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Appeals heard on November 24, 2003, at Calgary, Alberta,

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JUDGMENT

          The appeals from assessments of tax made under the Income Tax Act for the 1998 and 1999 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's chief source of income is a combination of his employment and farming.

Signed at Ottawa, Canada, this 8th day of January, 2004.

J.T.C.C.

REASONS FOR JUDGMENT

Bowie J.

[1]      Mr. Neal appeals from his income tax assessments for the years 1998 and 1999. His appeals were heard under the Court's informal procedure. The only issue is whether he is entitled to deduct his losses incurred in farming from his other income, without restriction. In assessing him, the Minister of National Revenue has taken the position that the Appellant's chief source of income in the two years in issue was neither farming nor a combination of farming and his employment as a drilling supervisor in the petroleum industry. She therefore applied section 31 of the Income Tax Act (the Act) to restrict the allowable losses to $8,750.00 in each year. The Appellant's position is that his employment and farming, in combination, are his chief source of income, and so he is not subject to the limitation imposed by section 31.

[2]      The Appellant's farming activity is breeding and training quarter horses for sale. When reporting his income for the years under appeal, he declared his income from employment and losses from farming as follows:

He was assessed on that basis initially, but by a subsequent reassessment the Minister disallowed certain farming expenses that he had claimed, thereby reducing the farming losses to $52,703 for 1998 and $28,468 for 1999, and also applied section 31 of the Act to restrict the allowable amount of the losses. In his appeals, Mr. Neal does not contest the recomputation of the losses, but says that they should be allowed in full.

[3]      In the late 1980s and early 1990s, Mr. Neal was engaged in raising cattle on a half section of land. His employment income in those years was negligible; it averaged only $2,736 between 1988 and 1993. In the same period, his farm income fluctuated between a loss of $8,815 in 1989 and a profit of $11,596 in 1992. His half section included a stand of timber, and to his later regret he entered into a contract with a lumber company to clear it. The result was a disaster for him, both ecologically and financially. In the fall of 1993, he found it necessary to sell both the land and the cattle, and to take employment in the oilfields on a full-time basis. He was able to make a good living as a drilling supervisor, but his preferred way of life was farming.

[4]      In 1994, the Appellant moved to three-quarters of a section of land near Rocky Mountain House, Alberta, that was made available to him by his father-in-law, to start raising registered quarter horses. He intended to develop the ranch into a business capable of supporting him and his family, while continuing to work in the oilfields as long as necessary to enable him to meet the very considerable start-up expenses of his new venture, and to support his family while doing so. His first priority, of course, was to build up a herd of horses, and his strategy for this was to purchase a stallion and five or six brood mares, all carefully selected for their bloodlines. He bred the mares each year, keeping the fillies to build the herd and selling the colts as soon as they were ready for the market place. To be saleable, the colts had to be broken and then trained, a process that required anywhere from two to four years. During that time they produced no income, but were a source of expense as they had to be fed and cared for.

[5]      Between 1994 and the time that the appeals were heard in October 2003, the Appellant had established a reputation as a supplier of high quality quarter horses for ranch, rodeo and show purposes. He had also achieved his ambition of building the herd to slightly more than 100 horses, made up of about 50 mares for breeding, 25 fillies, and the remainder geldings and stallions for sale. All this took time, however. In 1998 the herd consisted of 41 horses, and by 1999 it was about 55. This result was not arrived at without a great deal of effort and expense. The Appellant's wife and daughter both did a lot of this work, tending and exercising the horses, particularly while the Appellant was occupied at his job in the oilfields. However, he has also done much of the work himself. His schedule required him to work 12 hours per day for two weeks, followed by one week off. He spent the week off working full-time on the ranch. In order to be able to work on the ranch full-time at the most critical time of the year, he worked only 9½ months in the oilfields and spent the period between May 1 and July 15 each year working at the ranch. This is the busiest time in the horse-breeding business, and therefore the time when it is most important for him to be available to attend to ranch business, including the foaling and training activities.

