Cwikula v. R., [1996] 2 CTC 46, 96 DTC 6152

Nadon J.: — This is an appeal by way of trial de novo from a decision of the Tax Court of Canada dated 31 July 1989 in which Taylor J.T.C.C. dismissed Walter Cwikula’s (the “Plaintiff’s”) original appeals from assessments of income tax for the 1982, 1983, and 1984 taxation years for want of prosecution. These appeals were heard together. These reasons, therefore, apply to each of the taxation years under appeal. The Plaintiff seeks to appeal the Minister of National Revenue’s (the “Minister’s”) notices of reassessment dated 12 January 1987 in which the Minister reassessed the Plaintiff as to tax payable for the 1982, 1983 and 1984 taxation years on the basis that the expenses incurred by the Plaintiff in operating his farm were personal or living expenses and that he was not entitled to claim any losses in computing his income for tax purposes.

The Plaintiff originally claimed that the farming operation was his chief source of income for the taxation years in question, or, in the alternative, that he could deduct restricted farming losses pursuant to section 31 of the Income Tax Act. At the commencement of the trial, the Plaintiff indicated that he was abandoning the first ground of appeal and so this decision is concerned only with the issue of whether the Plaintiff was entitled to claim restricted farming losses for the taxation years in question.

Facts

The Plaintiff is appealing the Minister’s reassessment dated 12 January 1987, in which the Minister reassessed his tax payable for the tax years 1982, 1983, and 1984, disallowing farm losses deducted from income in the following amounts:

In the 1985 and 1986 taxation years (for which the Plaintiff was not audited), the Plaintiff claimed the following:

At trial, Mr. Cwikula stated that his family bought the farm currently operated by Mr. Cwikula in 1952. The farm is situated five miles south of Revelstoke. The property now consists of some fifty acres with a main residence and outbuildings. Thirty acres is cultivated land, fourteen acres is pasture and bush and six acres consists of trailer rental area. Over the time the farm was held by his father, Mr. Cwikula testified, the farm operated at sufficient profit to enable his father to pay for the farm and earn a living. Mr. Cwikula stated that he gained valuable experience as a child on the farm. Upon his father’s death, Mr. Cwikula, who was then thirty-six years old, inherited the property. Mr. Cwikula testified that he believed that at some point, he would realize a profit on his farming operation. Although Mr. Cwikula directed his energies to other income-producing operations, he estimates that he spent between 420 and 470 hours per year working on the farm at the relevant times.

During the years under appeal, the Plaintiff worked in construction full- time from May to October. He worked approximately 75 hours per month from October to March on highway maintenance for the government of British Columbia. According to his 1982 income tax returns, the Plaintiff worked full-time for Columbia Hydro Constructors Ltd., and the province of British Columbia, and received Unemployment Insurance benefits for a total income of $42,157.11. In 1983, the Plaintiff worked full-time for Emil Anderson Construction Ltd. and the province of British Columbia for a total income of $38,592.26. Finally, in 1984, the Plaintiff worked full-time for Emil Anderson Construction Ltd., the province of British Columbia, and received Unemployment Insurance benefits for a total income of $27,021.75.

Decision of the Tax Court

In a reproduction of the appeal transcript, Taylor, J.T.C.C. indicated that he would not grant an adjournment despite Mr. Cwikula’s apparent indisposition at the time. His Honour further remarked that:

It should be noted that in the Statement of Defence [at para. 5f], the Defendant observes that in the Plaintiff’s 1982 revenue, the Plaintiff included $2,340.00 from land rental which should properly be relocated as income from property. Consequently, the Plaintiff’s revenue from the farming operation was nil and his net loss totalled $6,633.24.

I have reviewed the information rather briefly but I had gone over it before this Appeal was set and in my view there is little if any possibility of Mr. Cwikula’s Appeal succeeding even if it were heard and that of course I preface by saying I have heard no evidence other than that which is filed or we have no evidence other that [sic] that which is filed in the Notice of Appeal and the Reply and the tax return.

The matter, as indicated, supra, was dismissed for want of prosecution on 31 July 1989. At trial, Mr. Cwikula indicated that he had been unable to attend the hearing on 31 July 1989 due to illness.

Statutory Provisions

The Minister held that the farming losses amounting to $4,293.24, $4,710.47, and $9,077.91 claimed as deductions from income in the 1982, 1983, and 1984 taxation years respectively were not losses from a business or property within the meaning of subsections 9(2) and 31(1) of the Act but were personal or living expenses within the meaning of paragraph 18(1 )(h) and subsection 248(1) of the Act.

The relevant provisions of the Act read, in 1987, the year the Plaintiff filed his Notice of Objection, in part, as follows:

9. (1) Income. - Subject to this Part, a taxpayer’s income for a taxation year from a business or property is the taxpayer’s profit from that business or property for the year.

