Citation: 2009 TCC 617
Date: 20091217
Dockets: 2007-3040(IT)G
2008-869(IT)G
BETWEEN:
JOHN H. CRAIG,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
REASONS FOR JUDGMENT
Hershfield J.
[1] The Appellant is
appealing reassessments of his 2000 and 2001 taxation years. The appeals
concern the application of the restricted farm loss provisions set out in
section 31 of the Income Tax Act (the “Act”).
[2] In respect of his
2000 taxation year, the reassessment being appealed made no adjustment to restricted
farm losses that the Appellant reported for that year in respect of certain
horseracing activities carried on by him. The appeal is made, nonetheless, on the
basis that the Appellant has since determined that he was entitled to claim the
subject losses in that year without restriction.
[3] In respect of his
2001 taxation year, the Appellant reported his horseracing activities as two
businesses. Losses incurred from the buying and selling of horses were reported
as being from a different source than those incurred in his horseracing
operation. The losses from the racing operation were reported as being subject
to the restricted farm loss provisions while the losses from his trading activity
were reported as losses from a non-farming business and not subject to the
restricted farm loss provisions. The Appellant was reassessed on the basis that
both activities were subject to the restricted farm loss provisions. The appeal
is made on the basis that the restricted farm loss provisions do not apply to
either activity.
[4] The Appellant
acknowledged at the hearing that he was not pursuing his position that the
buying and selling of horses was a separate non-farming business. His appeal
was to be advanced on the basis that his horseracing operation included the
buying and selling of horses and was “farming” as defined in section 248 of the
Act in both years under appeal but was, nonetheless, not subject to the
restricted farm loss provisions in section 31 of the Act.
[5] The issue in these
appeals then is whether the losses in question are subject to the restricted
farm loss provisions set out in section 31 of the Act. The Appellant
asserts that those losses are ordinary business losses.
Factual Background and
Preliminary Findings
[6] The following is an
overview of the Appellant’s activities that relate to the issue raised in these
appeals and have either been agreed to or have been established by the evidence
to my satisfaction:
a.
The
Appellant has been practising law for approximately 35 years and is presently a
partner at the law firm Cassels, Brock & Blackwell LLP in Toronto;
b.
His
income from his law practice for his 2000 and 2001 years was $770,423 and
$646,600 respectively. In those years, respectively, he billed for some 900
hours and 1300 hours of recorded time. His
remuneration reflected his value as a business generator who maintained
personal relationships with clients to the benefit of the firm. He managed and
supervised the work being done for these clients by other lawyers in the firm
and provided strategic advice. Many of his clients have become well-established
clients of the firm. New clients come by word of mouth. As well, it seems he is
well-respected in his field and attracts clients by virtue of his reputation. His
law income has increased in recent years to seven figures without material change
in his time commitment to the practice;
c.
In
addition to his law practice, he acts on the boards of directors of several
companies (as many as seven). His time on such boards (averaging some 100 hours
a year) is recordable and billable time in his law practice. Fees are paid to
the firm. In relation to these activities he has received stock options which
have resulted in him personally reporting significant gains as employment
income;
d.
Unrelated
to his law practice, but related perhaps to his area of interest and
specialization in the legal world, he has made significant capital gains on
equity investments in the oil and gas sector;
e.
As
set out in the Reply and Exhibit A-4 and agreed to or testified to at the
hearing, the Appellant reported the following income and losses during the
years 1996 to 2001:
|
Year
|
Employment
Income
|
Net Professional Income (from the
Law Practice)
|
Investment Income (Taxable
Capital Gains)
|
Farming Income (Loss)
|
|
1996
|
588,600
|
715,085
|
213,915
|
(63,924)
|
|
1997
|
517,350
|
668,579
|
259,989
|
(273,061)
|
|
1998
|
35,200
|
653,715
|
128,667
|
(185,142)
|
|
1999
|
487,500
|
710,066
|
313,881
|
(142,803)
|
|
2000
|
24,000
|
770,423
|
372,732
|
(222,642)
|
|
2001
|
36,000
|
646,600
|
129,331
|
(205,655)
|
f.
The
Appellant acknowledged that in the subject years he relied on his law practice
income (including his employment income) and his capital gain investment income
for his livelihood. As well, it is safe to say that these cash flow streams
financed his horseracing operation in the subject years;
g.
The
Appellant has a capital investment in his law firm that varies annually and
ranged from $150,000 (the amount in 2000 and 2001 respectively was $165,000 and
$150,000) to $280,000 in the current year. The capital invested in his
portfolio (the source of his capital gains) was acknowledged to be higher than
the capital investment in the horseracing operation, not counting annual costs
to cover operational deficits;
h.
The
Appellant testified that there was some small overlap between his horseracing
activities and his law practice. He admitted horseracing was not a popular
avenue for entertaining clients and noted that even though his biggest client
happened to be a horse breeder, which contributed to the collegial side of
their relationship, it was his talents as a lawyer that brought that
relationship into being, not his connection to horseracing;
i.
The
Appellant sees himself slowing down and phasing out his law practice over the
next six years at which time he will have reached the age of retirement
prescribed by his firm;
j.
Turning
to his horseracing activities, the Appellant has been actively involved for
some 25 years in standardbred horse ownership and racing which included the
buying and selling of standardbred horses (the “horseracing operation”). The
business is operated year round. Standardbred horseracing is not a seasonal
activity;
k.
Prior
to his entry into the horseracing scene, there is no evidence that the
Appellant had any background, experience or training with respect to any aspect
of horseracing. He retained the services of a trainer to facilitate his entry
into this new venture and continued to retain such services under a fairly
comprehensive arrangement which incorporated the provision of all required
maintenance of the horses as well as their training;
l.
