First Farm Inc. (Formely Romo Seafood Limited) v. Her Majesty the Queen, [1994] 1 CTC 2584, 93 DTC 1237

Hamlyn, J.T.C.C.:—First Farm Inc. (formerly Romo Seafood Ltd.) ("First Farm") [1] has appealed an assessment for the 1987 taxation year. The assessment was confirmed by the Minister of National Revenue (the "Minister") on November 26, 1990.

The appellant primarily was reassessed on the basis that its chief source of income was neither farming nor a combination of farming and some other source of income.

The Minister applied section 31 of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the "Act") and restricted the appellant’s loss to $5,000 in that year. The amount of the appellant’s losses for 1987 was $209,551.

Within these losses of $209,551 was included, under the heading of streets and roads the sum of $19,014. The Minister disallowed this sum on the basis it was a capital expenditure within the meaning of paragraph 18(1)(b) of the Act.

An amount of $87,639 carried forward as farm losses from the taxation years 1984 and 1985 from a predecessor company (Ideal Management Ltd.) (“Ideal’’) and deducted by the appellant in 1987 was also disallowed by the Minister as the Minister restricted the losses for those years pursuant to section 31 of the Act.

First Farm was a corporation that provided managerial and consulting services to other businesses and also operated a farm business.

The major quantitative source of income for the 1987 taxation year was from managerial and consulting contracts as well as investment income.

The appellant's position

The appellant submits that during the 1984, 1985 and 1987 taxation years it carried on farming on a full-time basis. The appellant further specifically submits the 1987 taxation year was one of the start-up years for a redirected farming operation in horse breeding and that its chief source of income was a combination of farming and some other source.

Mr. Ronald Goguen, the principal shareholder and chief executive officer of the appellant, had a life-long interest in race horses and had turned his business attention toward this redirected venture.

By 1987 the appellant had invested in the farming operation $394,761 (Exhibit A-6) and the capital investment was expected to increase significantly thereafter.

The appellant submits that the horse breeding business is by its very nature one involving long-term investment with profits rising only after considerable start-up losses together with very significant and long-term capital investment.

Projections indicated the farming operation should become profitable at a date in the future and that profits would be substantial. The appellant was prepared to fund the losses until that time only because it had a reasonable expectation of profit. This operation was to be unique to New Brunswick and the Maritimes.

The appellant hired professionally trained personnel to operate the business and had purchased high-grade stock. The farm itself had all the trappings of a highly organized, well-structured and well-planned operation poised for success.

The appellant applied for and obtained public funding through the Moncton Regional Development Initiatives Board Inc. The loan was made as assistance towards the establishment of a race horse breeding and boarding business. The appellant also obtained mortgage financing from the Farm Credit Corporation.

The appellant’s disallowed losses for the years 1984, 1985, 1987 and 1988, as stated in the amended reply to Minister’s reply to notice of appeal are as follows:

The losses were explained in part as follows: the type of operation required a long-term commitment of capital and labour and only after ten years could profitability be expected. The boarding aspect of the operation received some bad but unwarranted publicity about the appellant’s care of horses. The horse industry suffered a downturn because of race track closures.

The respondent's position

The Minister submits that the appellant carried on farming as a sideline business during its 1987 taxation year.

The appellant’s chief source of income for the 1987 taxation year was investments ana the provision of managerial and consulting services to various related companies engaged in drilling operations.

The appellant’s chief source of income for its 1984, 1985 and 1987 taxation years was neither farming nor a combination of farming and some other source of income.

Also, the Minister submits that the appeal with respect to the 1988 taxation year is invalid on the basis that no notice of objection was filed by the appellant to the “loss determination" (subsection 152(1.1) of the Act) of the appellant of November 7, 1990, as required by section 169 [now subsection 169(1)] of the Act.

Moldowan

In Moldowan v. The Queen, [1978] 1 S.C.R. 480, [1977] C.T.C. 310, 77 D.T.C. 5213, Dickson, J. described a two-level test in deciding from which class of farmer the taxpayer belongs:

1. the Court must determine whether there is a source of income, i.e., whether there is a reasonable expectation of profit; and if there is a reasonable expectation of profit;

2. the Court must then determine whether the farming operation or farming and some other subordinate source of income is a taxpayer's chief source of income.

