Anthony M. Guerin and Meredith Ann Filshie v. Minister of National Revenue, [1991] 1 CTC 2634, 91 DTC 855

Garon, T.C.J. [Orally]:—The appeals of the appellant Anthony Guerin from the income tax reassessments of the Minister of National Revenue for the 1985, 1986 and 1987 taxation years raise two issues. One issue has to do with the disallowance by the Minister of National Revenue of the alimony payments the deduction of which had been claimed by the appellant Guerin and the other issue, which is common to both appellants, involves the disallowance by the Minister of National Revenue of the losses claimed by both appellants relating to their farming activities during the same years. The appeals of both appellants on this second issue were heard on common evidence.

I shall first deal with the issue involving only the appellant Guerin with respect to the deduction of alimony payments in the three years in issue.

There is no dispute about the facts. It is admitted by the Minister of National Revenue that with the exception of one element all the other requirements for the entitlement to the deduction provided by paragraph 60(b) of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the "Act") are applicable here. More specifically, the respondent disallowed the payments made by the appellant Guerin under clause 24 of the separation agreement on the basis that they were not made for the maintenance of the recipient and the child of the marriage within the meaning of paragraph 60(b) of the Income Tax Act.

During the years 1985, 1986,and 1987, the appellant and Jacqueline Guerin were married to each other. The appellant Anthony Guerin and his wife, at the time, had entered into, in December 1976, a separation agreement. Clause 24 of the separation agreement provides as follows:

Notwithstanding anything to the contrary herein contained, the husband covenants and agrees to pay unto the wife such income tax as may be payable by her in respect of all or any payments received hereunder from the husband whether for the maintenance of herself or the child of the marriage. At any time after December 31st of each and every year the wife shall forward unto the husband a copy of her income tax return together with her calculations showing the income tax payable in respect of the payments received by her hereunder and the husband shall pay unto the wife the said amount of income tax payable on or before the April 30 each and every year and so on from time to time. For the purposes of this paragraph the payments made by the husband hereunder shall be considered to be the last income or earnings of the wife and income tax thereon shall be computed accordingly.

It is not disputed that Jacqueline Guerin could use the moneys received under this clause as she pleased. There was no requirement under the separation agreement for Mrs. Jacqueline Guerin to produce evidence that she reported in her return of income the receipt of the payments made for her maintenance and that of the child under the separation agreement or that she paid income tax in respect of such payments. Pursuant to the aforementioned clause of this Agreement, the appellant Guerin paid directly to Jacqueline Guerin the following amounts set out below opposite the years hereafter indicated:

As appears from the wording of clause 24 of the separation agreement, the payments of income tax once a year by the appellant Guerin to his wife at the time were directly tied to the maintenance payments to be made to her under the subject Agreement. These payments were not related to any other source of income that Mrs. Jacqueline Guerin might have had in these years. In fact, there is an express reference in this clause to "such income tax as may be payable by her in respect of all or any payments received hereunder from the husband whether for the maintenance of herself or the child of the marriage". The apparent purpose of the clause is that the receipt of the maintenance payments is to be a net amount, i.e., free from income taxes. In other words, these payments to Mrs. Guerin in respect of income taxes constitute in reality an increase in the actual maintenance payments that she received under the separation agreement.

In addition, these payments in respect of income tax payable by Mrs. Jacqueline Guerin were part and parcel of amounts to be paid by the appellant Guerin to his wife at the time for her maintenance and support and that of her child. Looking at the whole of the separation agreement it seems clear that the maintenance and support of the appellant Guerin's wife and child were the purpose for which the payments of income tax were made. For what other purpose could it be?

The matter could perhaps also be viewed from another angle. Mrs. Jacqueline Guerin was required by the Income Tax Act to include the maintenance payments in her income and pay income tax in relation thereto and the payments of income tax by the appellant Guerin to her in respect of such maintenance payments were therefore of assistance to her in meeting her annual obligations under that Act. These income tax payments were designed to provide her with funds to satisfy this legal requirement and are therefore in the nature of maintenance payments.