Over
the years preceding 2000 he studied industry publications and absorbed
knowledge from his trainer and others. His focus and attention to all aspects
of the industry, from breeding to racing regulations and his regular attendance
at horse sales, races and training sessions, gave him over 15 years of
operational experience perhaps best reflected by the fact that he was Chair of the Standardbred Appeal
Board. As well, I note, that he was a founding member of the Standardbred
Horse Owners Panel (“SHOP”), a group dedicated to freeing the industry of drug
use that has haunted the horseracing world and has impacted the success of
clean operations such as his;
m. He built his operation
up from nothing to 10 to 15 horses by the mid-1990s. In 2000, he had as many as
20 horses. This he determined was too many for his operation to handle. A
change in his operational planning aimed at fewer, better and younger quality
stock meant a reduction in his stable from 20 to some 14 horses in 2001,
declining further to 11 horses at the time of the hearing;
n.
For
many years, including his 2000 and 2001 taxation years, the Appellant has
devoted more than 600 hours annually to horse ownership, racing and trading
activities. His activities include:
-
morning
review of internet racing services and daily telephone updates and discussions with
the trainer on all aspects of operations including training progress, lameness
and racing strategies; one hour daily; 250 hours a year;
-
Saturday
meetings with the trainer and veterinarians and watching training almost every
week. These meetings included discussion of similar topics covered in daily
telephone conversations including training regimes, racing strategies and horse
sales; 4.5 hours weekly; 200 hours yearly;
-
attending
race tracks in excess of 40 times a year; in a given year his horses could be
racing 150 to 160 times a year; 150 hours a year;
-
reviewing
horse sales catalogues and attending sales 3 to 4 times a year;
-
attending
appeal board hearings; as chair of the Standardbred Appeal Board, the Appellant
hears appeals from decisions made at the track or pertaining to races. He hears
7 to 8 appeals a day, 3 to 4 times a year;
-
maintaining
records for annual tax returns and for filing quarterly GST returns.
o.
Revenues
are derived from winnings (“purses”) and horse sales. The average purse at an
A-track would be in the range between $12,000 and $50,000 per race. The top five
horses share the purse. The percentages from first to fifth are 50, 25, 12, 8
and 5. Stakes races pay substantially higher purses but require a series of
payments to be made to enter a horse;
p.
Stakes
races might have purses ranging from $30,000 to in excess of $1,500,000 for the
top cup events. Purses have gone up dramatically since being enriched by
increased stakes payments, revenues from slot machines and the like and Ontario grants for Ontario-sired
horses;
q.
There
are hundreds of stakes races each year. In 2000, the Appellant had six wins and
quite a few seconds and thirds. In 2001, he had the same number of wins but
fewer seconds. These were not sufficient to pay expenses. Better success was
achieved in the next two years;
r.
The
Appellant’s income/loss position relating to his horseracing operation is as
follows:
|
Taxation
Year
|
Income
(Loss)
|
|
1986
1987-91
|
$ 27,222
Unspecified losses
|
|
1992
|
$ 25,500
|
|
1994
|
$ 28,850
|
|
1995
|
$ 73,000
|
|
1996
|
($ 63,924)
|
|
1997
1998
1999
2000
2001
|
($237,061)
($185,142)
($142,803)
($222,642)
($205,655)
|
|
2002
|
$ 69,000
|
|
2003
|
$ 32,000
|
|
2004
|
($ 81,212)
|
|
2005
|
($ 66,262)
|
|
2006
|
($ 63,924)
|
|
2007
|
($ 143,003)
|
|
2008
|
($ 85,043)
|
s.
In
addition to financing operational losses, the Appellant invested significant
amounts of money in his racing stock. The investment each year was estimated by
the Appellant as follows:
|
Taxation
Year
|
Capital
|
|
1994
|
$190,000
|
|
1995
|
$206,000
|
|
1996
|
$341,000
|
|
1997
|
$130,000
|
|
1998
|
$221,000
|
|
1999
|
$222,000
|
|
2000
|
$412,000
|
|
2001
|
$254,000
|
t.
The
Appellant acknowledged that his investment in subsequent years was lower,
ranging from $100,000 to $300,000. This was due to a change in his operational
strategy which was to reduce his stable to fewer better quality horses;
u.
Aside
from some equipment, such as harnesses and sulkies, the Appellant has virtually
no capital investment in his horseracing operation other than in the
racehorses. He has no direct obligations relating to rent, staff or other
overhead except as covered under his arrangement with the trainer;
v.
From
inception of the horseracing operation to present, the Appellant has retained
the same trainer.
The arrangement with the trainer includes the provision of all facilities, feed
and hands needed to maintain and train the Appellant’s horses. The trainer
issues monthly statements to the Appellant with quarterly summaries. The
monthly statements itemize expenses for each horse and include a training fee
(for the number of days the particular horse was trained, if any), farm or stall
fees on a daily basis, veterinary expenses and other sundry items. It also,
incidentally, shows purse winnings, if any, for the month. The winnings are
shown in the calculation of an additional item on the trainer’s monthly
statements, namely, an additional fee based on 5% of a horse’s winnings during
the month;
w. The trainer owns an
interest (25%, 33.33% or 50%) in some of the horses included in the Appellant’s
horseracing operation. Indeed, in 2000 and 2001 the trainer had an interest in
a majority of the horses included in the Appellant’s horseracing operation as
shown on the trainer’s statements;
x.
