Donald F. McGillivary v. Her Majesty the Queen, [1995] 2 CTC 2006

Rowe D.J.T.C.C.:—The appellant appealed from assessments of income tax with regard to his 1986, 1987 and 1988 taxation years. The Minister of National Revenue (the "Minister”) assessed on the basis the appellant was entitled only to restricted farming losses pursuant to 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’s position is that he is entitled to deduct the full extent of his losses incurred in his farming operation on the basis that farming was a "chief source of income".

The appellant resides at Cassidy, British Columbia, on Vancouver Island. In 1981 he purchased a 37.7 acre farm, directly across the road from his own principal residence which was situated on a ten- acre parcel. The farm was in a run-down condition and had not been farmed for approximately 20 years. The appellant stated that he had been in the airline business and when he sold out that enterprise he found himself, at age 50, wanting some other endeavour to occupy his time. He had no experience in farming and decided to raise cattle, choosing Herefords, which initially were not of good quality, although he continually worked towards improving the herd. In September 1982, he bought a commercial fishing boat for the sum of $145,000, rebuilt and rerigged it, and had it ready to use for commercial herring fishing in the spring of 1984. Later that year, the boat was used for salmon fishing and did not have a successful season. By the end of December 1985, he had 30 cattle on the farm and he understood from the auditor from Revenue Canada that she would recommend full farm losses be allowed. In terms of the fishing business, he leased a herring license for $20,000 and went on the boat and worked as a deckhand. In 1986, he fished for herring in March and his wife remained home and looked after the cows during the calving period. In 1987, he had to pay the sum of $60,000 in order to lease a herring license. He had purchased his first boat, "Eldorado" for $145,000 and sold it for $260,000. He then purchased and sold another vessel for profit and in 1988, he paid $700,000 for a 51 per cent interest in a fishing company which owned a boat. At this point, he had nearly $1 million invested in boats, owing 100 per cent of the vessel "Canada Spirit", and a 33/64th interest in the "San Juan II". In 1988, as a consequence of his transactions buying, selling fishing boats, he reported a taxable capital gain in the sum of $176,000. In 1992, he sold the farm and all of the cattle. However, for the years under appeal, the appellant stated he had about 50 head which he ran on his own land and on 50 acres he leased. He grew feed for his own livestock and sold the surplus. The average annual crop of calves numbered 26 and in the appellant’s view, "it takes about five years to learn what you are doing". The difficulty was that he had a poor quality herd at the beginning and it was about five years before he learned how to purchase good quality animals. He belonged to the West Coast and Vancouver Island Hereford Association and obtained information from that organization. During his years at farming, he had a good cow die and a bull calf born dead, and one season, the hay rotted due to excessive moisture. He had been reluctant to spend between $2,000 and $5,000 per cow in order to build up a herd. In 1988, he paid $5,600 for a bull which was expected to produce good quality calves. His farm was located such that it was inconvenient to use the services of an artificial insemination clinic but he was confident a proper breeding program would overcome the problems in his early farming years where the offspring were "an awful mixture". The appellant stated that he was working toward a 10 per cent return on an investment of $150,000. He had installed irrigation so he could run 30 cows on his own 37.7 acres and believed the operation could be successful without having to spend $30,000 on a bull to service a small herd of only 30 cows.

