Brown v. R., [1996] 2 CTC 2026, 97 DTC 280

Sarchuk J.T.C.C.: — William J. Brown appeals from assessments of tax with respect to his 1989, 1990 and 1991 taxation years. In computing his income for those years the Appellant deducted the amounts of $68,039.88, $119,111.63 and $65,012.01 respectively as farm losses. The Minister of National Revenue (the Minister) reassessed to limit the Appellant’s losses to $8,750.00 for each of the taxation years pursuant to the provisions of subsection 31(1) of the Income Tax Act (the Act). The assessment was made on the basis that farming was not a chief source of income for the Appellant. The Minister also contends that the losses actually incurred by the Appellant for the 1989, 1990 and 1991 taxation years were $34,390.00, $115,133.00 and $47,279.00 respectively. This calculation of the losses is not in dispute.

Facts

The Appellant was raised in Scotland where he attended school and worked on a farm as a hired hand. In time he graduated from an industrial college as a qualified electrician. He emigrated to Canada in 1967 and in the following year accepted employment with Ford Motor Company (Ford) at its plant in Talbotville, Ontario where he works to this day.

In 1972 the Appellant purchased his first property, a 50-acre farm, at a cost of $16,000.00. In 1975 and 1976 it was rented to a cash crop farmer. Concurrently the Appellant built a residence on the property and moved in with his family in December 1975. In 1977 he began working the farm, produced and sold crops. That same year he purchased 44.46 acres of land located on Highway 401 for $33,000.00. It had not been farmed for a number of years and required substantial rehabilitation, in particular brushing and clearing. The Appellant brought this farm into production in or about 1979 or 1980. In May 1986 the Appellant purchased a further 173.73 acres of farm land approximately seven or eight miles from the home farm. The cost of this acquisition was $165,000.00. This property had been previously utilized as a cattle feed lot and included a large silo and an implement shed. It too was said to be in a run-down condition and substantial work was required to bring the soil back to proper condition in order to increase fertility and production.

In the years following 1986 the Appellant’s main concern was to bring the recently purchased farm into production. In 1989 in response to a government incentive program he seeded 94 acres to hay. As it turned out gross income was quite low because too many entered the plan and created a glut on the market. The Appellant baled and sold some of his product but ultimately gave away 56 acres of hay to a local dairy farmer. He did, however, state that the program helped to rehabilitate the land. The Appellant testified that in 1989 drought conditions also affected the crops seeded on the other farms as a result of which he showed a very poor return and reported a loss of $34,390.00.

In 1990 the hay program was still in place on the larger farm while the balance of the arable land was seeded to corn and soya beans. That year a tornado struck, destroyed 68 acres of corn and damaged 39 acres of soya beans and 56 acres of hay. To compound his problems the debris left by the tornado had to be cleared before harvesting and it was virtually impossible to take any crops off. He says he did manage to salvage approximately 10 acres of corn. The debris also precluded him from fall ploughing which had the further effect of reducing the crop the following year. The Appellant’s estimate is that the tornado cost him approximately $33,000.00 in lost income. [1]

In 1991 the Appellant planted 166 acres of soya beans and 74 acres of corn but drought again produced poor yields and an attendant loss in that taxation year of $55,891.00 (no capital cost allowance claimed).

The Appellant says that over the years he invested in excess of $300,000.00 in his farming operation on account of land and equipment. Currently he farms approximately 242 acres, all improved, part of which has been tiled for better production. He does not dispute that losses were reported from his farming operation in every year from 1978 to 1993 except in the 1988 taxation year for which he reported a profit of $10,878.00. In 1994 the farm showed a profit of $1,495.00 and with respect to the current taxation year sales to date amount to $46,573.00 and a total of $67,000.00 for the full year is expected. Expenses to date are said to be $28,250.00 and will be no higher than $35,000.00 for the full year.

Appellant’s Position

Although the Appellant was employed by Ford throughout the years in issue he in actual fact spent considerably more time in his farming business than in relation to his employment. He had reached the position of supervisor at Ford but in the early 1980’s he relinquished it because his control and flexibility over work and vacation scheduling was limited. In 1986 he accepted the position of preventive maintenance electrician which enabled him to work a regular 5 am. to 1 p.m. shift. That, coupled with his entitlement to six weeks vacation and his seniority gave him the flexibility needed to best attend to the requirements of his farm operation.