The
trainer pays for his interest in such horses and shares proportionately in all
expenses incurred in respect of them, including his training fee and his 5%
winnings fee. A rough estimate of the trainer’s percentage share of the capital
and expenses of the Appellant’s entire horseracing operation might be in the
order of 20%;
y.
The
Appellant has no written plan to demonstrate that his horseracing operation can,
or could have, a reasonable chance of consistently earning profits, being a
chief source of income or being the means by which he could earn his
livelihood. Indeed, the Appellant acknowledged that his legal career in, prior
to and since the subject years was his chief occupation and livelihood. He
further acknowledged that this will likely continue to be the case going
forward until his retirement from law in a few years. By that time, he believes
he will devote more time to his horseracing operation and board of directors
work.
[7] Notwithstanding the
Appellant’s lack of knowledge and experience going into the horseracing
operation and the appearance that it could be run without much, if any, input
from him, I am satisfied by his testimony that by 2000 he played a very active
role in this business. While the trainer had full responsibility for the
training and maintenance of the horses, he only made recommendations on other aspects
of the operation, including which horses to buy or sell, which horses to rest, which
horses to race in one category or another or at which track particular horses will
race. In these areas the final decision rested with the Appellant.
[8] I am satisfied, as
well, that his devotion to this operation over the years has contributed to
knowledge and experience that support a finding that he is more than a simple
investor who contracted out operations. His daily preoccupation with assessing
every aspect of his business underlines his commitment to its success under his
stewardship. He familiarizes himself with his own horses, the competition, the
racing options and tracks in order to make, in consultation with the trainer,
daily decisions necessary for a successful operation. In short, I am satisfied
that he had, by the years in question, become experienced in all areas about
which a successful operator would have to be informed. However, this must be
taken in perspective. Profitability is a gamble where the intervention of good
or bad breaks play such an important role. Good or bad luck, if you will, can
determine profitability. I am satisfied that the Appellant’s approach,
experience, knowledge and devotion of time and resources give him a foundation
for as realistic a vision and expectation of profitability as might be expected
of any horseracing operator. This is supported by the trainer’s investment in
the operation.
[9] The Appellant personally
maintains the records of, and separate business registrations and GST
registrations for, his horseracing operation. He does not keep financial
statements and frequently referred to his investment from year to year as
estimates. Exhibits relating to such investments were admitted to have been
prepared for the purposes of the hearing. The Respondent asserted that this was
not consistent with the operation of a commercial enterprise.
[10] An understanding of
the need for and the purpose of financial statements shed some light on this
concern.
[11] Firstly, financial
statements are required to show an outsider where a business stands. For
example, it helps a bank assess where a business stands when the bank is being
called upon to lend money and the business forms part of the bank’s security. It
helps investors assess the value of their investment and informs partners about
what is happening in respect of their interest in a business. A sole proprietor
has no reason to prepare financial statements. The Act does not require
them of such operators.
[12] Secondly, the format
of financial statements paints a picture of the financial situation of an
operation at a single point in time, traditionally at the end of a fiscal or
business year. A sole proprietor might be able to tell you his financial
situation at any point of any day, but if asked in 2009 what the investment was
in 2000, he would have to ask on what day or estimate the average for the year
by going back and resurrecting records. That is what he did.
[13] The Appellant
prepared statements of income and loss at the end of each year from his
records. They are reported to the penny and there is no question as to their
accuracy. Essentially, all expenses are on the trainer’s statements and the
Appellant’s share of earnings, as reported, have not been questioned. As well, his
records of buying and selling racehorses, and the time when those
records were prepared, have not been questioned. Accordingly, his records of
his capital investment should not be in question. The objection is without
merit.
[14] While the Appellant
had no written business plan, he certainly adopted new approaches and modified
approaches to his operation from time to time with a view to increasing profitability.
[15] In 1997, the
Appellant made the decision to expand his horse ownership by acquiring more
yearlings (horses that are less than two years old). These were longer term
prospects. Accordingly, the losses over the next two to three years were not
surprising. The Appellant chose to do this with a view to achieve greater profitability
over time. While this increased losses and increased business risks, purses
were going up, (particularly for horses eligible for the Standardbred Ontario
Sires Stakes program which yielded lucrative purses) so the rewards for the
investment in yearlings looked favourable.
[16] The results of this
strategy paid off modestly in 2002 and 2003 but he had too many horses to
maintain so he revised his business plan by downsizing to better quality
horses. As he said, it cost as much to maintain a losing horse as a winning
horse and staffing shortages for a larger stable contributed to problems as
well.
[17] Still, results have
continued to be disappointing. Overall, the Appellant admits to mistakes along
the way, such as making bad purchase choices and insisting on horses racing at
too early an age which contributed to lameness. As well, emerging in 2003/2004
was the wide-spread use of illegal performance- enhancing drugs that gave less
scrupulous owners an unfair advantage. In this regard the Appellant took some
personal pride in his role as a founding member of SHOP in bringing about what
he referred to as huge changes in drug testing and the stiffness of penalties.
[18] The Appellant
testified that he would, and expected that he could, continue with his
horseracing operation, on a smaller scale at least, without his law practice
income.
Statutory Framework
[19] The relevant
provision of the Act reads as follows:
31(1) Loss
from farming where chief source of income not farming -- 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 the
taxpayer's loss, if any,
for the year from all farming businesses carried
on by the taxpayer shall be deemed to
be the total of
(a) the
lesser of
(i) the amount by which the total
of the taxpayer's 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 the taxpayer exceeds the total
of the taxpayer's 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) $6,250, 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).