In cross-examination, the appellant agreed that a document setting out farm income and profit/loss for the years 1982-1992 was accurate. This schedule was filed as Exhibit R-1. Filed as Exhibit R-2, were the appellant’s income tax returns for the taxation years 1987-1991, inclusive. The appellant stated that there has been a serious downturn in the fishing industry on the west coast over the past two or three years and he has been attempting to sell his vessels. The appellant agreed the schedule of income from other sources for the years 1985-1992, inclusive, was accurate and this document was filed as Exhibit R-3. The herring season occupied his time for about one month per year, ending about mid-April. The necessary repair on the boats was contracted out as was repair of nets and other gear. The appellant stated that the majority of his time was spent on the farm. As for the improvement to the quality of the herd, the appellant agreed that he had placed his hopes for the future on the abilities of the $5,600 bull to produce high-quality offspring. He did not choose to spend the sum of $5,000 for testing to determine whether or not the bull’s semen was commercially viable. He stated that he initially purchased the farm in order to prevent it from being developed into a commercial trailer park or similar commercial development. Then, he purchased some animals in order to produce sufficient income so as to qualify for a municipal tax rate based on the land being used as a farm. The farm was put on the market in 1989, then taken off for a time and relisted in 1990, which led to a sale in 1992. Filed as Exhibit R-5, was a schedule of farm income and expenses for the years 1987-1991, inclusive. In 1990, the sum of $34,750 was realized from the sale of logs on the farm property and was shown as farm income. Other income that went into the category of farm income was rent from the farm house.

The appellant submitted that he believed he was entitled to claim his full losses on the basis that he had been looking for farming as his chief source of income and that he had committed his time and capital to that pursuit.

Counsel for the respondent submitted that, despite there being no log of time spent on each enterprise, that the appellant did spend a major portion of his time on the farm. However, income was derived from an income averaging annuity contract which required a large amount of capital to produce income of $50,000 per year together with other interest income. In addition, the appellant had invested and reinvested in fishing vessels to the extent that he had more than $1.1 million invested. The farm had shown losses continuously for ten years and the alleged profit in 1990 was not created by farming income as defined by subsection 248(1) of the Income Tax Act.

The seminal case in the area of farm losses is the decision of the Supreme Court of Canada in Moldowan v. The Queen, [1978] 1 S.C.R. 480, [1977] C.T.C. 310, 77 D.T.C. 5213. Then, the Federal Court of Appeal in Morrissey v. Canada, [1989] 1 C.T.C. 235, 89 D.T.C. 5080, reconsidered the issue. As a consequence, Strayer J. of the Federal Court-Trial Division, in Mohl v. The Queen, [1989] 1 C.T.C. 425, 89 D.T.C. 5236, applied the resulting methodology and the extensive analysis done by him at trial in Morrissey to deal with the issue and arrive at the conclusion the taxpayer had produced nothing more than a sideline business. The Federal Court of Appeal then considered full farming losses in the case of Poirier Estate v. The Queen, [1992] 2 C.T.C. 9, 92 D.T.C. 6335, and most recent, the case of The Queen v. Timpson, [1993] 2 C.T.C. 55,93 D.T.C. 5281 (F.C.A.).

In Moldowan, at pages 487-88 (C.T.C. 315, D.T.C. 5216) of the judgment of Dickson J. (as he then was) His Lordship stated:

In my opinion, the Income Tax Act as a whole envisages three classes of farmers:

(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.

(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.

(3) The taxpayer who does not look to farming, or to farming and some subordinate source of income, for his livelihood and who carried on some farming activities as a hobby. The losses sustained by such a taxpayer on his non-business farming are not deductible in any amount.

The reference in subsection 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. 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. A man who has farmed all of his life does not become disentitled to class 1 classification simply because he comes into an inheritance. On the other hand, a man who changes occupational direction and commits his energies and capital to farming as a main expectation of income is not disentitled to deduct the full impact of start-up costs.

In Morrissey, the taxpayer like the appellant in this appeal, had been granted the concession by the respondent that he was farming with a reasonable expectation of profit. As to the suitability of the taxpayer falling into the category of a class 1 farmer, Mahoney J. at page 242 (D.T.C. 5084) Stated:

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.

In Mohl, at page 428 (D.T.C. 5238-39), Strayer J. stated:

It now appears clear from the Supreme Court decision in Moldowan as recently interpreted by the Federal Court of Appeal in Morrissey v. Canada, [1989] 1 C.T.C. 235, 89 D.T.C. 5080 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 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).

The decision of the Federal Court of Appeal in Timpson was delivered by MacGuigan J.A. and the entire judgment is as follows at page 56 (D.T.C. 5282):

The leading case with respect to the deduction of farming losses from income from another source is Moldowan, supra, per Dickson J., as he then was.

