Edward Hilts and Peggy Hilts v. Minister of National Revenue, [1991] 1 CTC 2433, 91 DTC 633

Margeson, T.C.J. [Orally]:—This is a decision in the matters of Edward Hilts versus the Minister of National Revenue, 86-2166(IT) and Peggy Hilts versus the Minister of National Revenue, 86-2167(IT). It was agreed at the outset that both of these cases would proceed upon common evidence.

The appellants appeal against reassessments by the Minister dated March 17, 1986 in which the Minister disallowed restricted farm losses, so-called, in the years 1981, 1982 and 1983 of $5,000, $4,355.56 and $4,241.28 respectively.

Facts

The evidence before me discloses that the appellant Edward Hilts during the relevant years was employed full-time by Alberta Government Telephones as an engineer, and his wife Peggy Hilts, the other appellant, was employed by the same company as a clerk. In the year 1980, the appellants purchased 80 acres of land of which 42 was cultivated, so-called, as they wanted to go into the farming business as partners, They had various reasons for doing so, including their belief that it would be a good way to bring up their family.

It is their position that they developed a plan for a 7-year period, divided basically into two phases. The first phase was to obtain the land and develop the platform, as they called it, and then in phase two to go into the livestock operations from which they intended to make a profit and at which time they would look to the farm as their sole source of income.

There can be no doubt that the appellants went about the commencement of their operation in what would normally be called a very business-like way. They decided to start from scratch, so to speak, and to use their limited resources from their salaries, and later as it turned out, by using other assets of theirs, such as pension plan benefits, to invest in the operation rather than purchasing a farm as a going concern, which would require the use of borrowed money. They considered such things as the type of farm they wanted, the financing required, their experience or lack of it, made use of government agricultural information and resources, sought advice from other farmers who had successful farm operations and even made use of the labour force and machinery and equipment of other persons when they did not have it themselves. They used all their means to develop the operation, including their own labour, some of their crops instead of cash, and in general had a clear picture of where they were going.

The appellants readily admit that the years 1981, 1982 and 1983 were the startup years when they needed to establish the facilities and that the later years would be their production years when they had established their livestock operation. The plan was subject to revision if need be. Phase one was to be 1981 to 1985, and phase two thereafter. It was admitted that no cash revenue was produced during 1981 to 1985, save a $300 sale of some hay which apparently did not get reported on the income tax return, but nonetheless evidence given here by Mr. Hilts was to the effect that in that year there was $300 cash crop sale, an insignificant amount obviously.

In 1984, they commenced the livestock operations, starting with pigs and then cattle. By 1986, the swine operation was in full swing, as Mr. Hilts put it, and they were projecting a profit. The wife left her employment in 1986 and went into the operation full-time. Following the year 1986, they encountered several problems, such as a fire, a downturn in hog prices and their decision to switch to a breeding herd of cattle in 1987. Following the fire they started up again, making use of the insurance money, which they had obtained. The wife returned to work, they altered their plan by terminating their pig operation and, as Mr. Hilts put it, following that they kept the momentum going and have made it, as ultimately the operation was turning a profit according to him.

It is to be noted that part of the platform included a large house, which was used by the appellants and their four children. It is clear that during the years 1981 to 1983 the appellants were using the other farmers to assist them and in turn paid out part of the crop to them rather than money. Sometimes turning over two-thirds of the crop as in 1981 and 50 per cent of the crop as in 1983. The portion of the crop that was kept in 1983 was stored for the livestock operation which was yet to come, or used as money to obtain services of others but none was sold for cash.

Mr. Hilts testified that his operation was not in place during the years in question, a significant piece of evidence, I believe; He admitted that they did not expect to see a profit for those years. He further stated that they had a break-even objective and met it, but not until 1986, which he called their "flagship year".

Respondent's Position

The respondent's position is that in each of the three years in question the appellants claimed a restricted farm loss, but in order to do so argues that they must be in the business of farming. The respondent says they were not. She argues that the losses were personal expenses and there was no profit or reasonable expectation of profit. There were no farming operations such as would entitle them to deduct the losses because there was only a preparation for business and they had not embarked upon the business until after 1983, and after that when losses occurred, according to her, they were allowed by Revenue Canada.

Her position is that they were not starting years or start-up years as sometimes referred to in these cases and she refers to Moldowan v. The Queen, [1978] S.C.R. 480; [1977] C.T.C. 310; 77 D.T.C. 5213, for that aspect of the case, and of course Moldowan, supra, is also useful in this case in another respect which I will refer to later.