I am therefore of the view that these payments of income tax made to Mrs. Jacqueline Guerin by the appellant Guerin under clause 24 of the separation agreement are deductible under paragraph 60(b) of the Income Tax Act. I am fortified in this conclusion by the approach adopted by the Tax Review Board, speaking through Mr. Guy Tremblay, now Judge Tremblay of this Court, in the case of Michel Fortin v. M.N.R., [1979] C.T.C. 2907; 79 D.T.C. 751. However, shortly before, the same Board had come to a different conclusion on the same question in the decision of Chairman Lucien Cardin, as he then was, in the case of Dr. W.F Shaw v. M.N.R., [1978] C.T.C. 3230; 79 D.T.C. 26.

The appeals of the appellant Guerin are therefore allowed in respect of this issue.

I shall now advert to the issue of the deduction of the losses incurred by both appellants in the 1985, 1986 and 1987 taxation years with respect to their farming operation.

At the outset, I should state that the two appellants claim the benefit of the limited deduction provided for by section 31 of the Income Tax Act. This deduction is available to taxpayers for whom farming is a sideline business. The maximum deduction allowed under section 31, in the years in issue was 5,000.

There is no quarrel about the essential facts and the appellant Guerin was the sole witness at the trial of these appeals.

The two appellants acquired their first farm property in the late fall 1975 at a cost of $44,000. It was a 90-acre property. It had been used for farming. At the time of the purchase of this property by the appellants, approximately 45 to 50 acres of land had been used for pasturing.

Some time later, a second property was acquired by the appellants for $40,000 on the occasion of a bankruptcy sale. That property had also been used for farming purposes and, in particular, for grain crops. That property had a total of 250 acres, of which 70 acres were actually being farmed. The other part of the property was wooded and could only be used for pasture. There were no buildings on that property.

A third property of approximately 125 acres was acquired shortly thereafter for $90,000. The latter property had a house and farm buildings and about 70 to 80 acres were used for pasture at that time.

In reassessing the two appellants for the years in issue, the respondent assumed that in respect of the acquisition of the subject farm properties and management of the farm operation there was a partnership on an equal basis between the two appellants and this assumption has not been challenged.

These properties are all situated in the municipality of Dundee, in the county of Huntingdon in the Province of Quebec. The area in question is close to the New York State border. Dairy farming and grain crop cultivation are the prevalent uses of farm property in that area.

There were no animals kept by the appellants in connection with this farming operation.

The appellant Anthony Guerin explained in this way the reasons why both appellants acquired the subject farming property:

We liked the area and we liked farming. We decided that we would go into the farming business in order to augment the income from an early retirement decision we had made, which was approximately, in my case, five or seven years away. At the time I bought my first property, I was seven years away from early retirement.

The farming operation was undertaken in 1976. the appellants “bought equipment, regular farming equipment, to cultivate what they call small ranks like wheat, barley and oats". An expense of $150,000 was actually incurred in purchasing the farm equipment. While they were the owners of this property they expanded the acreage under cultivation by about 50 acres. They converted the use of the first and third parcel of land from pasture to grain crop cultivation. In addition, the appellants removed stones in certain fields, dug ditches for natural drainage, commissioned the drawing up of drainage plans by surveyors and experts in the field and with the financial assistance of the Quebec government, by way of grants, installed drainage on part of the land. During the period of interest to this litigation, the appellants had one full-time employee year round and for some time a second employee on a seasonal basis. The appellant Guerin also stated that the appellants were declared, for the purposes of the Agricultural Act of Quebec, to be farmers and given a card which entitled them to rebates in respect of property taxes and made them eligible for grants relating to land improvement and certain other benefits.

The appellant Guerin also testified that both he and his wife spent on the farm all their available time, week-ends, holidays and additional holidays accumulated from previous years. The appellant estimated that on average, they spent, in addition to week-ends, six to seven weeks per year at the critical times, being the planting season and the harvesting season. They inhabited one of the houses on one of the parcels of land. Once in a while they visited the farm property during the winter and spent week-ends in the. farming community but no work was then done.

