Reginald Falconer v. Minister of National Revenue, [1991] 1 CTC 2503, 91 DTC 785

Sobier, T C.J.:—The appellant appeals from a reassessment by the respondent whereby the respondent disallowed the amounts of $3,643 for the 1984 taxation year and $1,472 for the 1985 taxation year claimed as farm losses and increased farm losses for the 1986 taxation year to $5,000. In doing so, the respondent did not permit the full farm losses claimed by the appellant but allowed the restricted farm losses set forth in subsection 31(1) of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the"Act").

The appellant gave detailed evidence of his operations and stated that he always wanted to farm and would have become a farmer no matter what happened to him. He undertook a course of study in agriculture at the Carleton County Vocational School and graduated with the highest honours. He gave evidence of how he acquired the lands he farmed and their worth at the time of acquisition (i.e., approximately $70,000). He set out other capital expenditures including a new barn and addition, worth in all approximately 30,000.

The farm operation from 1978 to 1985 was a cow-calf operation and in short the appellant's experience led him to the realization that a cow-calf operation could never be profitable and gave examples of how this was the case. In particular he vividly showed that the cost of maintaining a cow for one year was for the greatest part always greater than the revenue generated from such an animal.

In 1986 he began a farming operation known as "backgrounding" whereby calves are purchased in late fall, fed during the winter, sent to pasture in the spring and early summer, sold in July and August. It is the appellant's contention that by keeping expenses at a current level there would be a profit once the levels of sale increased. However, it was clear from his tax returns for the 1986, 1987 and 1988 taxation years that the losses even in a "backgrounding" operation continued. In fact, in 1987 and 1988 they were greater than in 1984 and 1985.

The appellant is no doubt an honest and hard-working man. When his work at the Heathsteel Mines in Newcastle, New Brunswick ceased, he found other employment in animal control and was very successful in earning net income of $10,782 in 1984 increasing yearly until 1988 when he earned a net income of $30,558.10. This income was from self-employment as a dog-catcher for various communities in his area. In addition the appellant made a profit from rental properties from 1981 to the present. The appellant stated in his evidence that during those years dog-catching was his main source of income.

When the mines reopened in 1990 he gave up the dog-catching business and returned as a miner on a full-time basis earning approximately $50,000 for that year.

The appellant puts great store in the fact that the government of New Brunswick through several departments and agencies considered him a farmer. There is no doubt that the appellant carries on a farming business.

The issue however, is whether he is a farmer entitled to deduct his full farm losses as a Class 1 farmer as that term was defined by Dickson, J., as he then was, in Moldowan v. The Queen, [1977] C.T.C. 310; 77 D.T.C. 5213 at 315 (D.T.C. 5216). Or whether he was during those years in question, a Class 2 farmer also defined by his Lordship and therefore only entitled to the restricted farm losses allowed by subsection 31(1) of the Act.

In order to be a Class 1 farmer and not limited to the restricted farm losses the appellant's chief source of income must be farming or a combination of farming and some other source of income. In determining whether a source of income is a chief source, Dickson, J. says at page 314 (D.T.C. 5215-16):

Whether a source of income is a taxpayer's "chief source" of income is both a relative and objective test. 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.

That the combination of incomes need not be connected is made clear on page 5216 and therefore the other sources of income need not be farm-related.

Dickson, J. defines a Class 1 farmer at page 315 (D.T.C. 5216) as:

(1) a taxpayer, for whom farming may reasonably be expected to provide the bulk of income or the centre of work routine. Such a taxpayer, who looks to farming for his livelihood, is free of the limitation of subsection 13(1) in those years in which he sustains a farming loss.

Was the appellant a person for whom farming was reasonably expected to provide the bulk of income or for whom it is the centre of work routine? Although the appellant spent most of his spare time working his farm, it did not provide him with the bulk of his income.

In 1981 to 1988 gross farm income and other income such as employment income, gross rental income, gross woodlot operation and gross dog-catching income were as follows:

It is not denied that he was a farmer but he is one described as a Class 2 farmer at page 315 (D.T.C. 5216):

(2) the taxpayer who does not look to farming, or to farming and some subordinate source of income, for his livelihood but carried on farming as a sideline business. Such a taxpayer is entitled to the deductions spelled out in subsection 13(1) in respect of farming losses.