The conclusion derived from this two-level test determines to which class of farmer a taxpayer belongs for the purpose of subsection 31(1) of the Act. At pages 487-88 (C.T.C. 315, D.T.C. 5216), Dickson, J. set out what are now the three classes of farmers:

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) [Income Tax Act, R.S.C. 1952, c. 148] 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.

Reasonable expectation of profit

In terms of a reasonable expectation of profit, Bowman, J. of this Court in Hover v. M.N.R., [1993] 1 C.T.C. 2585, 93 D.T.C. 98 [2] , at page 2596 (D.T.C. 106) has stated:

Once it is conceded, either by the very fact of applying section 31 or otherwise, that a business exists, the taxpayer's reasonable expectation of profit ceases to be a factor in determining whether he is to be subject to the restrictions of section 31. It is true that the concession implicit in the fact that the Minister applied section 31 is not necessarily binding on the Court if the facts clearly establish that there was no hope of ever making a profit.

In this case the Minister applied section 31 thereby conceding that a business exists.

Chief source of income

Whether a source of income is a taxpayer's "chief source of income" is both a relative and objective test. In Moldowan, supra, Dickson, J. stated at page 486 (C.T.C. 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. It is decidedly not a pure quantum measurement. A man who has farmed all of his life does not cease to have his chief source of income from farming because he unexpectedly wins a lottery. 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.

The Federal Court of Appeal in Roney v. M.N.R., [1991] 1 C.T.C. 280, 91 D.T.C. 5148 (F.C.A.), has further interpreted the rationale in Moldowan, supra. At pages 286 (D.T.C. 5153-54), Desjardins, J. stated:

The ratio in Moldowan, supra, is that the reference, in subsection 31(1) of the Act, to a taxpayer whose source of income is a combination of farming and some other source, contemplates a man whose major preoccupation is farming. It recognizes that such an individual may have other pecuniary interests such as income from investments or income from a sideline employment or business. These however remain auxiliary or subsidiary to his chief source of income. A quantum measurement of farming income, although not alone decisive, is relevant and cannot be ignored. The distinguishing features of “chief source of income", i.e., the taxpayer’s reasonable expectation of income from his various revenue sources and his ordinary mode and habit of work, are to be analyzed in the light of considerations such as the time spent, the capital committed and the profitability both actual and potential.

In light of the above decisions, the factors to be taken into account to determine if farming is the chief source of income are:

(i) the time spent;

(ii) the capital committed, and;

(iii) the profitability both actual-and potential.

Start-up costs

Concerning the start-up costs, it was held in Moldowan, supra, that the permissible amount to be deducted depends on the class the taxpayer finds nimself in. Dickson, J. stated referring to the class (1) farmer at 488 (C.T.C. 315):

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.

Start-up costs are considered over an extended period of time if evidence is accepted that the farm operation eventually will provide the appellant with the bulk of his income, that is, the commitment of time and capital, the expectation of profit and the change in business direction are such that a favourable comparison over time can be made to the other source of income (Hover, supra, Roney, supra, and Poirier Estate v. The Queen, [1992] 2 C.T.C. 9, 92 D.T.C. 6335 (F.C.A.)).

Combinations of income as a chief source of income

Bowman, J. in Hover, supra, page 2599 (D.T.C. 107-08) commented on sources of income as follows:

The Act does not specifically require that the other source of income be either subordinate or sideline. It would seem that if farming can be combined with another source of income, connected or unconnected, it can as readily be combined with a substantial employment or business as with a sideline employment or business. Indeed, if the other source were merely subordinate or sideline it would not prevent farming alone from being itself the taxpayer’s chief source of income without combining it with some other unrelated subordinate source.

Given the amount of income that the dental practice produced and the amount of cash it contributed to the farming operation it cannot be described as either subordinate to farming, in terms of the revenue that it produced, or a sideline business. It was an essential adjunct and complement to the farming operation. Without it the farming operation could not have been commenced nor could the substantial capital expenditure and start-up costs have been incurred. In this sense it formed an integral part of the combination. While I am of course bound to follow the principles enunciated by Dickson, J., I must attempt to apply them to the facts before me and I must conclude, if I am to give effect to the word "combination", that by “subordinate” he intended to include a source of income that although substantial is integral to the very existence of the farming operation.