(1.1)
Restricted farm loss -- For the purposes
of this Act, a taxpayer's "restricted farm loss"
for a taxation year is the amount, if any, by which
(a) the amount determined under
subparagraph (1)(a)(i) in respect of the
taxpayer for the year
exceeds
(b) the total of the amount determined under
subparagraph (1)(a)(ii) in respect of
the taxpayer for the year and
all amounts each of which is an amount by which the taxpayer's restricted farm loss for
the year is required to be reduced because of section 80.
(2)
Determination by Minister -- For the
purpose of this section, the Minister may determine that
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.
Appellant’s Argument
[20] The Appellant’s
position is that the horseracing operation, in combination with his law
practice, was his chief source of income in the subject years so that section
31 of the Act has no application to him to restrict his loss from his
horseracing operation for those years.
[21] The Appellant relies
heavily on the case of Gunn v. The Queen.
[22] Mr. Gunn, like the Appellant, was a lawyer with substantial
professional income. Mr. Gunn also operated a crop and cattle farm over an 18
year period while he was practising law. In every year, except for two, the
taxpayer incurred losses, in some years over $100,000, from his farm
operations.
[23] In Gunn, the
Federal Court of Appeal noted that the seminal case on the application of
section 31, Moldowan v. The Queen,
had attracted criticism. The Appellant notes the nature of such criticism by
reference to the decision by Justice Bowman (as he then was) in Hover v. Canada (Minister of National
Revenue - M.N.R.) and by Justice Joyal in Harold
S. Hadley v. Her Majesty the Queen.
These cases suggest that the Moldowan test leads to an unworkable
situation since it in effect means that a person cannot avoid the application
of section 31 unless he can establish that his other source of income is
subordinate to farming. If he could establish that, he would have established
that farming was his chief source of income and this would render the
combination test in section 31 meaningless.
[24] The Appellant goes
on to argue that the Moldowan decision invoked statutory construction
principles that are no longer acceptable. The Appellant cites several
authorities in support of this argument. Support of this argument is indeed
found in Gunn itself and, accordingly, reliance on such other
authorities seems unnecessary.
[25] The combination test in section
31 that the Appellant advances is stated in Gunn at paragraph 83.
83 In my view, the combination question
should be interpreted to require only an examination of the cumulative effect
of the aggregate of the capital invested in farming and a second source of
income, the aggregate of the income derived from farming and a second source of
income, and the aggregate of the time spent on farming and on the second source
of income, considered in the light of the taxpayer's ordinary mode of living,
farming history, and future intentions and expectations. This would avoid the
judge-made test that requires farming to be the predominant element in the
combination of farming with the second source of income, which in my view is a
test that cannot stand with subsequent jurisprudence. It would result in a
positive answer to the combination question if, for example, the taxpayer has
invested significant capital in a farming enterprise, the taxpayer spends
virtually all of his or her working time on a combination of farming and the
other principal income earning activity, and the taxpayer's day to day
activities are a combination of farming and the other income earning activity, in
which the time spent in each is significant.
[26] The Appellant cites Brian J.
Stewart v. The Queen as
authority for the proposition that on the facts of the case at bar, the
Appellant’s horseracing operation cannot be found to be a personal endeavour. Further,
considering the capital investment in the horseracing operation and the number
of horses owned by the Appellant in that operation, it is argued that the
operation has reached a level of commerciality, commitment and importance
within the taxpayer’s settled routine and business life, such that it cannot be
considered a sideline business.
[27] Further, as acknowledged by
Justice Woods in Clemmer v. The Queen
at paragraph 19, an investment in farming should also include “the entire
monetary contribution to the business, not simply expenditures in the nature of
capital.” The Appellant’s contributions in this regard were clearly significant.
[28] The time spent in the
horseracing operation relative to the time spent in his law practice is
material.
[29] Based on such facts, it is
argued that the Appellant has satisfied the Gunn formulation of
identifying a chief source of income, so as to recognize that his chief source
for the taxation years in issue was a combination of his horseracing operation
and his law practice. It is also pointed out, to support the Appellant’s
argument, that the evidence of profitability in some years must be given considerable
weight.
[30] The Appellant acknowledged that
in Gunn the Federal Court of Appeal stated that the result would have
been the same in that case even if the Moldowan principles were more
strictly applied. Relying on the similar focus given to their respective farming
businesses by Mr. Gunn and the Appellant, the Appellant argues that he too
should be found to be free of the section 31 restriction as was Mr. Gunn.
[31] In dealing with the question of
the binding nature of Gunn the Appellant referred to Johnson v.
Canada
where Justice Webb concluded that he was bound by the Gunn combination
formulation.
[32] In respect of the issue that
the Appellant relied on a hired trainer to operate the business, the Appellant
relies on Astroff v. M.N.R. and
Felicella v. The Queen
which found that such factors are not relevant. With respect to the
risky nature of the business, the Appellant relies on Clemmer where
Justice Woods, dealing with this very point in a similar context, remarked that
it was not desirable for a court to second-guess the business judgment of a
taxpayer.
[33] The Appellant also reviewed a
number of cases where horseracing activities were found to be subject to
section 31 of the Act. It was argued that all such cases can be
distinguished from the case at bar.
Respondent’s Argument
[34] The Respondent argues that the
Appellant’s chief source of income was neither farming nor a combination of
farming and some other source of income. Rather, his chief source of income was
income from his law practice or from a combination of his law practice and
investment income. It was emphasized at the hearing that the Appellant
identified these two income streams as the source of his livelihood and that in
any event, he has not proven otherwise.