The respondent equates the case at bar to the factual situation in Collin Craddock v. M.N.R., [1986] 1 C.T.C. 2006; 86 D.T.C. 1014. The position she takes here is that they were putting in place their facilities to support a livestock operation. She refers to Exhibit R-3, introduced into evidence, and says that the appellant acknowledged that the facilities had to be in place to get a business going. Even the grain was put in storage to support the future operation. These, she refers to, as pre-start-up years.

She says that the expert's evidence that there was real economic possibility of profit does not help the appellants because the accountant in his evidence acknowledged that for income tax purposes the important parts were the revenue and expense claims, and if you look at those rather than include an increase in capital as put in by the appellants in the statements, there is only a build-up of capital and not profit expectation. But the accountant's statement amounts to, to paraphrase her or to conclude what I think she was concluding, is that it is no more than if you took all of the assets and added them up and deducted the expenses, there would be money left over.

Appellants’ Position

The appellants’ position is that the operation must be looked at as a whole, from beginning to end. They say that the platform creation supported the future plans for a profitable operation when production started. They say that they were in the business of farming and directing it toward a profitable operation. They say that there were linkages between phase one and phase two. They had a flagship year, 1986, and they met it.

Analysis and Decision

The relevant sections of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the "Act") for consideration here are subsections 31(1) and 248(1); paragraphs 18(1)(a) and 18(1)(h). In order for the appellants to succeed here they must show on a balance of probabilities that they come under subsection 31(1), which requires them to be in the business of farming, and under paragraph 18(1)(a) the outlay or expense must have been incurred for the purposes of gaining or producing income from the business. They cannot be personal or living expenses under paragraphs 18(1)(b) or 248(1)(a), and there must be a reasonable expectation of profit during those years.

What constitutes a reasonable expectation of profit was considered in Moldowan, supra, and as pointed out therein the list is not exhaustive, it is an objective determination to be made from all the facts. What constitutes the business of farming was discussed by this Court in Craddocks. M.N.R., supra, by Rip, J. In that case two taxpayers who purchased a 71-acre farm in 1979, of which 55 acres were arable, the property was in very poor condition and the taxpayers devoted the next few years to making repairs to the buildings and to improving the land. They purchased their first cattle in 1981 and in 1983 acquired a particular breed of cattle for the purposes of starting a breeding business. They deducted restricted farm losses from their income in 1980 and 1981 and the deductions were disallowed.

The Court, in considering the factual situation held that the taxpayers were not in the business of carrying on farming in 1980 and 1981. What they were doing was preparing the farm for use as a farm at some time in the future. These were not start-up costs, the Court decided, as they could not support a business enterprise in those years under appeal, Judge Rip found that there was no evidence to show that with the amount of capital invested in 1980 and 1981 the property could reasonably be expected to make a profit. The facts in the Craddock case are remarkably close to the case at bar.

Further, the appellant here in cross-examination said that the expenses in 1981, 1982 and 1983 were not start-up costs, but part of the whole operation and there were linkages between phase one and phase two. Further, the appellant readily admits that there was no possibility of making a profit during the years under appeal. There can be no doubt that the appellants here, as indicated earlier, went about the establishment of their operation in a very organized and planned manner. They mapped out their strategy and in the end appear to accomplish what they intended. However, it is not every enterprise that can come within the four corners of the Income Tax Act. It is clear that the appellants learned what they could about farming, got advice, found out what they needed, how to do it and obviously kept their eyes on developing trends in the marketplace, and indeed even changed their plan to some extent to ensure that in the end they would have a viable enterprise. They readily admit that they made mistakes in their returns to Revenue Canada and were not sure what Revenue Canada expected of them at first, but apparently they do now. They sought accounting advice, but obviously only after the deductions in 1981, 1982 and 1983 were disallowed.

The evidence of their accountant, although qualified as an expert, assists them very little in this case because nothing that he said in any way goes to show that their operation had a reasonable expectation of profit in the relevant years and it amounts really to nothing more than a valuation of assets.

It is apparent that what the appellants were doing in the years under review here were expending funds to improve the capital assets of the property so that a business might be carried on in the future when the production aspect of their enterprise commenced, but they were not during those years carrying on the business of farming. That is in the sense required under the Income Tax Act, even though they were obviously hardworking, had spent considerable time on planning and felt that they were in the farming business. They are to be commended.

There are various sections of the Income Tax Act which allow taxpayers to take into account expenditures made on behalf of capital assets, but that does not make those expenditures deductible, as the appellants seek to claim them here.

In light of the facts presented before me I have no difficulty in deciding that the appellants were not engaged in the business of farming, that there was no reasonable expectation of profit from thé operation during the relevant years and the expenses are not deductible. That is sufficient to dispose of these appeals.

The reassessments of the Minister are confirmed and the appeals are dismissed.

Appeals dismissed.