18. (1) General limitations. - In computing the income of a taxpayer from a business or property no deduction shall be made in respect of

(a) general limitation. - an outlay or expense except to the extent that it was made or incurred by the taxpayer for the purpose of gaining or producing income from the business or property;

(h) personal and living expenses. - personal or living expenses of the taxpayer, except travelling expenses (including the entire amount expended for meals and lodging) incurred by the taxpayer while away from home in the course of carrying on his business; [2]

31(1) Loss from farming where chief source of income not farming. - Where a taxpayer’s chief source of income for a taxation year is neither farming nor a combination of farming and some other source of income, for the purposes of sections 3 and 111 the taxpayer’s loss, if any, for the year from all farming businesses carried on by the taxpayer shall be deemed to be the total of

(a) the lesser of

(i) the amount by which the total of the taxpayer’s losses for the year, determined without reference to this section and before making any deduction under section 37 or 37.1, from all farming businesses carried on by the taxpayer exceeds the total of the taxpayer’s incomes for the year, so determined from all such businesses, and

(ii) $2,500 plus the lesser of

(A) « of the amount by which the amount determined under subparagraph (i) exceeds $2,500, and

(B) $2,500, [3] and

(b) the amount, if any, by which

(i) the amount that would be determined under subparagraph (a)(i) if it were read as though the words “and before making any deduction under section 37 or 37.1” were deleted,

exceeds

(ii) the amount determined under subparagraph (a)(i);

and for the purposes of this Act the amount, if any, by which the amount determined under subparagraph (a)(i) exceeds the amount determined under subparagraph (a)(ii) is the taxpayer’s “restricted farm loss” for the year.

(2) Determination by Minister. - For the purpose of this section, the Minister may determine that a taxpayer’s chief source of income for a taxation year is neither farming nor a combination of farming and some other source of income.

248. (1)

“personal or living expenses”. - “personal or living expenses” includes

(a) the expenses of properties maintained by any person for the use or benefit of the taxpayer or any person connected with the taxpayer by blood relationship, marriage or adoption, and not maintained in connection with a business carried on for profit or with a reasonable expectation of profit,

(b) the expenses, premiums or other costs of a policy of insurance, annuity contract or other like contract, if the proceeds of the policy or contract are payable to or for the benefit of the taxpayer or a person connected with him by blood relationship, marriage or adoption, and

(c) expenses of properties maintained by an estate or trust for the benefit of the taxpayer as one of the beneficiaries; … “restricted fram loss”. - “restricted farm loss” has the meaning assigned by subsection 31(1);

These provisions were in force for the 1982, 1983, and 1984 taxation years under appeal. Subsection 31(1) of the Act restricts the amount which a taxpayer engaged in “farming” as defined in subsection 248(1) may deduct as his farming business loss in a given taxation year. Subsection 31(1) limits to $5,000 for taxation years prior to 1988 or $8,750 for taxation years after 1988, the amount by which a taxpayer’s income from all other sources may be reduced by losses incurred as a result of carrying on farming activity as a secondary source of income.

Analysis

The leading case on the issue of farm losses still continues to be Mo Ido wan v. R. (sub nom. Mo Ido wan v. Minister of National Revenue (1977), [1978] 1 S.C.R. 480, [1977] C.T.C. 310, 77 D.T.C. 5213. In that case, the Supreme Court of Canada established three classes of farming for the purpose of establishing the extent to which farm losses may be deducted by a taxpayer:

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 may deduct all farm losses in a taxation year.

2. A taxpayer who farms as a sideline business, who is entitled to restricted deductions under subsection 31(1).

3. A taxpayer who farms as a hobby and is not entitled to farm loss deductions.

Revenue Canada adopted this classification system in its Interpretation Bulletin IT-322R dated 25 October 1978. Mr. Justice Dickson, as he then was, elaborated on this system of classification in Moldowan at pages 485-86 (C.T.C. 313-14; D.T.C. 5215-16):

The next thing to observe with respect to s. 13(1) [now 31(1)] is that it comes into play only when the taxpayer has had a farming loss for the year. That being so, it may seem strange that the section should speak of farming as the taxpayer’s chief source of income for the taxation year; if in a taxation year the taxpayer suffers a loss on his farming operations, it is manifest that farming would not make any contribution to the taxpayer’s income in that year. On a literal reading of the section, no taxpayer could ever claim more than the maximum $5,000 deduction which the section contemplates; the only way the section can have meaning is to place emphasis on the words “source of income’’.

Although originally disputed, it is now accepted that in order to have a “source of income’’ the taxpayer must have a profit or a reasonable expectation of profit. Source of income, thus, is an equivalent term to business. ... If the taxpayer in operating his farm is merely indulging in a hobby, with no reasonable expectation of profit, he is disentitled to claim any deduction at all in respect of expenses incurred.

... [W]hether 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: ...

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. ... 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. A change in the taxpayer’s mode and habit of work or reasonable expectations may signify a change in the chief source, but that is a question of fact in the circumstances.

In Moldowan, Dickson J. (as he then was) enunciated a two-fold test to determine whether a taxpayer carrying on farming operations is entitled to a deduction in respect of losses from farming. First, the taxpayer must establish whether the farming provides a “source of income”, i.e. the farming provides a profit or a reasonable expectation thereof. The circumstances of the case must be examined, including:

1. The profit and loss experience in past years;

2. The taxpayer’s training;

3. The taxpayer’s intended course of action;

4. The capability of the venture as capitalized to show a profit after charging capital cost allowance.

This test, according to Dickson, J. (as he then was) is an objective one, to be determined on all the facts. If no “source of income” or reasonable expectation of profit is established, the taxpayer falls into class 3 as one who farms as a hobby.