In Hover, supra, Bowman, J. further held at page 2602 (D.T.C. 110):

I have therefore concluded on the evidence that the appellant’s chief source of income was a combination of farming and dentistry and that section 31 does not apply to the determination of his income for the 1984, 1985 and 1986 taxation years.

In so deciding, Bowman, J. held that an interrelation existed between the two sources that permitted the combination. The interrelation was a provision of financing from dentistry to farming in the sense that the other business formed an integral part of the combination.

Analysis

Ideal, the predecessor company to the appellant, was wound up into Romo Seafood Limited ("Romo"). Romo thereby acquired farm assets that included the purchase of the farm that was the site of Romo's farm business. Romo then divided the farm operation into several parts including racing, boarding and breeding.

The original barn on the farm was totally renovated and extensive fencing was installed. Financing for the farm operation came from income from Romo's management contracts and borrowed funds.

The appellant for the farm operation through the direction of its major shareholder and chief executive officer acquired considerable knowledge, assets and management personnel. The capital expenditure and horse inventory expenditure was significant; from 1987 through 1992 the cost of construction and race horse inventory as a percentage of total investment grew from 24 per cent to 67.2 per cent. By 1992 the total cost of construction and race horses was $2,752,704 (Exhibit A-6). Between 1986 and 1991, ten miles of fencing was installed, 3,000 feet of water lines were laid and the new barns and the renovated barns were completed. The construction was of the highest quality. The laboratory for the breeding operation had all of the state of the art equipment to conduct its business.

The time spent on farming business by the operating mind behind the appellant (Ron Goguen) and certain other employees of the appellant was considerable, extensive and continuous; while Mr. Goguen had other business activities those endeavours did not diminish the extensive focus given to the corporation and its farm activities.

Profitability is a question of fact and objective analysis. In the early years of the farm business profitability projections were non-existent and overall plans were not delineated. However, after 1986, projections and planning appeared. The projections prepared by the appellant’s accountants for financial institutions indicate that over the long-term profitability would be significant. Examination and cross-examination of the appellant’s witnesses on the profitability projections confirmed the forecasts were objective and not wildly speculative or fanciful.

The expert testimony of Dr. Glen Brown (a veterinarian and a race horse and breeding farm manager with over 30 years of successful breeding farm experience) indicated the path chosen by the appellant was the right path in terms of capital expenditure and initial live stock acquisition. Dr. Brown further submitted the base of the appellant in terms of facilities, personnel and acquired knowledge was sound and appropriate and the time and effort expectation of the appellant as to profitability was realistic, that is, a long period of capital infusion with considerable ongoing "hands on" management.

For 1987, the appellant had net earnings of $604,459 (Exhibit R-1, tab 7) in respect of its business operations while claiming during the same period a loss of $209,551 on its farming operation. It is to be noted by agreement of counsel this loss did not include the carried forward losses of 1984 and 1985.

The time spent by the appellant through its employees and Mr. Goguen was focused and directed. The capital committed by the appellant as shown by the analysis from 1987 to 1992 indicates that over two-thirds of its capital investment was farming and that the amount of capital infusion was considerable. The taxation year 1987 was clearly a start-up year for the redirected farm business and this redirection commenced in 1986. The future profitability conceded by the Minister was further confirmed by the appellant’s documentary evidence and the expert testimony of Dr. Brown. From the evidence, the critical path chosen was the right path to significant profitability.

When one source of income provides financing for another, nothing precludes the combination of both being a chief source of income. In this case, according to the evidence, the sources of investment and management fees as sources of income were to be phased out and replaced by farm income. The time commitment of the appellant through Mr. Goguen ana the employees and the extensive capital infusion confirm the decision that farming could realistically be the significant source of income. Farming was not a sideline business to the appellant. I therefore conclude the appellant's chief source of income was a combination of farming and investments and management fees. Therefore, section 31 does not apply to the determination of income for the 1987 taxation year.

