Lionel Lemieux v. Minister of National Revenue, [1991] 1 CTC 2180, 91 DTC 454

Couture, C.J.T.C. [Translation]:—The appellant is appealing assessments for the taxation years 1985 and 1986.

The appellant, representing himself, explained at the hearing that he and his wife had started a horse-raising business in 1985 with the intention of setting up an equestrian centre in the next few years. They were employed by the Commission scolaire de Taillon, where he was a school principal and she was a computer analyst. Although both were relatively young, their respective dates of retirement from their jobs were approaching. Their intention was to organize their activities with a view to their retirement by undertaking this project, which would provide them with an occupation after leaving their jobs. They both rode horses, had been interested in horses for many years and were relatively knowledgeable about the care and training of horses. Each one owned a horse.

The appellant pointed out that he had been riding horses since the age of five, and that his wife had done so since 1975. She took riding courses from 1980 to 1983. She bought her first horse to practice the sport in 1977. In 1979 she bought a 36-acre plot at Deschaîllons, about 200 kilometers from Montréal, which was neglected at the time, and 25 acres of which was leased to a farmer who brought it into production again. She converted six acres into a horse pasture. The husband bought his first horse in 1983. In 1984 they rented five acres of land from a farmer. There were two buildings on this land, which was part of an 82-acre farm.

The project was started in partnership. The appellant explained that its beginnings were quite modest because of inadequate financial resources, and they thus had to proceed cautiously. They had made inquiries in the area where they lived, to find the appropriate location to undertake their project.

In 1985, they obtained a farm producer card from the Ministère de l'Agriculture of the province of Québec and transferred their riding horses to the partnership. They received this certificate from the Ministère de l'Agriculture after a visit to the premises by an official, followed by an annual inspection. One of their horses was certified by the Ministère de l'Agriculture as a broodmare. That same year, they bought a thoroughbred mare that was also certified as a broodmare. The two buildings were converted by the partnership into stables, one of which could hold eight horses, and the other two.

In 1985, therefore, the assets of the partnership consisted of two broodmares and a riding horse that was trained for use in riding classes in 1986. In addition, the partnership held a lease on a five-acre plot of land on which there were two buildings. During this first year the partnership also had one horse boarding in its stables. The latter was in fact its only source of income for the year. According to the witness, a riding horse cannot be used for teaching. A horse must be trained and schooled specifically for that purpose. Such training may take from three to six months, depending on the horse's temperament.

They acquired a third broodmare in 1986, but the one that had been transferred to the partnership in 1985 and which had previously belonged to the appellant's wife was trained to be an instructional horse, because their veterinarian had recommended it not be used for breeding.

The evidence showed that in 1987 the partnership owned two instructional horses, two broodmares and one colt and had two boarding horses.

I do not intend to describe in detail all the events which occurred in connection with the operation of this project between 1985 and 1989: I will just refer to those most useful in arriving at a decision on the nature of the activity in which the partnership was engaged.

The witness pointed out that the owner of the farm had led them to understand that he would eventually sell them his farm and based on this possibility they wanted to expand their facilities, but they were not ready to make further investments based on a mere possibility without an assurance that they would become owners of this farm, or at least obtain a long-term lease for the entire farm. In 1985 and each subsequent year the appellant and his wife made a verbal offer to buy the farm from its owner, without success. Consequently, in 1988 they asked a notary to meet with the owner and to make him a formal offer, which was refused. Following this refusal, they went on looking for a place to continue with their operations. Following the owner's November 1988 refusal, they purchased an 82-acre farm in St-Athanase d'Iberville which included a 30-stall stable, a 5/8-mile racetrack, four open-air riding fields and an indoor riding field for winter riding, as well as for training, five fenced-in feed lots and a nine-room house in which they have since lived. They purchased all of the above for a sum exceeding $600,000.

The appellant entered two tables in evidence. The first shows the number of horses that belonged to the partnership and the number that it was board- ing.

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The second summarizes income and expenditure for the period indicated:

Counsel for the respondent did not challenge the veracity of these figures. It should be noted, however, that the data for 1989 are incomplete since, according to the appellant, the auditor for the partnership had not told him, as of the date of the hearing, what portion of the interest on the farm's mortgage was assignable to the partnership and constituted an expense for the latter. The appellant contended that, even if this expense were taken into account, he believed the partnership's operations for 1989 showed a slight profit.

Continuing his testimony, the appellant mentioned that, because of his job as principal for the Commission scolaire Taillon, his working hours enabled him to devote a great deal of time to working on the farm. He finished work at 3:30 p.m. each day, and by 4:00 p.m. was already at work on the farm. He also had two months’ vacation each year, and had statutory holidays during the school year and every weekend available. He stated that he used all of his spare time to work on the farm. Although his wife did not have the school vacations, she was nonetheless entitled to annual vacations and statutory holidays, and was free every weekend. Like the appellant, she spent all her spare time working on the farm.

In 1988, the appellant added horse training (that is, preparing a horse for riding) to the list of services offered by the partnership. The witness used the expression "breaking in a horse". This, therefore, provided another source of income for the partnership. His wife, for her part, had taken riding courses from 1980 to 1983. From 1985 to 1988 she acquired some skill in this activity, and in 1988 began teaching horseback riding. She testified that she is recognized as a sports trainer by the Fédération équestre des sports. At the date of the hearing she was teaching more than ten students a week and was giving courses nearly every evening and on Saturdays.