The appellant Guerin explained that their strategy was to buy good land that was not necessarily used for farm purposes "to develop it and make it into first class arable land with a view to making it a paying and profitable business”. He pointed out that the conversion of a given price of land from one purpose to another takes two to three years and that one does not get the level of yields that would be achieved if it were a going concern.

With respect to the financing of the entire property it was disclosed that 2/3 to 3/4 of the total purchased price of $174,000 was financed and the balance came from funds supplied by both appellants, With respect to the financial aspects of this farming operation, appellant Guerin indicated that as part of their yearly planning the appellants estimated their expenses and revenues. In terms of expenses, the cost of seed grains, fertilizer and equipment was taken into account. For instance, it was mentioned that it was more advantageous economically speaking to lease the harvesting equipment and to arrange for the services of a driver than to buy the equipment. As far as revenues are concerned, the expected yields and expected prices for the crops were calculated. The appellants expected not to do much better than to break even in the first few years and after that "there was a very reasonable expectation of the business”. It was learned that most of their neighbours were doing well spending their winters in Florida, at least prior to the recession that surfaced in 1981 or thereabouts. Although most of the neighbours had acreage larger than that of the appellants, the appellants believe that their property was of an economic size with 250 acres under cultivation out of 465 acres. In this way this farm property was to contribute to their retirement income. At that point, some of the costs of farming would go down because during their retirement years the appellants themselves would be able to do some of the work.

However, events did not unfold as anticipated. In addition to the usual vagaries involved in carrying on an agricultural operation there were three unexpected developments namely the astronomical increase in interest rates for personal loans toward the latter part of the 1970s and the early 1980s as the rates of interest went from nine or ten per cent to all the way up to 20-24 per cent, the very serious recession of 1981-82 affecting the economy and finally the “collapse”, to adopt the appellant Guerin’s terminology of the grain crop business. In connection with the latter aspect, appellant Guerin stated that when they started acquiring the above farm properties, wheat was selling at approximately $160 a metric ton. He went to add that in 1981-82 the price of wheat tumbled into a low as $90 a metric ton and has stayed even today at the level of $100 to $120 a metric ton.

As a result, the appellants sustained very serious losses as set out in paragraph 7(d) of the reply to the notice of appeal in the case of the appellant Guerin:

It is also in evidence that prior to the years 1980 to 1985 the appellants had losses in 1976, 1977, 1978 and 1979 but the amounts of such losses were not disclosed.

By 1983, the appellants realized that the financial burden was too great to bear and decided that they will start renting the land until the situation in the farming business stabilizes. The appellant Guerin said this much about their expectations in 1983 or 1984:

Q. Did you intend to keep the land and continue on?

A. Very much so. We thought that if we could rent the land at a reasonable rent, and notwithstanding that we would continue to incur very high losses, we would be able to bear that because of our other income. But unfortunately—. . .

After advertising by word of mouth that the land was available for renting the appellants actually rented the land at the highest rental they could get during the years in issue to local farmers who continued to farm the properties. In this respect, it is the custom that no arable land goes unattended or lays fallow.

The evidence shows that the appellants reduce their losses by renting some of the land and selling part of it. In 1985, they actually sold one parcel of land in order to decrease the debt load. In 1987, they dispose of the house and buildings on another tract of land but kept the land for future use. In 1988, they sold another property. In the result, the appellants continue to own the best land that is available for farming purposes, that is, approximately 125 acres.

During the years 1985 to 1987, the appellant Guerin was Vice-President Marketing for a major company and his employment income, as appears from his tax returns, went from $113,000 to $169,000 while the income from the appellant Filshie's employment with the government of Canada averaged out $64,000 during these three years.

As to the appellants' expectation in 1985 of making a profit from the farming operation, the following portions of the evidence of the appellant Guerin are significant:

Q. Lets take the 1985 taxation year, the first year that is under appeal here.

At that time, when did you expect to make a profit from the farming business?