Streets and roads issue

The appellant expended $19,014 in its 1987 taxation year for certain landscaping, clearing, earth moving and excavation. This was recorded within the appellant's books under the heading of streets and roads. The Minister disallowed the expenditures on the basis the expenditures were capital expenses within the meaning of paragraph 18(1 )(b) of the Act. The evidence at trial showed the expenditures were deductions permitted in computing income from a business, that is, amounts paid by the appellant in the landscaping of grounds around the structure primarily used for the purpose of producing income from the farm business.

Limitation period issue

Counsel for the appellant submits that each of the taxation years 1984 and 1985 for Ideal was assessed by the Minister as filed by Ideal. Counsel further submits that the Minister's disallowance of the said loss carryforward was an attempt by the Minister to do a loss redetermination or reassessment beyond the three-year limitation period provided by subsection 152(4) of the Act and is therefore void.

This issue has been determined by the Exchequer Court of Canada in New St. James Ltd. v. M.N.R. (1964), 34 Tax A.B.C. 344, 64 D.T.C. 121 (T.A.B.), aff'd [1966] C.T.C. 305, 66 D.T.C. 5241. In that case the original assessment for 1955 was a “nil assessment", New St. James having reported a loss after deducting the cost of the alterations as an expense of some $38,000, which loss was carried forward to 1956. In computing its income for the 1956 reassessment, the Minister recalculated the 1955 loss to be carried forward at $330 by treating the cost of the alterations as an amount subject to capital cost allowance rather than a deductible expense. New St. James maintained that its 1955 loss had been determined by the Minister when making the original "nil assessment" and that the loss could not be altered by him when making the reassessments for 1956 to 1959 because the four- year time limit of subsection 46(4) had elapsed with respect to 1955.

New St. James, supra, relied on subsection 46(4) of the Income Tax Act, R.S.C. 1952, c. 148, as am. S.C. 1960, c. 43, section 15 (the predecessor to subsection 152(4)) and argued that the Minister was precluded thereby from inquiring into the actual loss in respect of which the allowance should be made. Sheppard, D.J. held at page 307 (D.T.C. 5243):

The limitation of subsection 46(4) only applies when four years have elapsed after the designated notice or notification and that has occurred only in respect of the 1955 taxation year.

Hence subsection 46(4) imposes no restriction as to any year other than 1955 and therefore not to the subsequent years 1956 to 1959 inclusive to which the four years have not elapsed and the limitation of subsection 46(4) cannot apply. For these subsequent years subsection 46(4), having no application, does not preclude an assessment being made in accordance with the provisions of this statute, including paragraph 139(1)(x) and subsection 32(5). That requires the loss for the years 1956 to 1959 inclusive being taken as provided by the statute, not as implied in the assessment for the year 1955.

As stated, the relevant parts of subsection 46(4) referred to by Sheppard, D.J. are now found in subsection 152(4) and are, for all practical purposes, unchanged.

The Minister’s reassessment of the appellant's 1987 taxation year made in June 1989 does not offend the time limitation provided by subsection 152(4) of the Act. I am satisfied that the Minister was not precluded from inquiring into the actual amount of non-capital loss available.

1984-85 loss carried forward issue

The predecessor company to the appellant, Ideal, was incorporated on or about March 17, 1980, and at all material times its shares were owned by Ronald Goguen.

The appellant, as indicated, states that Ideal was involved in the horse-racing business from 1981 through May 31, 1986 at which time the company was wound up in Romo Seafood Limited. The appellant sought to deduct in computing its income for the 1987 taxation year losses of Ideal’s horse-racing business carried forward from Ideal's 1984 and 1985 taxation years of $55,383 and $32,256 respectively. The appellant submits that those portions of the loss carried forward from Ideal arise from the operation of the horse-racing business which was the chief source of income for the said Ideal in those years and thus constitute non-capital losses or farm losses by virtue of paragraphs 111(1 )(a) and (d) of the Act and are deemed by subsection 88(1.1) of the Act to be losses of the appellant and are not subject to the restrictions of section 31 of the Act in the circumstances.