In his tax returns for the 1985 and 1986 taxation years, the appellant claimed the portion of losses allowed under subsection 31(1) of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (‘the Act”) on the grounds that the partnership's operation of the farm was a business within the meaning of the Act and of the case law.

For its part the respondent, by his assessments, refused to accept the losses in question, claiming that they did not result from the operation of a business but were expenses of a personal nature, because the operation of the farm by the partnership did not offer a reasonable expectation of profit during the years in question.

The evidence submitted by the appellant was not disputed by the respondent. What counsel for the respondent did argue was that a correct interpretation of the evidence would not justify a finding that the activities of the appellant and his wife in putting their plan into action constituted a business, since the organization itself and its components were too modest to generate profits in 1985 and 1986. They consequently offered no reasonable expectation of profit as required by the Act and the resulting case law.

Briefly summarized, the evidence demonstrated that the appellant and his wife, both of whom were fond of horseback riding and had therefore been interested in horses for many years, had formulated a plan to develop an equestrian centre in view of their approaching retirement from their respective jobs, an activity that would provide them with new occupations as substitutes for practising their respective professions.

Each of them owned a horse, and before renting a five-acre plot of land in Carignan, a town on the south shore of the St. Lawrence River, they searched locally for a place where they could establish themselves and where they could carry out their project. When they received a final answer from the owner of the farm from whom they were renting five acres of land, namely that he did not want to sell them his farm, they did not hesitate to purchase a farm in St- Athanase, where they established themselves in a permanent manner and continued to expand their operation. I am convinced that the operation the appellant and his wife launched in 1985 was not the result of a spontaneous decision, but had been planned for a long time following careful consideration and was supported by the experience of each of them in the field of horse care and training.

There is abundant case law on this type of operation, to help determine when it is simply a dream of the backers, and obviously offer no possibility of profit, and when it is purely a scheme to deduct expenses from their income which are essentially personal ones and are incurred in the pursuit of a leisure activity.

The leading case on the points that must be considered to determine if an activity does or does not constitute a business within the meaning of the Act is that of the Supreme Court of Canada in William Moldowan v. The Queen, [1978] 1 S.C.R. 480; [1977] C.T.C. 310; 77 D.T.C. 5213. Dickson, J. states the following at 313-14 (D.T.C. 5215; S.C.R. 485) regarding the concept of a reasonable expectation of profit:

There is a vast case literature on what reasonable expectation of profit means and it is by no means entirely consistent. In my view, whether a taxpayer has a reasonable expectation of profit is an objective determination to be made from all of the facts. The following criteria should be considered: the profit and loss experience in past years, the taxpayer's training, the taxpayer's intended course of action, the capability of the venture as capitalized to show a profit after charging capital cost allowance. The list is not intended to be exhaustive. The factors will differ with the nature and extent of each undertaking: The Queen v. Matthews, [1974] C.T.C. 230; 74 D.T.C. 6193. One would not expect a farmer who purchased a productive going operation to suffer the same start-up losses as the man who begins a tree farm on raw land.

After considering all of the facts, I feel that in the circumstances the respondent's finding was premature. I base this conclusion on the foregoing comments, and in particular on the fact that the first criterion mentioned by the learned judge concerns the profit and loss experience in past years. This statement is clear and unequivocal.

In view of this statement, I am persuaded that a finding on whether an enterprise offers a reasonable expectation of profit can only be made after a number of years of operation, a number which may vary depending on the type of operation but allows for an objective assessment of all pertinent criteria under the circumstances. In other words, this objective assessment is only possible when the enterprise is considered as a whole following a reasonable period of operation. Such a period exists for any business launched by an entrepreneur, and is known as the “start-up period". Once this phase is over, the criteria proposed in Moldowan are to be applied. The financial structure of the enterprise, including its resources in the form of its assets, the experience and ability of its promoter and the prospects in the field of commerce in which it is engaged, are all factors which contribute and will continue to contribute to its profitability; but their effectiveness will only become apparent once this start-up phase is over.

The number of years which constitute a reasonable start-up phase has never been fixed, since the question is one of fact, but in the judgment of the Associate Chief Justice of the Federal Court of Canada in The Queen v. Steven Gorjup, [1987] 2 C.T.C. 129; 87 D.T.C. 5348, the following remarks should be noted (at page 138 (D.T.C. 5355)): "Given the defendant's situation here, I do not find that ten years is an unreasonable length of time to experience start-up costs."

Applying these factors to the appellant's situation, I do not hesitate to accept his claim that in 1985 he and his wife launched an equestrian centre project, starting with horse raising. Their subsequent actions and behaviour in undertaking and developing this project were, in my opinion, consistent with what would be required to operate on a commercial basis.

It is impossible for me to agree with the position of counsel for the respondent. In my opinion, it is not acceptable based on the order in which Dickson, J. listed his criteria for the respondent to determine whether the operation offered a reasonable expectation of profit after one or two years of operation, even if its beginnings were modest because of the taxpayer's financial limitations. Prudence in expanding an operation reduces the risks of its financial collapse.

There is no fixed rule for determining the number of years necessary to ascertain if an operation may have a reasonable expectation of profit. I am, however, persuaded that such a determination is not possible after only two years of operation, whatever the activity. In my view, the evidence has clearly shown that, since the income of the operation gradually increased from 1985 to 1989, it offered this reasonable expectation of profit for 1985 and 1986, and the respondent's finding is therefore inadmissible.

The appeals are allowed for these reasons and the appellant will be entitled to his costs on a party-and-party basis.

Appeals allowed.