[35] Although the Respondent conceded
that the Appellant’s horseracing operation was a business, it was still argued
that he carried it out with an indifference toward the losses being incurred
and relies on the Federal Court of Appeal decision in Minister of National
Revenue v. Donnelly
as authority for asserting that in such cases section 31 applies.
[36] Again relying on Donnelly,
the Respondent notes that the profitability of the business has to be assessed
in relation to the investment. An inordinately small profit relative to time
and capital invested cannot be treated the same as a degree of profitability
that is more reasonable in those relative terms.
[37] The Respondent also relies on
a strict application of the test in Moldowan. To the extent that the Gunn
decision is at odds with the Moldowan decision, the Respondent argues
that I am bound by the Supreme Court of Canada decision in Moldowan, as
found in Falkener v. Canada. In Moldowan, to be free of
the section 31 restriction, the taxpayer has to be a person whose major
preoccupation is farming. The Respondent argues that this is the only
construction of the subject provision that makes any sense at all.
[38] Other cases are relied on to
support the view that section 31 is there to protect the full-time farmer who
obtained a subordinate source of income to sustain his farming activity. See,
for example, Loyens v. The Queen.
The Respondent readily distinguishes cases relied on by the Appellant including
Gunn, which clearly presents the best comparable for the Appellant. The
Respondent further submits that if Gunn does expand the principles in Moldowan
in an acceptable way, such expansion is not sufficient to assist the Appellant
in the case at bar. In short, the Respondent has argued that the facts in Gunn
are distinguishable from those in the present appeal.
[39] The Respondent argues that
recognizing profits in 6 of 25 years of operation does not signal the horseracing
operation as a chief source of income. Rather, it signals a chief source of
losses – a sideline business at best.
[40] In reviewing cases such as Moldowan,
Canada v. Morrissey, Afzal
v. R.
and Donnelly to name a few, the Respondent argues that comparing the
facts of those cases to those of the current case demonstrates that the
Appellant falls into a category of farmer who is subject to the section 31 loss
restriction.
Analysis
[41] As noted, the Respondent conceded in argument that the
horseracing operation was a business. This is a concession that the horseracing
operation is a source of income.
[42] Recognizing that the horseracing operation was a business suggests
that it was not a personal endeavour such as a hobby. This reasoning relies on
the analysis in Stewart where the Supreme Court of Canada cast a new
light on the meaning of the phrase “source of income”. The case was of landmark
significance in finding that, under the Act, there was no restriction on
claiming losses arising out of an activity found to be a source of income; i.e.
there was no restriction on losses incurred in an activity pursued as a
business as opposed to a personal endeavour. Those concepts are mutually
exclusive. On this basis, a concession that the horseracing operation was a
business is, as the law stands today, a concession that it was not a personal
endeavour.
[43] The relevance of this reasoning and
conclusion is that if section 31 targets personal endeavours such as hobby
farmers, as suggested in so many cases before and after Moldowan, then it
would follow that persons who have devoted themselves to farming in a
business-like manner sufficient to meet the tests established in Stewart
will never be subject to that section. That clearly cannot be so.
[44] Even if a farming business is found to be a
business under the Stewart test, the section 31 loss restriction will
still apply if it is a sideline business. In spite of the anomalies that arise
in dealing with section 31, the jurisprudence invoking a sideline business
restriction construction of the section is well-ingrained in the law. Without
such concept, the riddle of the combination question and its applicative
obscurity would be even more perplexing than it has been.
[45] However, the notion of a sideline business
has not been easily applied. Indeed, as set out in the Moldowan
formulation of three classes of farmers, the sideline business test has been
the object of considerable criticism. If farming has to be more than a sideline
business to avoid the section 31 loss restriction, then the tendency is to
suggest that it must be the chief source, which renders the combination
test meaningless.
[46] This, in my view, is where the Gunn
analysis expands on the interpretive principles set down in Moldowan so
as to narrow the scope for restricting farm losses. In doing so it provides
considerable assistance in rationalizing a satisfactory construction of section
31. In my view, it confirms that a farming operation will not be considered a
sideline business for the purposes of the combination test in section 31 even
if it may never be the chief source of income of the taxpayer operating
it.
[47] Applying section 31
in this way or as otherwise applied in Gunn, opens the door for the
Appellant. That is, to succeed in his appeals the Appellant is totally reliant
on if and how I apply Gunn.
[48] The starting point
of the analysis is to consider the construction of section 31 as directed in Moldowan
and compare it to that employed in Gunn to better understand in what
respect the Gunn construction is more generous. It will then be possible
to determine if the Appellant warrants having the same result as afforded Mr.
Gunn under that construction. If I make that determination in favour of the
Appellant, it will be necessary to determine if that construction can prevail
without a further finding that the Appellant also met the Moldowan
criteria, as did Mr. Gunn.
The Moldowan Classification
of Farmers
[49] It would be helpful to set out an expanded reiteration of
the guiding principles in Moldowan that formulate three
classes of farmers:
i)
the class (1) farmer is, in today’s terms, one
who meets the Stewart test for income from a business and who has met
the further criteria set for farmers who can claim their farm losses on an
unrestricted basis. They are farmers “… for whom farming may reasonably be
expected to provide the bulk of income or the centre of work routine.”
(emphasis added).
They look to farming for their livelihood even though there are years in which
they sustain losses;
ii)
the class (2) farmer is
one who passes the Stewart test but who has not met the additional class
(1) criteria;
iii)
in Moldowan, the
class (2) farmer is “the taxpayer who does not look to farming, or to farming
and to some subordinate source of income, for his livelihood but carried on
farming as a sideline business.”