Pursuant to section 31 of the Act, a taxpayer whose chief source of income is neither farming nor a combination of farming and some other source of income may not claim more than the limit prescribed in section 31 of the Act in any year in respect of farming losses. Any loss in excess of this limit becomes the taxpayer's "restricted farm loss" for the year and can be carried back three years and forward ten years (paragraph 111 (1 )(c) of the Act) but is only deductible against the taxpayer's income produced by its farming business for the year.

On the facts before me there is some conflicting evidence between the evidence on the appeal and certain cited passages from the transcript at discovery. Mr. Goguen stated at trial that Ideal carried on farming on a full-time basis and only farming in 1984 and 1985. On discovery Mr. Goguen maintained the business of Ideal included other business as well as farming.

For these reasons, and the varied and diverse business activities of Mr. Goguen that were interwoven through many corporate entities including Ideal, without clear delineation, I come to the conclusion during the 1984 and 1985 taxation years that farming, while a business to the appellant, the appellant’s "chief source" of income was neither farming nor a combination of farming and some other source.

1988 taxation year

The appellant in its pleadings raised an issue in relation to a "loss determination" for the 1988 taxation year.

The appellant did not file a notice of objection in conformity with section 169 [now subsection 169(1)] of the Act following the "loss determination” (subsection 152(1.1) of the Act) made by the Minister on November 7, 1990, for its 1988 taxation year.

The relevant provisions of the Act are:

152(1.2) The provisions of paragraphs 56(1 )(l) and 60(o), this Division and Division J, as they relate to an assessment or a reassessment and to assessing or reassessing tax, are applicable, with such modifications as the circumstances require, to a determination or a redetermination and to determining or redetermining amounts under this Division, except that subsections (1) and (2) are not applicable to determinations made under subsection (1.1) and, for greater certainty, an original determination of a taxpayer's noncapital loss, net capital loss, restricted farm loss, farm loss or limited partnership loss for a taxation year may be made by the Minister only at the request of the taxpayer.

DIVISION J — APPEALS TO THE TAX COURT OF CANADA AND THE FEDERAL COURT

169. Where a taxpayer has served notice of objection to an assessment under section 165, he may appeal to the Tax Court of Canada to have the assessment vacated or varied after either

(a) the Minister has confirmed the assessment or reassessed, or

(b) 90 days have elapsed after service of the notice of objection and the Minister has not notified the taxpayer that he has vacated or confirmed the assessment or reassessed;

but no appeal under this section may be instituted after the expiration of 90 days from the day notice has been mailed to the taxpayer under section 165 that the Minister has confirmed the assessment or reassessed.

The purported appeal on this issue is quashed on the ground that no notice of objection was filed by the appellant within 90 days of the decision of the Minister (November 7, 1990).

Conclusion

For the taxation year 1987, I conclude, that the combination of farming, investment and management fees was the chief source of income for the appellant corporation.

The appellant can claim as a deduction in the computation of its income for the 1987 taxation year a loss in the amount of $209,551 as its chief source of income for the 1987 taxation yearwas a combination of farming, investment and management fees.

The carried forward losses in the amount of $87,639 are restricted farm losses and as such are not deductible for the 1987 taxation year, as there was no income from the farming business to deduct these losses.

From the evidence, contradictions and the lack of clarity for the 1984 and 1985 taxation years, I conclude that farming or the combination of farming and some other sources of income was not the chief source of income for Ideal.

The appellant for the 1987 taxation year, within the aforesaid sum of $209,551 can deduct the business expenses (itemized under the heading of streets and roads in the appellant’s company statements) but more clearly delineated at trial (landscaping, earth moving and earth removal) as deductions permitted in computing income from business incurred in the sum of $19,014.

The appeal was not pursued for 1988 as the jurisdictional steps prerequisite for the appeal had not been completed.

Decision

The appeal is allowed for the 1987 taxation year and referred back to the Minister for reconsideration and reassessment on the basis that the appellant is entitled to deduct losses in the amount of $209,551.

The purported appeal for the 1988 taxation year is quashed.

The appellant is entitled to its costs.

Appeal allowed in part.