That the appellant had a full-time job as well as a farm operation would not necessarily preclude him from being a Class 1 farmer. See Graham v. The Queen, [1985] 1 C.T.C. 380; 85 D.T.C. 5256 (F.C.A.) where the Federal Court of Appeal allowed the full deductions of the taxpayer's farm losses even though he was employed full-time. An examination of Graham, supra, indicates extraordinary circumstances in that the taxpayer's full-time thrust in life was farming as evidenced by the fact that among other things he took time off work without pay, changed job location to accommodate his farm activities, slept only five hours per day, worked "full-time" eight hours a day and farmed 11 hours a day. The Federal Court-Trial Division and the Federal Court of Appeal found no difficulty in finding Mr. Graham a Class 1 farmer in accordance with the Moldowan tests.

The same cannot be said for the appellant. He carried on farming as a sideline business albeit with vigour and tenacity and worked to improve himself and his farm. However, using his own income statements it was obvious that he had no reasonable expectation of profit in the cow-calf operation and there is no indication that there will be a reasonable expectation of profit in the “ backgrounding” operation.

Accordingly, the Court finds the respondent's reassessment correct and the appellant is only entitled to the restricted farm losses set forth in subsection 31(1) of the Act. The appeal is accordingly dismissed.

Appeal dismissed.

David Dyer v. Minister of National Revenue

[Indexed as: Dyer (D.) v. M.N.R.]

Tax Court of Canada (Mogan, T.C.J.), February 20, 1991, (Court No. 86-1039).

Income tax—Federal—Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72,

c. 63)—18(1)(a)—Deductions—Building renovation costs—Capital outlay or expense.

The appellant purchased a house and subsequently spent approximately $33,000 on renovations. He converted the house into two self-contained apartments, renting one and living in the other. At issue was the allocation between capital outlays and repair expenses of the costs of the renovations and the subsequent allocation of repair expenses between personal expenses and those incurred to earn a rental income. The test was whether the outlay was such as to bring into existence a capital asset different from that which it replaced.

HELD:

On the evidence, most of the renovation costs were laid out by the appellant to achieve improvements to the house that were different in kind from repairs to the house as it originally was, and were therefore capital outlays. Sixty per cent of the total cost of the renovations was on a capital account, with the remainder deductible as repair and maintenance costs. With respect to the allocation of repair expenses between personal expenses and those incurred to earn rental income, most of the repair expenses, i.e., 60 per cent, should be allocated to the rental apartment. Appeal allowed.

K. Rose for the appellant.

P. Leslie for the respondent.

Cases referred to:

Canada Steamship Lines Ltd. v. M.N.R., [1966] C.T.C. 255; 66 D.T.C. 5205 (Ex.

Ct.);

Shabro Investments Ltd. v. The Queen, [1979] C.T.C. 125; 79 D.T.C. 5104;

M.N.R. v. Vancouver Tugboat Co., [1957] C.T.C. 178; 57 D.T.C. 1126;

British Insulated and Helsby Cables v. Atherton, [1926] A.C. 205; 10 T.C. 188.

Mogan, T.C.J.:—In the fall of 1981, the appellant paid $42,750 to purchase the house located at 5 Gower Street in St. John’s, Newfoundland. He acquired only a leasehold interest. In the first eight months of 1982, the appellant paid approximately $33,000 to contractors and suppliers to renovate the house. When the work was completed, there were two self-contained apartments: one on the second and third floors and one on the ground floor and basement. The appellant occupied the lower apartment and, in August 1982, he rented the upper apartment. The issues in this appeal are all factual concerning a reasonable allocation of the $33,000 between capital outlays and repair expenses and between those repair expenses which are either personal or revenue producing.

The appellant claimed that the aggregate cost of renovations was $33,755 but the respondent accepted an aggregate cost of only $32,410 and disputed the remaining $1,345 as an amount not proven with receipts or vouchers. At trial, the appellant did not produce any documents to prove that the aggregate cost of renovations exceeded $32,410 and the onus was on him to do so. Therefore, I begin with a finding that the aggregate costs which require allocation in this appeal are $32,410.