In this description, the second source is described as “subordinate” even
though quantitatively it would have to be the higher source of income. If
farming is merely a sideline activity then, relatively, the other source will
not be a “subordinate” activity (source of income) and cannot be used in the
combination test to prop up the sideline farming business as being part of the
two sources that together comprise a chief source;
iv)
this has been taken to
mean that only one of two sources can be predominant and that this source must
be farming to avoid the application of section 31 restricted loss treatment. While
it is necessary to appreciate that such predominance cannot be determined
simply by dollar amounts, it is this application of the combination test that
would render it sterile if applied strictly;
v)
the class (3) farmer
does not meet the Stewart test and is denied all losses under Moldowan.
[50] Of importance in
this reiteration of the Moldowan classes of farmers is that it recognizes
limits to the combination test being used as the vehicle whereby a profitable
source can be used to prop up an unprofitable farming source so as to add it to
the already identified class (1) group of farmers. It is restrictive and seemingly,
if not clearly, directs that farming must be the chief source even in
the combination test.
The Gunn Approach
[51] In determining whether the farming activity
is to be part of the combination formula, we are instructed in Gunn at
paragraph 83 to consider that:
… the combination question should be interpreted to require
only an examination of the cumulative effect of the aggregate of the capital invested
in farming and a second source of income, the aggregate of the income derived
from farming and a second source of income, and the aggregate of the time spent
on farming and on the second source of income, considered in the light of the
taxpayer's ordinary mode of living, farming history, and future intentions and
expectations. …
[52] My reading of this formulation of the combination test is that it requires
that the chief source factors being examined in respect of farming, including
potential profitability, be considered relative to the chief source factors
being examined in respect of the second source being included in the
combination. This is consistent with the directive in Moldowan that
profitability be assessed relatively.
[53] The challenge in Gunn is to assess how material the
farming source contribution must be to the aggregation formula. Other
authorities suggest that the contribution need not be quantitatively
substantial (as held in Taylor v. Canada
and Kroeker).However, in my
view, it is implicit in Gunn that the farming source must make a
meaningful contribution to the aggregation formula so as to suggest that farming is or has the potential
to be a chief source.
The Gunn
Construction vs. The Moldowan Construction
[54] Drawing from my
reading of Gunn, it is clear to me that in the combination test there is never a need to
establish that farming will ever provide the bulk of a taxpayer’s income or
even that it will ever need to be the predominant business or work activity of
the taxpayer. As recognized in Gunn, this invokes a more generous test than the Moldowan
suggestion that farming must be the chief source even in the
combination test. Recognizing that the tests in these cases are different, this
Court has already expressed conflicting views on whether Gunn is a
binding authority in the face of Moldowan.
[55] Still, the factors considered in Gunn also
form part of the analysis in Moldowan. At page 4, Dickson J. (as he then
was) noted:
… 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. …
[56] That is, the
criteria or factors considered in identifying a chief source in Moldowan,
including, but not limited to profitability, are not dissimilar from those relied
on in the Gunn articulation of the aggregation formula. In both
cases the time spent, the
capital committed, the potential profitability and the taxpayer’s ordinary mode
and habit of work are the criteria for determining whether farming is more than
a sideline business.
[57] If that were the end
of the comparison of the two cases, one could conclude that Gunn is not
at odds with Moldowan. That, however, as noted, is not the end of the
comparison. Contrary to Moldowan, Gunn
suggests that the activity propping up the farming income need not be
subordinate to farming but rather it suggests that the farming activity,
relative to the other source, must make a relevant or meaningful contribution
to the aggregation formula assessed by using the Moldowan criteria.
[58] Applying the
combination test in this way, Gunn affords class (1) treatment to an
expanded group of farmers by allowing that the combination test can apply to
give that result even where farming alone may never be the chief or predominant
source from either a quantitative perspective or from a commitment perspective.
[59] Still, the question
arises whether this expanded application of Moldowan is such a departure
from it as to suggest that it cannot bind this Court. A strict application of the rules of stare decisis
may well bind me to follow Moldowan. This was the finding of Justice
Bowie in Falkener. It does strike me as unlikely that any court should
be able to distinguish a higher court’s decision if it undermines the very
mandate of that decision even if the mandate has gone beyond what thoughtful
critics have suggested can properly be drawn from the legislation.
[60] However, I am not certain that Gunn
undermines the very mandate of the Moldowan decision. What it does is avoid
the contradictions and difficulties that have been the Moldowan legacy.
There is in Gunn a harmonious union of the language of section 31 and
discernable distinctions between casual farming activities and committed
farming preoccupations. Such distinctions become more apparent by applying the Gunn
approach which itself draws on factors relied on in Moldowan.
Rationalizing an abundance of cases purporting to apply Moldowan becomes
clearer under the lens of a Gunn analysis.
[61] Indeed, it is my view that Gunn simply puts the Moldowan analysis back on track as a
workable construction of section 31 – one that does not render it sterile while
paying heed to the language of the section. The Gunn
analysis uses the personal and commercial commitment factors embraced in Moldowan
in a manner that fits into the combination formula stipulated in section 31. That is, after all, what Moldowan was
attempting to do. The sideline or auxiliary business concept was embraced in Moldowan
as a means to avoid an untenable construction of the subject provision. Gunn
does that very thing as well, and adopts an approach that embraces the Supreme Court
of Canada’s dictate to apply the restriction to a sideline farming business. As such, I feel compelled to apply
it as a means of avoiding some of the unintended aspects of a rigid application
of those few lines in Moldowan that summarily formulate three classes of
farmers.
[62] At the heart of this
acceptance of the Gunn analysis is my view that it is compatible with a satisfactory construction of the language
of section 31.