At the time the trial judge decided this case in 1987, the implications of the Moldowan test had not been so fully spelled out by this Court as they have been since in Morrissey, supra', Gordon v. Canada, [1989] 2 C.T.C. 277, 89 D.T.C. 5481; Roney v. M.N.R., [1991] 1 C.T.C. 280, 91 D.T.C. 5148; Connell v. Canada, [1992] 1 C.T.C. 182, 92 D.T.C. 6134; Poirier v. Canada, [1992] 2 C.T.C. 9, 92 D.T.C. 6335.

The trial judge limited his examination solely to the question of the taxpayer’s reasonable expectation of profit (Appeal Book at 147):

I am satisfied on the evidence here that the plaintiff had a "reasonable expectation of profit". Most assuredly this profit did not arise as soon as the plaintiff predicted but the market, the high interest rates and the time required to gain credibility all conspired to delay what he had every right to expect-a profit.

But this consideration gets, at best, only to a finding that farming is a "source of income", not that it is "a chief source of income", as required by subsection 31(1) of the Income Tax Act.

We find this case to be on all fours with Poirier, where we said at page 10 (D.T.C. 6336):

It is...now clear that what is required for a determination that farming is a chief source of income is a favourable comparison of farming with the other source of income as to such matters as the time spent, the capital committed, and the profitability, both actual and potential....

Applying the present view of the law to the facts in the case at bar, it is patent to us that farming was in a subordinate position to the respondent’s employment occupation. Farming comes closest to a rough equality on the time factor, but it lags far behind on the capital and income tests.

In our view, the trial judge would have come to the same conclusion in the case at bar if he had applied the correct legal test.

The appeal should therefore be allowed with costs both here and in the trial division, the decision of the trial judge of May 12, 1987, set aside, and the reassessments for the 1977 and 1978 taxation years restored.

The appellant was unable to state what his profit and/or loss position was in 1986 from his fishing business, but advised that he showed a profit of $17,806 in 1987 and suffered an operating loss, in an unknown amount, in 1988. The appellant, as a result of having sold out an airline business, was in the position of having a large amount of capital which he then chose to invest in an income averaging annuity. To that extent, and in light of his ability to earn other investment income from his capital, he could produce adequate income to meet his needs from that passive investment. He also invested a substantial amount of money-in excess of $1 million, in the fishing business and it produced profit during the years under appeal, directly from operating revenue or from taxable capital gain. A person who chooses to begin farming as a second or third career after having been successful at previous endeavours, and therefore able to enjoy a steady income, would not become disentitled from being considered a class 1 farmer merely because the quantum of the farming income would be unlikely to ever match that of the pension, investment or other amounts of income generated in a passive sense. The problem the appellant has in the present appeal is that the farming operation as structured, in light of his inexperience in the industry, and his admitted reluctance to spend money on quality animals to bring the herd up to standard, was incapable of showing a profit in the years under appeal. I am aware the Minister has conceded the issue of profitability per se, but the farming operation was not one in which there was a reasonable expectation of it being significantly profitable. The appellant had committed a substantial amount of capital and time to the fishing business, including purchasing boats which he then repaired, refitted and sold for a profit, but was unwilling to dedicate the necessary capital to upgrade the quality of the small herd so that a steady, albeit not large, profit, might be generated therefrom. It is not only the interest and income averaging annuity contract income which must be looked at, but also the participation in the fishing industry, which had a capacity for and a realization of, profit that was indeed significant. The appellant may have devoted more time to farming than to fishing but the contribution of time in combination with capital was considerable and his participation in the fishing business was not merely a sideline business. Having regard to all of the evidence, it is apparent the Minister correctly assessed the appellant for the years under appeal by restricting farm losses in accordance with subsection 31(1) of the Income Tax Act. The appeal is hereby dismissed and the respondent is entitled to costs on a party-party basis.

Appeal dismissed.