, in
2000 and the first six months of 2001, the farm showed a profit
after deduction of capital cost allowance.
[57]
When the appellant's gross employment income from Armbro and
gross farming income are compared, the farming income is greater
in 1994 and 1995. In 1996 and 1997, the employment income is
greater, but the appellant testified that his cattle sales were
low in those years because he held animals over in order to
better the quality of the herd. The proceeds from Top Meadow
Farms' first production sale were between $650,000 and
$700,000. It is therefore reasonable for the appellant to expect
a substantial profit when he holds his first production sale (in
a year or so). The evidence adduced by the appellant of the
various awards that his cattle have won and which should provide
a solid basis for a successful production sale strengthens the
reasonableness of that expectation.
[58]
In my view, the facts of this case more closely resemble those
in The Queen v. Graham, [1985] 2 F.C. 107 (F.C.A.). In Graham, it was held that
a taxpayer was entitled to the full deduction of farm losses
despite the fact that he held full-time employment elsewhere. The
taxpayer, who had been raised on a farm, arranged a flexible
shift schedule around his hog-farming operation. He took his
holidays, took days off without pay and traded shifts with
co-workers to accommodate the demands of the farm at planting and
harvest time. Robertson J.A. commented on the
Graham case as
follows in Donnelly, supra, at paragraph 19:
[19] In the
end, Graham stands or falls on its unique facts. But there is at least
one lesson that can be derived from the case. It seems to me
that Graham comes closer to a case in which an otherwise full-time
farmer is forced to seek additional income in the city to offset
losses incurred in the country. The second generation farmer who
is unable to adequately support a family may well turn to other
employment to offset persistent annual losses. These are the
types of cases which never make it to the courts. Presumably, the
Minister of National Revenue has made a policy decision to
concede the reasonable expectation of profit requirement in
situations where a taxpayer's family has always looked to
farming as a means of providing for their livelihood, albeit with
limited financial success. The same policy considerations allow
for greater weight to be placed on the capital and time factors
under section 31 of the Act, while less weight is given to
profitability. I have yet to see a case where the Minister denies
such a taxpayer the right to deduct full farming losses because
of a competing income source. Perhaps this is because it is
unlikely a hog farmer such as Mr. Graham would pursue the
activity as a hobby.
[59]
Although the appellant has had 20 years of losses (including the
years at issue), which - on this I agree with the respondent -
should not be ignored, I do not, however, find that to be
especially unreasonable in the circumstances of this case. The
situation here is not much different from that in the
Miller and Paquette cases referred to by the appellant, where 13 and 14
years of farm losses had been incurred prior to the years there
in question. In the Hover
case, also cited by the appellant, it was
recognized that start-up periods for operations that are begun
from scratch will be longer than those in cases where the
taxpayer purchases a going concern. In the present case, the
taxpayer acquired farms that required substantial investment in
order to be viable. Furthermore, the appellant in the case at bar
switched from a cow-calf to a seed stock operation. Although
similar in nature, a seed stock operation does require different
capital investments.
[60]
In the circumstances, I do not find that the number of years of
losses is detrimental to the appellant's claims. In my view,
he has shown that his chief source of income was farming or a
combination of farming and employment income from Armbro during
the years in question.
[61]
The appeals are allowed, with costs, and the assessments are
referred back to the Minister for reconsideration and
reassessment on the basis that the appellant may deduct the
amounts of $48,725, $65,123, $85,968 and $77,214 as farm losses
for the 1994 through 1997 taxation years respectively and is
entitled to ITCs in the amount of $15,741 for the quarterly
reporting periods from January 1, 1995 to December 31,
1997.
Signed at Ottawa,
Canada, this 25th day of July 2002.
J.T.C.C.