[63] If one initially
limits the class (1) farmer group to farmers for whom farming may reasonably be expected to provide
the bulk of their income, then in determining who belongs in that
class, we must employ an overall quantitative assessment of the farming operation
regardless of a loss sustained in a particular year. However, since section 31
asks if the farming operation was a chief source of income in the particular
year, which is a loss year, the meaning of “chief source” must be broadened
to include other factors. Acknowledging this need not preclude identifying the
initial class (1) group in the context of an overall quantitative assessment.
Indeed, this should be clear from the initial class (1) description of a farmer
as a taxpayer who looks to farming for his livelihood even though there are
years in which they sustain losses.
[64] If one limits, in
the first instance, the class (1) farmer group in this way, a number of
contradictions are avoided when one goes on to analyze the combination test
which surely can only be there to expand the class (1) farmer group eligible to
claim losses on an unrestricted basis.
[65] In the combination
test we must find that the taxpayer’s chief source of income in the loss year
was a combination of farming and some other source. Since this farmer has not
established that it is reasonable
to expect that farming has been or will provide the bulk of income based on an overall quantitative
assessment, a determination is required under the combination test not only as
to potential profitability but as to the level of commitment the taxpayer
demonstrates to the farming source. The commitment has to demonstrate that the
activity is more than a sideline business. In cases like Gunn and the
case at bar, the determination of the level of commitment becomes somewhat of a
comparative exercise as between the source that props up the farming source and
the farming source itself.
[66] The
language of section 31 can only support this construction if in the combination
test the phrase “chief source of income” takes on a special
meaning applicable only in the context of that test. Indeed, its meaning must
be altered in the combination test even when compared to its meaning in
establishing the initial class (1) group of farmers. In the combination test it
should not be necessary to establish that farming will ever provide the bulk of
a taxpayer’s income. In the combination test we are instructed by Moldowan
to look at other factors that demonstrate that farming is not a sideline
business.
[67] This approach is
inherent in the Gunn decision.
[68] Further, Gunn
suggests that the less generous approach is not consistent with modern rules of
statutory construction that seek to avoid anomalies such as those inherent in a
strict application of Moldowan’s three classes of farmers.
[69] Gunn also
suggests that there is no historical basis for finding that Parliament intended
such a narrow approach. This suggestion requires elaboration.
[70] There is an historical
record that Parliament intended that hobby farmers or gentleman farmers not be
allowed to use the treasury to subsidize their country life indulgences. However, that record does not
necessarily reflect an intention to restrict loss claims in respect of farming
activities that have been carried out with such degree of personal commitment
as to credibly establish an intent to operate an economically, commercially
viable business with a meaningful profit potential. There is no parliamentary
record that would suggest that a farming activity that met this threshold could
not properly be included in the combination test in section 31, regardless of
many years of losses.
[71] Many amateur photographers, stamp collectors
or yachting enthusiasts with a considerable passion and commitment for their
respective endeavour will not pass the Stewart test to have losses from
their endeavours deductible but if they can pass that test they will
be able to use their losses on an unrestricted basis. Farming
enthusiasts of the recreational or country gentleman variety who do not make
the bulk of their income from farming have a higher bar to reach to get similar
treatment as afforded to these hobbyists. In order to use farming losses on an
unrestricted basis, their farming endeavours must be pursued in such a manner
as to be seen as one of two or more chief sources. Section 31 raises the bar
for the farmer. The Gunn threshold appears to me to recognize the height
of the bar that best reflects a construction of the language of the section that
does not contradict the legislative intent. Further, it does not, in my view,
violate the underlying principles recognized in Moldowan. Accordingly, having
found an approach that does justice to those principles and to the words of the
Act, I would feel compelled to follow that approach if required.
[72] I am suggesting then that the test is
whether the taxpayer’s mode of operation has sufficient commitment and commerciality
and profit potential to be recognized as a chief source applying the Moldowan
commitment and profitability criteria. Looking at time spent, capital invested,
and a meaningful profit potential arising from a dedication to profitability, the
question of whether the taxpayer is recognizable as a committed, viable commercial
player in a genuine economic sector of the economy should be readily answered.
Such a test will not put recreational farmers in an advantaged position.
Distinguishing Gunn on the
Facts
[73] The Appellant’s case
still rests on my finding that the facts in Gunn are not sufficiently
distinguishable as to warrant a different result.
[74] The facts in Gunn
involve a cattle-breeding and crop-raising operation that lost money every year
for 15 consecutive years (1987- 2001) before making a profit in 2002 (three
years after the years under scrutiny in that case). Mr. Gunn lost money again
in 2003 and made a profit in 2004.
[75] In concluding that farming was not a sideline business
for Mr. Gunn, the Federal Court of Appeal
accepted Mr. Gunn’s undisputed evidence as to the profit potential of his farm
and gave some weight to the synergies of his law practice and his farm
operations. While I do not make this latter finding in the case at bar, I
accept the Appellant’s undisputed evidence as to the profit potential of his
horseracing operation.
[76] Further, I note that the weight of the factors considered in the Gunn analysis, other
than demonstrated profitability, clearly point in that case, as they do here,
to the impugned farming business being more than a sideline business. Even
though both taxpayers derived their principal income from the practice of law and
their total hours spent at their law practices exceeded that devoted to their
farming businesses, they both devoted a material amount of capital and a very
significant part of their daily work routine to their farming businesses. In
both cases the business was pursued as a major business preoccupation. The
Appellant’s mornings, evenings and weekends were consumed by a dedication to
enhancing the potential profitability of the operation. This was more than a
distraction from his normal mode of living or an entertainment or sport. Like
Mr. Gunn, his dedication was to the economic success of the operation.