The Appellant submits that although originally in poor condition the farms have now been rehabilitated and are capable of reasonably good production. Recent revenues have been substantial. The farm business is well managed and is on the right course, as evidenced by the growth and financial health of the operation. As well, the Appellant has invested a substantial amount of capital into this venture, including the profits from the disposition of investment properties in 1986. [2]

Counsel for the Appellant argued that the criteria in Moldowan v. R. (sub nom. v. The Queen) (sub nom. Moldowan v. Minister of National Revenue), [1978] 1 S.C.R. 489, [1978] C.T.C. 310, 77 D.T.C. 5213, as applied in McCambridge v. Minister of National Revenue, [1981] C.T.C. 2314, 81 D.T.C. 251 (T.R.B.), Graham v. R. (sub nom. Graham v. The Queen), [1983] C.T.C. 370, 83 D.T.C. 5399 (F.C.T.D.); (sub nom. R. v. Graham), [1985] 1 C.T.C. 380, 85 D.T.C. 5256 (F.C.A.) Hadley v. R. (sub nom. Hadley v. The Queen), [1985] 1 C.T.C. 62, 85 D.T.C. 5058 (F.C.T.D.), R. v. Wylie (sub nom. Canada v. Wylie), [1992] 1 C.T.C. 236, 92 D.T.C. 6294 (F.C.T.D.), Mott-Trille v. R. (sub nom. Mott-Trille v. Canada), [1994] 1 C.T.C. 215994 D.T.C. 1013 (T.C.C.) and Martin v. R., [1996] 1 C.T.C. 2008 (T.C.C.) have been met and that he is entitled to the benefit of full farm losses in the taxation years in issue.

Respondent's Position

The Respondent contends that the Appellant did not look to farming or to farming and some subordinate source of income for his livelihood but carried on the farm operation as a sideline. The Respondent relies on the fact that during the relevant years the Appellant worked full-time as an electrician for Ford and had been doing so for over 25 years. In the taxation years in issue the Appellant earned the amounts of $60,423.98, $60,557.82 and $63,638.42 as income from his employment with Ford. During those same taxation years the Appellant actually incurred farm losses of $34,390.00, $115,133.00 and $47,279.00. The Respondent further contends that at all material times the Appellant did not spend more time in relation to the farm operation than he did in relation to his employment at Ford.

On this basis the Respondent contends that the farming operation carried on by the Appellant did not and could not have reasonably been expected to provide the bulk of the Appellant’s income. Accordingly his chief source of income was neither farming or a combination of farming and some other source of income.

Analysis

The issue is whether the income from the farm business of the Appellant was a chief source of income within the meaning of subsection 31(1) of the Act, thereby enabling him to deduct from income the entire amount of allowable farming losses suffered by him in the taxation years in issue.

It is common ground that the Appellant was engaged in farming activities which constituted a source of income for the purposes of the Act. Subsection 31(1) of the Act restricts the deduction available for such losses to $8,750.00 in circumstances where the chief source of income of a taxpayer is neither farming nor a combination of farming and some other source of income. The leading authority in respect of the interpretation to be given to subsection 31(1) of the Act is Moldowan vv. R.. Dickson J., as he then was, suggested that the test for determining whether a source of income constitutes a chief source of income for a taxpayer is both relative and objective. In this regard, “the distinguishing features of ‘chief source’ are the taxpayer’s reasonable expectation of income from his various sources in his ordinary mode and habit of work”. Dickson J. concluded that the Act as a whole contemplates the existence of discrete classes of taxpayers who farm as a livelihood, as sideline businesses and as hobbies. In relation to these three classes of farmers, only those who farm for their livelihood are entitled to the full deduction for farm losses while those who engage in sideline businesses may deduct losses of $8,750.00 in a taxation year. In describing more fully the taxpayer who farms for his livelihood Dickson J. stated at pages 487-88 (C.T.C. 315; D.T.C. 5216) that for such individual, the farming “... may reasonably be expected to provide the bulk of income or the centre of work routine”. Dickson J. further said:

The reference in section 13(1) to a taxpayer whose source of income is a combination of farming and some other source of income is a reference to Class (1). It contemplates a man whose major preoccupation is farming but it recognizes that such a man may have other pecuniary interests as well, such as income from investments, or income from a sideline employment or business. The section provides that these subsidiary interests will not place the taxpayer in Class (2) and thereby limit the deductibility of any loss which may be suffered to $5,000.00. While a quantum measurement of farming income is relevant, it is not alone decisive. The test is again both relative and objective, and one may employ the criteria indicative of “chief source” to distinguish whether or not the interest is auxiliary.

It is also instructive to refer to Morrissey v. R., (sub nom. Canada v. Morrissey) [1989] 1 C.T.C. 235, (sub nom. R. v. Morrissey), 89 D.T.C. 5080 (F.C.A.), where Mahoney J. said at pages 241-242 (D.T.C. 5084):

"Moldowan also says, dealing with the difference between classes 1 and 2, ‘while a quantum measurement of farming income is relevant, it is not alone decisive’. ... Moldowan suggests that there may be a number of factors to be considered but we are here concerned only with three: time spent, capital committed and profitability. In defining the test as relative and not one of pure quantum measurement, Moldowan teaches that all three factors are to be weighed. It does not, with respect, merely require that farming be the taxpayer’s major preoccupation in terms of available time and capital."