If, however, the court determines that the taxpayer had a reasonable expectation of profit from the farming business, the court must then go on to the second part of the test and decide whether farming or farming and another source of income is the taxpayer’s chief source of income in relation to some other source. This part of the determination is a relative one. The Court in Moldowan observed that the court must look at the taxpayer’s reasonable expectation of income from his various sources of revenue and his ordinary mode and habit of work. The may be tested by considering the time spent, the capital committed, and the profitability, both actual and potential, with respect to farming as compared to any other sources of income enjoyed by the taxpayer. This list enumerated by the Court is, again, not intended to be exhaustive, nor are the individual factors of equal value. Their individual importance depends on all the circumstances of the individual taxpayer’s case. For a source of income to be considered the taxpayer’s chief source of income in a taxation year, it is not necessary that the income produced from it be greater in that year than the income from all the taxpayer’s other sources.

A reasonable expectation of profit is, in my view, the paramount con- sideration. In Morrissey v. R. (sub nom. Morrissey v. Canada), [1989] 1 C.T.C. 235 (sub nom. R. v. Morrissey) 89 D.T.C. 5080 (F.C.A.), the Minister admitted that the taxpayer was farming with a reasonable expectation of profit, so the Court had no choice but to find that the taxpayer fell either into class 1 or class 2. The Court, however, was of the opinion that profitability was improbable. The majority of the Court held at page 242 (D.T.C. 5084):

On a proper application of the test propounded in Moldowan, when, as here, it is found that profitability is improbable notwithstanding all the time and capital the taxpayer is able and willing to devote to farming, the conclusion based on the civil burden of proof must be that farming is not a chief source of that taxpayer’s income. To be income in the context of the Income Tax Act that which is received must be money or money’s worth. Absent actual or potential profitability, farming cannot be a chief source of his income even though the admission that he was farming with a reasonable expectation of profit is tantamount to an admission which itself may not be borne out by the evidence, namely that it is at least a source of income.

The first issue to be determined, then, is whether the farm had a reasonable expectation of a profit. The first factor to be examined is the profit and loss experience in past years. The Plaintiff’s (unaudited) tax returns for the years between 1979 and 1994 were adduced in evidence. Between 1979 and 1991, the Plaintiff incurred losses each year, except for a small profit of some $15 in 1979. Most recently, in 1992, the Plaintiff incurred a farming loss of $279.71. In 1993, the Plaintiff declared a net profit of $3,053.91 from farming, but that included $9,710.00 revenue from rental income, which is properly not included as income from farming. The Plaintiff therefore incurred a net farming loss of $6,656.09 in 1993. This evidence, in my view, clearly does not point to an operation that has a “reasonable expectation of a profit”.

The second indicator of an operation that has a reasonable expectation of a profit is the taxpayer’s training. This, in my view, is of lesser weight than the first factor. In the instant case, the taxpayer states that he learned farming as a boy on the same land that is the subject of this litigation. Formal training need not be a prerequisite for the taxpayer to fulfil this requirement. Many farmers farm full-time without the benefit of any formal training whatsoever. In the case at bar, this factor 1s, at best, neutral. In testimony, the Plaintiff stated that he had a Grade 11 education and that most of his farm training was “on the job”.

The third factor to be taken into consideration is the taxpayer’s intended course of action. It appears that the Plaintiff did have an intention, at least for the 1987 taxation year, of expanding the farming operation through the rental of additional lands. The Plaintiff also asserted in his Statement of Claim that he sought to improve the productivity of his farm in each of the taxation years in question and his major preoccupation in those years was the farming business. It is my view that there is really no evidence to support these contentions. In oral testimony, it was clear that, while Mr. Cwikula is a well-meaning man, he, too, is aware that the farming operation is not profitable and cannot see expanding the farm operation in the near future. Indeed, in his closing submissions, Mr. Cwikula conceded that he would have to “rethink” his approach to the farming operation, since it was clear on the evidence that it had not turned a profit.

The fourth factor to be considered is the capability of the venture as capitalized to show a profit after charging capital cost allowance.

In 1982 and 1983, the Plaintiff had three head of cattle. In 1984, the Plaintiff sold eight cattle for a profit of some $7,500, but incurred expenses of some $18,000. It is clear that the capital committed is not sufficient to show a profit after charging capital cost allowance.

On the basis of my analysis of the facts in light of the factors enumerated in Moldowan, I conclude that the Plaintiffs farming operation showed no reasonable expectation of profit and that the Plaintiff must fail. It is clear that the Plaintiffs farming operation is not a business.

For the foregoing reasons, the Plaintiffs appeal for each of the taxation years in question shall be dismissed. Costs shall be in favour of the Defendant. The Defendant shall have its disbursements. However, the taxable fees shall be limited to one action.

Appeals dismissed.