[77] Like Mr. Gunn,
the Appellant was involved in his farming business beyond the farm; beyond the
stable and track in the case at bar. I have given weight to the fact that the
Appellant was an active member of and contributor to the community of standardbred
horseracing. He worked to improve the integrity of standardbred racing so as to
improve the potential profitability of his operation. His knowledge of the
competitions that determined profitability was sufficient to place him as
chairperson of the industry’s appeal board.
[78] One distinction that the Respondent might rely on is
the degree of potential profitability. One aspect of this concern is the
relative potential of profitability of the Appellant’s farming activities
compared to that of Mr. Gunn and another is the risk associated with
horseracing.
[79] In Gunn, the taxpayer’s net farming income in the 18th
year was some $96,000 compared to his law practice income of $247,000. While
this quantitatively puts farming in a better proven relative position for Mr.
Gunn than for the Appellant, I do not believe the analysis can be that finite. Further,
to rely on such a distinction would require me to penalize the Appellant for
having established a lucrative law practice which required a somewhat modest
amount of billable time relative to that required by many other lawyers earning
far less.
[80] As well, in support of a conclusion that Gunn
cannot be distinguished on the basis of relative potential profitability, I note
that unlike Mr. Gunn, the Appellant had two consecutive profit years
immediately following the years under appeal.
[81] As to the risks associated with horseracing, I do not agree with the emphasis that the Respondent
places on that factor. Farmers operate in an extraordinarily risky environment.
Assessing the commitment to profitability should not be based on speculation as
to the risk inherent in different types of farming activities but rather, as
suggested in both Moldowan and Gunn, it must be based on the
investment of time, capital and energy of the taxpayer reflective of a
commitment and devotion to its economic success. As in Gunn, the farming
operation in the Appellant’s case was sufficiently commercial and part of his ordinary
mode of living and work routine as not to be considered a sideline business.
[82] There is another factual distinction between the two cases that may well be at the heart of the
Respondent’s position. Mr. Gunn was a cattle and grain farmer with a farming
background who worked the farm himself. His activity relates to human
sustenance. It is an essential part of our Canadian economy. The Appellant is a
city lawyer who pursues horseracing from, relatively speaking, a comfortable
distance. His activity provides sporting entertainment.
[83] The combination in this case of a horseracing operation
being carried on by a city person who contracts out so much of the work does
raise a few perceptual problems for the Appellant. The combination of these
perceptions feeds the view that
horseracing operations, as opposed to other farming operations, are inevitably,
if not inherently, a recreational diversion, more consistent with a
self-indulgent sideline than with an objective expectation of earning a profit
that would make a meaningful contribution to the aggregate income requirement
in the section 31 combination test.
[84] I recognize that this perception cannot be ignored. I
also recognize that it derives from a cynicism, in cases such as this, that the
endeavour is none other than a recreational distraction. While one must be
careful not to decide cases on perceptions and cynical mindsets, the
distinctions causing those perceptions and mindsets still need to be considered
although it might be possible to dispose of this concern by referring to Gunn
which, at paragraph 67, shuns the notion that section 31 can be applied more assiduously to horseracing activities. It might also be possible to gloss over this concern by pointing out
that some authorities have cast doubt on whether the degree of profitability is
relevant in the application of section 31 of the Act.
[85] As well, and perhaps most importantly, I note that the Act defines farming to include horseracing
and imposes the same test for the application of a loss restriction rule
on both the Appellant and Mr. Gunn. This might be sufficient reason to dispose
of this concern over the
perception of horseracing inherently being a personal indulgence. As the Act reads, Mr. Gunn cannot be given better tax treatment
than the Appellant simply because we perceive horseracing differently than
grain and cattle farming. The Act should address this concern not the courts.
[86] However, dealing with this concern in this manner does
not seem entirely satisfactory.
[87] A more satisfactory way to deal with this concern is to
rely on the activity in question being scrutinized by applying objective
criteria to the issue of potential profitability. Regardless of its business
form and the extent of the taxpayer’s devotion to its economic success, the
test of there being a reasonable expectation of meaningful profitability (relative
to the other source being considered in the combination test) must not only be
a relative one but must be an objective one as well.
[88] Applying such a test to the case at bar does not, in my
view, put the Appellant on weaker ground. The factual similarities with Gunn
encourage me to find that even such a test would have to favour the Appellant. The Appellant is entitled to hire a trainer and have
his operation housed and maintained by contracting out the provision of these
supplies. That does not undermine the evidence supporting the reasonableness of
his expectation that his horseracing operation might become, potentially, a
chief source measured by its contribution to the combination test in section 31.
Indeed, as noted, the involvement of the trainer, who has also invested in the
Appellant’s operation, serves in this case to add weight to the Appellant’s faith in its potential profitability.
[89] Viewing the two
cases as a whole, I agree with the Appellant. They cannot be sufficiently
distinguished to warrant a different result. If the Federal Court of Appeal found that Mr. Gunn was
not subject to section 31 loss restrictions even on the Moldowan
interpretation of the combination test, as it did at paragraph 93, then the
Appellant should be allowed the same result. As such, even if my acceptance of
the expanded construction of the combination test in section 31 in Gunn
is misguided, I am satisfied, in any event, that the facts of the two cases are
not sufficiently distinguishable to give a different result.
Conclusion
[90] Accordingly, the appeals are
allowed with costs.
Signed at Winnipeg, Manitoba this 17th day of December 2009.
"J.E. Hershfield"
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