From this it is clear that no single factor is necessarily determinative of the issue but each must be considered and given the weight it deserves in the particular circumstances before the Court.

In considering the criteria suggested in Moldowan I turn first to the time spent by the Appellant in his various endeavours. It is fair to conclude that the Appellant made a substantial commitment of time to the farming operation. That is quite evident from the Appellant’s testimony. However it is equally fair to say that there was a correspondingly substantial commitment of time to his employment with Ford. Although he took steps to schedule his hours of employment to suit the needs of the farm it was obvious that the Appellant did not and could not jeopardize the income earned from his employment with Ford without which the farm operation could not have survived. As well one cannot ignore the fact that the Appellant was also involved in real estate investments during these years income from which played an important role in the financial health of the farm property. The importance of his employment and investment income over the years as the financial bulwark for an unprofitable farm operation is crystal clear.

With respect to capital commitments it is obvious that they were more substantial with respect to the farm than with respect to the Appellant’s other activities. First, his employment at Ford by its very nature, required very little or no investment. Second, although he was involved in investment in rental properties in the City of London, they were on the face of it not as substantial as those with respect to the farm operation. I do not ignore the fact that the profits from the real estate investments were ploughed back into the farm business. This is consistent with the Appellant’s statements regarding his intended course of action.

I turn next to profitability, both actual and potential. The Appellant’s farm operation has been profitable in but two of 18 years he has farmed. The losses in many of the years were quite substantial. No doubt in 1989, 1990 and 1991 storms and drought may have played a role in the poor financial results. However, an analysis of the statements of income and expenses for those years discloses that little or no evidence that, even given reasonable crops, a profit would have been generated. There was some testimony regarding the likelihood of profit in 1995 but it is difficult to gauge the accuracy of the Appellant’s projection. There was no reasonable explanation regarding the $30,000.00 to $40,000.00 difference between the expenses projected for 1995 and the actual expenses incurred in taxation years 1992, 1993 and 1994. The accountant’s projections for 1995 were for the most part speculative and in my view quite unrealistic. I note further that the Appellant’s returns for 1987 to 1994 inclusive disclose that capital cost allowance was not always claimed and optional inventory adjustments were not always made. I emphasize that the Appellant as a taxpayer was quite perfectly entitled to file his returns on this basis. However, in my view the favourable year to year comparisons made by him (and his accountant) are of limited value unless these annual distinctions are taken into account. That was not done either by the accountant or by the Appellant.

The decisions relied upon by the Appellant, more specifically Martin, Mott-Trille and Wylie, are not entirely inconsistent with the decision of the Federal Court of Appeal in R. v. Morrissey and I choose not to follow them. The decisions in Hadley and Graham pre-date Morrissey and Poirier (Trustee of) v. Canada (sub nom. Poirier Estate v. R.), [1992] 2 C.T.C. 9 (sub nom. R. v. Poirier), 92 D.T.C. 6335 (F.C.A.) and must be read in that context.

The correct approach in appeals involving the provisions of subsection 31(1) of the Act is that expressed by Strayer J. in Mohl v. R. (sub nom. Mohl v. Minister of National Revenue), [1989] 1 C.T.C. 425, 89 D.T.C. 5236:

"It now appears clear from the Supreme Court decision in Moldowan [3] as recently interpreted by the Federal Court of Appeal in Her Majesty the Queen v. Morrissey* that, for a person to claim that farming is a chief source of income, he must show not only a substantial commitment to it in terms of the time he spends and the capital invested, but also must demonstrate that there is a reasonable expectation of it being significantly profitable. I use the term ‘significantly profitable’ because it appears from the Morrissey decision that the quantum of expected profit cannot be ignored and I take this to mean that one must have regard to the relative amounts expected to be earned from farming and from other sources. Unless the amount reasonably expected to be earned from farming is substantial in relation to the other sources of income then farming will at best be regarded as a ‘sideline business’ to which the restriction on losses will apply in accordance with subsection 31(1)."

Strayer J. also noted that the test of whether there was a reasonable expectation of profit is an objective one. With respect to this Appellant’s farming operation not only was there no profit experienced in the years in issue but there was also no realistic expectation of a substantial profit of the sort which would constitute a chief source of income within the meaning of subsection 31(1) of the Act.

The appeal is dismissed.

Appeal dismissed.