When filing his 1982 income tax return, the appellant made the following allocation of his renovation costs and reported the following amounts with respect to real estate rentals at 5 Gower Street:

When issuing the reassessment under appeal herein, the respondent claims that he made the following significant changes in the allocation of the appel- lant's renovation costs:

In response to the appellant's notice of objection for 1982, the respondent did not reassess but confirmed the prior reassessment on the basis that the amount of $15,171 claimed as maintenance and repair expenses was not deductible in computing income because $4,201 were personal or living expenses and $10,970 were capital outlays. The above computations and the respondent's confirmation dated March 18, 1986 indicate that the two disputes between the parties concern the allocation between capital outlays and repair expenses and the subsequent allocation of repair expenses between personal expenses and those incurred to earn rental income.

In the fall of 1981, the house at 5 Gower Street was owned by a Mrs. Herrick who did not reside there herself but rented the house to two separate tenants on the basis that it contained a flat on the second floor, a flat in the basement, a ground floor which was somehow shared by the two tenants and a third floor that was not habitable. Mrs. Herrick told the appellant that one of the tenants wanted to remain after his purchase but he had already decided to make two self-contained apartments; to occupy the lower one himself; and to perform the renovations immediately after the purchase when the house was not occupied. The appellant testified that, although there were two tenants in place at the time of his purchase, the house had been allowed to run down and it was in need of repair.

The appellant prepared a handwritten summary of the renovations which was entered in evidence as an exhibit. The main items were:

1. An oil furnace and oil tank were removed from the basement; baseboard electric heaters were installed throughout the house; and the entire house was rewired.

2. A partition wall was removed in the basement.

3. A fire-rated partition was erected on the ground floor to separate the staircase (to the second floor) from the hallway and the remainder of the ground floor.

4. Two solid core, steel enclosed, self-closing doors were installed at the main (street) entrance.

5. A partition wall was removed on the second floor.

6. Basement—a bathroom was expanded to install a new shower; new kitchen cabinets were installed; and repair to floor covering.

7. Ground floor—repair fireplace, windows and window boxes.

8. Second Floor—replacement of firebrick and refacing two fireplaces; new kitchen cabinets; repair plumbing, windows and window boxes.

9. Third floor—install new bathroom; repairs to chimneyfacing, windows and window boxes.

10. Inject insulation in exterior walls.

11. Replaster and repaint throughout.

The appellant hired a contractor to do most of the work. The contractor finished the upper apartment so that the tenant could move in by August 1982 but he did only the rough work on the lower apartment so that the appellant could do the finishing himself. The appellant stated that he was only trying to get the house back to its original condition but it appears that he converted a house with two flats and an unused third floor into a duplex with two self- contained apartments using the basement and all three floors. The appellant did not receive itemized invoices from the contractor but only invoices for lump sum amounts. In other words, the contractor did not allocate the cost of his work among the floors. There was, however, a separate contract of $6,100 for electrical work including the new baseboard heaters.

The issues in an appeal like this are almost exclusively factual. Prior cases do, however, provide some guidelines. In Canada Steamship Lines Ltd. v. M.N.R., [1966] C.T.C. 255; 66 D.T.C. 5205 (Ex. Ct.), Jackett, P. stated at 258 (D.T.C. 5207):

Things used in a business to earn the income—land, buildings, plant, machinery, motor vehicles, ships—are capital assets. Money laid out to acquire such assets constitutes an outlay of capital. By the same token, money laid out to upgrade such an asset to make it something different in kind from what it was—is an outlay of capital. On the other hand, an expenditure for the purpose of repairing the physical effects of use of such an asset in the business—whether resulting from wear and tear or accident—is not an outlay of capital. It is a current expense.

In Shabro Investments Ltd. v. The Queen, [1979] C.T.C. 125; 79 D.T.C. 5104, Jackett, C.J. delivered judgment for the majority in the Federal Court of Appeal and stated at 130 (D.T.C. 5108):

There is no doubt that, in this case, from the point of view of the persons making physical use of the building, once the floor was replaced, it was essentially the same as the old floor as it was before it subsided. So regarded, the replacement of the floor could be regarded as a repair of damage to the building. However, from the point of view of the owner or tenant of the building as such, a building the floor of which was "floating" on garbage fill has been changed into a substantially improved building, namely, a building the floor of which is supported by steel piles. . . . As already indicated, with some hesitation I have come to the conclusion that the problem must be so regarded and that the removal of the old floor, the sinking of the piles and the placing thereon of a concrete slab reinforced by steel was a single operation whereby an improvement was made to the building that was essentially different in kind from a repair to the building as it Originally was.