A. We could not exercise a judgment on that. For that particular year we did not expect to make a profit as we were not farming that year.

Q. But when did you expect to make a profit: 10 years, 15 years, 20 years? When? Did you have any idea as to when you would make a profit?

A. When we originally planned, we expected to at least break even by year seven, or so; year seven or eight, from 1976.

Q. So, that would be about year 1983?

A. Approximately.

Q. 1983-84?

A. Yes, 1983-84. And then beyond year seven, we assumed that there would be a reasonable income arising out of those properties.

Q. But in 1984 you stopped farming and started to rent the land.

A. Yes.

Q. So, in 1984 you must have realized that there was no possible way that you would make a profit out of farming.

Am I correct?

A. No, I would not put it that way. In 1984 we realized that we could not make a profit out of leasing the lands that we had at that time.

Q. But why did you stop farming? You stopped farming in 1984?

A. In 1983.

Q. In 1983. Okay. When you stopped farming in 1983, why did you stop?

A. Because at that point in time it was obvious that the three factors that I mentioned earlier were still in play.

The interest rates had decreased somewhat, but the farming business was still in a period of high instability.

Q. You knew that for the next few years you would not make a profit out of your business.

A. For the next year, yes. For 1984 we knew that we would have to rent the property again and we did not expect to make a profit.

Q. And at that time, in 1983 or‘84—whichever year you want to take—when did you make a profit?

When you ceased farming, when did you expect to make a profit? Which year?

A. We were not sure. We were waiting to see the economic development in the farming business. We assumed, at that time, that the cycle—this business operates in cycles, as most others. We assumed that there would be a change in the cycle; that there would be a resumption of profitability in that sector.

Q. You told us previously that you had 245 acres under cultivation. You told us that that was a reasonable farming operation and that it would show a reasonable profit after a while.

A. Yes.

Q. But instead of increasing the amount of farm land under cultivation, or under crops, starting in 1985, or maybe 1984, instead of increasing the amount of land under cultivation, or trying to improve your land, you started to sell the land, until you were down to, you said, 125 acres.

Did you think you could make a profit or make a living out of 125 acres?

A. No, I do not expect to make a living out of 125 acres.

Q. Do you expect to make a profit out of 125 acres?

A. Not on 125 acres, no.

Q. So, when you started selling off your land in 1984 and 1985, 1986, and 1987, when you reduced the number of acres under cultivation, you must have realized that there was no way you could make a profit in the future, if you were reducing the number of acres under cultivation.

A. For those particular years that you are referring to, that did not prevent us from having confidence, one the market stabilized, that we could reacquire land in that same area.

Q. You would have to repurchase the land that you had sold in 1985?

A. Not necessarily the same land.

Q. Well, other land.

A. Yes.

The situation has not changed in 1990. The appellant claimed that retaining the "land that would provide the highest yields" is "a very sound core basis for a farming operation”. These losses were halved from the time they started renting the property.

Paragraph 7(f) of the reply to the notice of appeal in the appellant Guerin's case sets out the gross income and the types of expenses incurred by the appellants in managing the farm property that they owned during the years in issue:

In light of these facts, it is apposite now to set out the respective positions of the parties.

It is the appellants' position, as formulated in their notices of appeal, that throughout all these years beginning with the acquisition of these farm properties this farm land was held primarily for the purpose of producing income. More specifically it is urged by the appellants that a farming business was conducted in years preceding the three years in issue and that during the years in issue the farmland was leased on a temporary basis until it was economically viable to resume the farming activities. For his part, the respondent narrowed the issue to the rental operation in the three years in issue and specifically contended that the respondent correctly disallowed the losses claimed by the appellants on the basis they did not have a reasonable expectation of profit from their rental property and that the outlays or expenses were not made or incurred by the appellant for the purpose of gaining or producing income from a property within the meaning of paragraph 18(1)(a) of the Income Tax Act. The respondent further submitted that the expenses claimed against the rental income are personal or living expenses within the meaning of subsection 248 of the Act and are not deductible pursuant to paragraph 18(1)(h) of the Act.