[6]      It is reasonable to infer from the emphasis given to it in the Reply to the Notice of Appeal that the Minister, in assessing, was considerably influenced by the Appellant's successive reported losses from farming for the years between 1994, when he began to raise quarter horses, and 2001. They amount to about $245,000 in the aggregate. However, these must be viewed in light of the fact that the Appellant started a new breeding operation in 1994. His evidence was that it takes anywhere from two to four years after the first horses are born before any are ready for sale and even then his policy was to retain horses to build his herd. The question is not whether the operation has been profitable in the past, however. It is whether the Appellant satisfies the requirement of section 31 of the Act as it has been interpreted in Moldowan[1] and subsequent judgments that explain it. As Dickson J. put it in Moldowan, at paragraph 13:

Whether a source of income is a taxpayer's 'chief source' of income is both a relative and objective test. It is decidedly not a pure quantum measurement. ...

He went on to say at paragraph 17:

The reference ... to a taxpayer whose source of income is a combination of farming and some other source of income is a reference to class (1). It contemplates a man whose major preoccupation is farming, but it recognizes that such a man may have other pecuniary interests as well, such as income from investments, or income from a sideline employment or business. The section provides that these subsidiary interests will not place the taxpayer in class (2) and thereby limit the deductibility of any loss which may be suffered to $5,000. While a quantum measurement of farming income is relevant, it is not alone decisive. The test is again both relative and objective, and one may employ the criteria indicative of "chief source" to distinguish whether or not the interest is auxiliary. A man who has farmed all of his life does not become disentitled to class (1) classification simply because he comes into an inheritance, On the other hand, a man who changes occupational direction and commits his energies and capital to farming as a main expectation of income is not disentitled to deduct the full impact of start-up costs.

[7]      In my view, the evidence places Mr. Neal squarely within the last sentence of this passage. Prior to 1994, he was a full time farmer, to judge by the limited evidence before me. His income in the years 1990 to 1993 was derived principally from his cattle farming. His change in occupational direction in 1994 was not to become an oilfield worker, but to become a horse breeder. His subjective evidence was to that effect, and it was not challenged. Equally important, the evidence of his activities after 1994 supports that view of the matter. I am satisfied on the evidence that his main preoccupation was with the ranch and not the oilfield. He arranged his work year with the oil company in such a way as to be at the ranch when it needed him most. He earned over $60,000 annually on average in the oilfields, but he put all of it, after feeding his family, into the ranch. That income enabled him to pay the bills for feed and the other needs of the horses while he built the herd up to 100 horses and established his reputation as a breeder of quality stock. I am satisfied, too, on the evidence that the ranch has the potential to become profitable in the near future. Mr. Neal testified that all that is now required in order to achieve that is to build an arena so that the horses can be trained there in the winter, and that he expects to build it within the next year.

[8]      Mr. Neal is not a sophisticated financial planner. However he did attach to his Notice of Appeal his five-year plan for the ranching operation, covering the years 2001 to 2006. These, together with his oral evidence as to his plans to build the arena in the year 2004, satisfy me that he will more likely than not achieve his goal of making the horse breeding operation sufficiently profitable that he can leave his employment and work on the ranch full-time within the foreseeable future. At that point, horse breeding will be the center of his work routine, and it will provide the bulk of his income. It is important to remember in this regard that the Appellant derived most of his income from farming in the years immediately before 1994, and that his work routine was centered on the cattle operation. He was a fulltime farmer. Since 1994, the horse breeding has been central to his work routine, although he has necessarily been diverted from it for two weeks of every three between July and May by the need to acquire cash to live on, and to build up his new venture.

[9]      There is a marked similarity between this case and The Queen v. Graham.[2]I will not reproduce all the assumptions of fact that the Minister has pleaded in this case. Many of those involve conclusions of law which, of course, should not be pleaded as though they were factual.[3] However, I think it is a fair conclusion to draw from paragraph 13 of the Respondent's Reply that the reassessments were motivated principally by two factors. One was that the Appellant had fulltime employment in the oilfield; the other was the losses that the ranching activity suffered for its first eight years. The same factors were present in Graham, but they did not preclude the conclusion that the taxpayer's main preoccupation was farming. Significantly, in both cases the Minister accepted that farming was a source of income for the taxpayer, but did not accept that it in combination with the employment was his chief source. I see no principled basis upon which Graham can be distinguished from the present case.

[10]     I find that for the years under appeal the Appellant was not subject to the limitation imposed by section 31. The appeals are allowed and the reassessments are referred back to the Minister for reconsideration and reassessment on that basis. The Appellant is entitled to his costs, consisting of such disbursements as he has incurred to pursue his appeals.

Signed at Ottawa, Canada, this 8th day of January, 2004.

J.T.C.C.