In the same case, Urie, J. delivered a concurring judgment in which he stated at page 132 (D.T.C. 5109):

The crucial question it appears [is] was the outlay such as to bring into existence a capital asset different from that which it replaced?

I have concluded that in this case it did. A new floor, of a different character and quality than the old floor came into existence. It performs the same function as the old floor and it adds nothing to the earning capability of the old one, but it substituted one kind of floor for another.

Applying the above guidelines, and in the absence of any objective allocation by the outside contractor, I conclude that most of the renovation costs were laid out by the appellant to achieve improvements to the house that were different in kind from repairs to the house as it originally was. The whole amount of the electrical contract ($6,100) was a capital outlay because it replaced the oil furnace with baseboard heaters and rewired the entire house. See M.N.R. v. Vancouver Tugboat Co., [1957] C.T.C. 178; 57 D.T.C. 1126. The erection of a fire-rated partition for the staircase to the second floor and the installation of steel enclosed doors at the main entrance were significant costs related directly to making two self-contained apartments; as were the costs of new kitchen cabinets, the expansion of the bathroom in the basement, the installation of a new bathroom on the third floor and the removal of partition walls. All of these were "once and for all” costs with a view to bringing into existence an asset or advantage of enduring benefit. See British Insulated and Helsby Cables v. Atherton, [1926] A.C. 205; 10 T.C. 188.

Certain other costs were of a "repair" nature as, for example, new floor covering, repairs to windows and window boxes, refacing fireplaces and replacing firebrick, fixing old plumbing, refacing interior wall of chimney, replastering and repainting the interior of the house. These are recurring expenses which result from normal wear and tear in a house that is rented to tenants and such expenses are deductible in computing income. Without the benefit of detailed invoices from the contractor or even his objective allocation of costs among the three upper floors and the basement, I am left to determine a reasonable allocation of the total renovation costs of $32,410. Having in mind the appellant's purchase price of $42,750 in the fall of 1981 and these additional costs of $32,410 within the next ten months, I find that the whole amount of the electrical contract ($6,100) was a capital outlay and 60 per cent of the remaining costs were on capital account. Therefore, I would determine the first allocation between capital outlays and repair expenses as follows:

The appellant testified that the contractor was instructed to finish the second and third floors while they were vacant so that they could be rented in a finished state as soon as possible but the contractor was to do only the necessary rough work on the ground floor and in the basement because the appellant wanted to keep his costs down by finishing his own lower apartment on a "sweat equity” basis. I therefore assume that most of the repair expenses should be allocated to the second and third floors and I find that 60 per cent of the repair costs should be allocated to the second and third floors as expenses incurred to earn income from property within the meaning of paragraph 18(1 )(a) of the Income Tax Act, and that 40 per cent of the repair costs should be allocated to the appellant's own lower apartment as personal expenses. Accordingly, I would compute the appellant's loss from real estate rentals as follows:

The onus was on the appellant to prove that the Minister's assessment was wrong. The appellant discharged that onus by proving that the Minister allocated too much of the total renovation costs to capital outlays but the appellant did not prove to my satisfaction that his (the appellant's) allocation was reasonable or even more reasonable than the Minister's. Having regard to the following facts (i) the house was rented to two tenants at the time of purchase; (ii) the purchase price in October 1981 was $42,750; (iii) the appellant expended $32,410 on renovations in the next ten months; and (iv) the house was converted into a duplex containing two self-contained apartments; it was unreasonable for the appellant to allocate $21,995 to repair expenses and only $10,415 to capital outlays. In all of the circumstances, I am satisfied that the allocations which I have determined above are more reasonable than those of the appellant or the respondent. If I were required to allocate the capital outlays, I would divide them equally between the upper rental apartment and the appellant's lower apartment.

The appeal is allowed with costs and the reassessment for 1982 is referred back to the respondent for reconsideration and reassessment in accordance with the above reasons.

Appeal allowed.