SCHEDULE A
|
Taxation years
|
Total
farm gross income
|
Gross
income from cattle sales
|
Total
farm expenses *
|
Labour
expenses
|
Livestock purchased
|
CCA
|
Net
income (loss) before adjustments
|
Inventory adjustments
|
Farm loss
claimed
|
Farm loss
adjusted and now claimed (excluding personal
expenses)
|
|
1994
|
$
95,468
|
$
81,908
|
$
291,449
|
$
14,342
|
$
25,520
|
$
30,000
|
($195,981)
|
$145,000
|
($50,981)
|
($48,725)
|
|
1995
|
$
92,560
|
$
80,295
|
$
290,416
|
$
9,672
|
$
14,650
|
$
27,252
|
($197,856)
|
$129,650
|
($68,206)
|
($65,123)
|
|
1996
|
$
65,320
|
$
58,197
|
$
329,588
|
$
9,336
|
$
43,392
|
$
26,350
|
($264,268)
|
$167,050
|
($97,218)
|
($85,968)
|
|
1997
|
$
46,325
|
$
33,609
|
$
318,140
|
0
|
$
30,572
|
0
|
($271,814)
|
$190,950
|
($80,865)
|
($77,214)
|
|
1998
|
$108,848
|
$
84,421
|
$
351,930
|
0
|
$
30,141
|
0
|
($243,082)
|
$206,028
|
($37,054)
|
0
|
|
1999
|
$126,152
|
$113,365
|
$347,180
|
0
|
$
28,124
|
0
|
($221,027)
|
$222,940
|
$
1,912
|
0
|
|
2000
|
$117,649
|
$
49,353
|
$381,101
|
0
|
$
7,888
|
$
51,861
|
($263,452)
|
$264,328
|
$ 875
|
0
|
|
2001
(6
months)
|
$115,371
|
$
61,554
|
$101,048
|
$ 275
|
$
18,602
|
$
20,022
|
$
14,323
|
0
|
0
|
0
|
*including
mandatory inventory adjustment
COURT FILE
NO.:
2000-3649(IT)G and 2000-3653(GST)I
STYLE OF
CAUSE:
Barry Enright v. The Queen
PLACE OF
HEARING:
Ottawa, Ontario
DATE OF
HEARING:
January 14 and 15, 2002
REASONS FOR
JUDGMENT BY: The Honourable Judge Lucie
Lamarre
DATE OF
JUDGMENT:
July 25, 2002
APPEARANCES:
Counsel
for the Appellant: G. Boyd Aitken
Counsel
for the
Respondent:
Charles M. Camirand
COUNSEL OF
RECORD:
For the
Appellant:
Name:
G. Boyd Aitken
Firm:
Borden Ladner Gervais, Ottawa, ON
For the
Respondent:
Morris Rosenberg
Deputy Attorney General of Canada
Ottawa, Canada
2000-3649(IT)G
BETWEEN:
BARRY
ENRIGHT,
Appellant,
and
HER MAJESTY
THE QUEEN,
Respondent.
Appeals
heard on common evidence with the appeal of Barry Enright
2000-3653(GST)I on January 14 and 15, 2002, at Ottawa,
Ontario, by
the
Honourable Judge Lucie Lamarre
Appearances
Counsel
for the Appellant: G. Boyd Aitken
Counsel
for the
Respondent:
Charles M. Camirand
JUDGMENT
The appeals from the assessments made under the Income Tax
Act for the 1994, 1995, 1996 and 1997 taxation years
are allowed, with costs, and the
assessments are referred back to the Minister of National Revenue
for reconsideration and reassessment on the basis that the
appellant may deduct the amounts of $48,725, $65,123, $85,968 and
$77,214 as farm losses for the 1994 through 1997 taxation years
respectively.
Signed at
Ottawa, Canada, this 25th day of July 2002.
J.T.C.C.
2000-3653(GST)I
BETWEEN:
BARRY
ENRIGHT,
Appellant,
and
HER MAJESTY
THE QUEEN,
Respondent.
Appeal heard
on common evidence with the appeals of Barry Enright
2000-3649(IT)G, on January 14 and 15, 2002, at Ottawa,
Ontario, by
the
Honourable Judge Lucie Lamarre
Appearances
Counsel
for the Appellant: G. Boyd Aitken
Counsel
for the
Respondent:
Charles M. Camirand
JUDGMENT
The appeal from the assessment made under Part IX of the
Excise Tax Act for the period from January 1, 1995 to
December 31, 1997, notice of which is dated April 6, 1999 and
bears number 00000001551, is allowed, with costs, and the
assessment is referred back to the Minister of National Revenue
for reconsideration and reassessment on the basis that
the appellant is entitled to input tax credits
totalling $15,741 for the quarterly reporting periods from
January 1, 1995 to December 31, 1997.
Signed at
Ottawa, Canada, this 25th day of July 2002.
J.T.C.C.
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