In considering these questions and particularly the concept of a reasonable expectation of profit it is useful to bear in mind the observations of Dickson, J., as he then was, in the decision of the Supreme Court of Canada in the case of Moldowan v. The Queen, [1977] C.T.C. 310; 77 D.T.C. 5213 at 313-14 (D.T.C. 5215):

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 the undertaking: The Queen v. Matthews, [1974] C.T.C. 230; 74 Ç.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.

Looking at the whole of the evidence I have concluded that prior to 1985 no farming business had been conducted. There could not possibly be any expectation of profit. It is true that the phenomenal increase in interest rates and the severe recession affecting the economy in general and the farming business in particular could explain in part the severity of these losses. However, the magnitude of the losses was such that no one could seriously entertain the idea that a profitable farming operation was a real possibility. These losses went from $32,000 in 1980 to roughly $82,000 in each of the 1981 and 1982 taxation years and increased substantially again in 1984 to almost $60,000 after decreasing in 1983 to about $37,500. During all these five years the gross income in proportion to the extent of the expenses was almost insignificant being, in the range of $4,000 to $7,000 except for the years 1980 and 1982 where it increased to about $20,000. There is no evidence that prior to the advent of the recession in 1980 the farming operation that had been undertaken in 1976 would likely have produced a profit absent the unexpected developments occurring in 1980 and subsequent years relating to the rise in interest rates and the recession. In this respect, the situation in the present appeals is totally different from that considered by Teskey, J. of this Court in the case of Kay B. Whitmore v. M.N.R., [1990] 1 C.T.C. 2145; 90 D.T.C. 1018. In the latter case, the taxpayer's rental operation generated profits for a couple of years prior to the advent of higher interest rates.

The loss experience beginning in 1976 and ending in 1984 clearly establishes that on an objective basis there could not be any reasonable expectation of profit from the farming operation. The "capability of the venture as capitalized to show a profit after charging capital cost allowance”, to adopt the terms of Justice Dickson in the Moldowan-case, supra, was not established. I would go further and say that even the remote possibility of achieving a profitable operation was not demonstrated. Looking at the appellants’ farming activities from their inception In 1976 to the years in issue I am of the opinion that the rental operation relative to this farm property could realistically be viewed as the final act in the pursuit of a hobby.

If the rental operation in respect of this farm property is viewed independently of the prior farming activities undertaken by the appellants, one is compelled again to conclude that the appellants had no reasonable expectation of profit in pursuing this operation. Again the extent of the losses in the vicinity of $33,000 or $34,000 is very substantial in relation to the gross income which did not exceed $3,100 in any of these three years. The interest expense alone was almost ten times the amount of gross income in each of the three years. Also the comments of the appellant Guerin in the course of the cross- examination in the lengthy excerpt reproduced earlier with reference to his expectation in 1985 respecting the rental operation of this farm constitute clear evidence that the appellants did not expect that this rental operation be profitable in the foreseeable future.

I am therefore of the opinion that the appellants did not have in the years in issue a reasonable expectation of profit from the rental operation of the subject farm property. Consequently, the deduction of outlays or expenses, which gave rise to the losses disallowed by the respondent, is prohibited by paragraph 18(1)(a) of the Income Tax Act on the basis that such outlays or expenses were not made or incurred by the appellants for the purpose of gaining or producing income from the subject property.

The assessments of the Minister of National Revenue with respect to both appellants are therefore confirmed on this issue.

Therefore, the appeals of the appellant Filshie are dismissed and the appeals of the appellant Guerin are allowed in part and the reassessments of the respondent are referred back to the Minister of National Revenue for reconsideration and reassessment on the basis that the payments in respect of income tax made by the appellant Guerin under clause 24 of the separation agreement are deductible in full in the computation of his income for the three years in issue.

In view of the divided success, the appellant Guerin is entitled to one-half of his taxed costs.

Appeals allowed in part.