Eldon James Johnson v. Her Majesty the Queen, [1993] 2 CTC 169

Pinard, J.:—This is an appeal by the plaintiff from a decision by the Tax Court of Canada which upheld notices of reassessments from the Minister of National Revenue denying the plaintiff taxpayer the right to deduct farming losses amounting to $4,218.66, $4,338 and $3,659 for the 1977,1978 and 1979 taxation years respectively.

After completion of the evidence at the hearing before me, on June 23, 1993, counsel for the plaintiff indicated he was not ready to argue orally and agreed rather to file written submissions by July 14, 1993. Counsel for the defendant was granted until August 4,1993 to file written submissions in reply. Since until this day counsel for the plaintiff has not filed his written submissions or applied for any extension of time, I consider it appropriate that judgment be rendered without any further delay.

In reassessing the plaintiff as he did, the Minister proceeded on the basis that the plaintiffs farming losses were not losses from a business within the meaning of subsections 9(2) and 31(1) of the Income Tax Act,, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the "Act"), but were personal or living expenses within the meaning of paragraph 18(1)(h) and subsection 248(1) of the Act.

The plaintiff is of the view that while during those years he did not look to farming for his entire livelihood, he carried on his farming operations with a reasonable expectation of profit, "as a part-time business".

The applicable statutory provisions in this income tax appeal are subsections 9(1), 9(2), 31(1) and 248(1), and paragraphs 18(1)(a) and 18(1)(h) of the Act:

9. (1) Subject to this Part, a taxpayer's income for a taxation year from a business or property is his profit therefrom for the year.

(2) Subject to section 31, a taxpayer's loss for a taxation year from a business or property is the amount of his loss, if any, for the taxation year from that source computed by applying the provisions of this Act respecting computation of income from that source mutatis mutandis.

31.(1) 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 his loss, if any, for the year from all farming businesses carried on by him shall be deemed to be the aggregate of

(a) the lesser of

(i) the amount by which the aggregate of his 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 him exceeds the aggregate of his incomes for the year, so determined from all such businesses, and

(ii) $2,500 plus the lesser of

(A) 1/2 of the amount by which the amount determined under subparagraph (i) exceeds $2,500, and

(B) $2,500, 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.

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

(a) 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 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;

248. (1) In this Act,"business" includes a profession, calling, trade, manufacture or undertaking of any kind whatever and, except for the purposes of paragraph 18(2)(c), an adventure or concern in the nature of trade but does not include an office or employment;

"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;

The basic issue in this appeal is whether the plaintiff carried on a farming business during his 1977, 1978 and 1979 taxation years with a reasonable expectation of profit.

Moldowan v. The Queen, [1978] 1 S.C.R. 480, [1977] C.T.C. 310, 77 D.T.C. 5213, [1] is the leading case as to what constitutes the operation of a business and whether or not a taxpayer can be said to have had a reasonable expectation of profit. The Court sets out the following test of “reasonable expectation of profit” at pages 485-86(C.T.C. 313-14, D.T.C. 5215):

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: Dorfman v. M.N.R., [1972] C.T.C. 151; 72 D.T.C. 6131. See also paragraph 139(1)(ae) of the Income Tax Act which includes as "personal and living expenses" and therefore not deductible for tax purposes, the expenses of properties maintained by the taxpayer for his own use and benefit, and not maintained in connection with a business carried on for profit or with a reasonable expectation of profit. 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.

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 D.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.

Moldowan is also the most widely recognized authority on the interpretation of subsection 31(1) of the Act. In that regard, Dickson, J. expressed the following opinion, at pages 487-88 (C.T.C. 315, D.T.C. 5216):

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.

Applying the Moldowan test, I can not conclude on the basis of the evidence in this case, that the farming activities in which the plaintiff was engaged in 1977, 1978 and 1979, were carried on with a reasonable expectation of a profit. The plaintiff, therefore, falls within the third class of farmers described above by Dickson, J., in Moldowan.

During 40 years, including the 1977, 1978 and 1979 taxation years, the plaintiff, who resided in Montréal, was employed full time as foreman and supervisor by M.L.W. Bombardier. The plaintiff, who explained he worked on farms when he went to school, purchased a farm in 1974, in Lochiel (Ontario), approximately 70 miles west of Montréal, for $33,000. He subsequently bought machinery and cattle. The plaintiff stated his first intention when he purchased the farm was to quit his job with M.L.W. Bombardier in 1978 and to take up farming full time. However, he left M.L.W. Bombardier in 1989, when his employer wanted to reduce his salary and because of his stated desire "to give an honest try to full-time farming". Prior to 1989, when the plaintiff began living on his farm permanently, the plaintiff only visited his farm once a week, during weekends, and for four to five weeks during summer vacations.

In 1976, the plaintiff purchased six cattle. Up until 1980, he increased his stock to 13 cattle, of which five were held at his farm and the remainder at a neighbour's farm. During that time, the plaintiff entered into an agreement with another neighbour whereby the latter would take care of the farm and the plaintiff's five cattle during the winter, and would also plough and seed 10 to 15 acres of land per year, in return for a rental fee of $500 per year, the right to utilize the plaintiff's land for pasture and the right to take a certain quantity of hay.

As shown by the chart (Exhibit D-3) appended hereto, [not reproduced] the profit and loss record of the plaintiff's farming operations never showed a profit from its beginning, in 1976, to 1992. It appears that until 1985 the plaintiff maintained the farm at minimal operation and that such operation generated minimal income and suffered consistent and significant losses.

In Chequer v. The Queen, [1988] 1 C.T.C. 257, 88 D.T.C. 6169 at 259 (D.T.C. 6170), my colleague Addy, J. stated the following:

There exists a burden of proof on every taxpayer who claims a deduction of net losses resulting from a business adventure, to establish that there was, at the time he engaged in and carried on with the business, a reasonable expectation of profit. The reasonableness of the expectation must be viewed objectively and cannot merely consist of an expectation which the taxpayer in good faith entertains to the effect that a profit will eventually be realized.

In view of all the facts and circumstances shown by the evidence, I am not satisfied that the plaintiff's farming operation as planned, structured and run could give rise to a reasonable expectation of profit for the taxation years in question. I find that during those years the plaintiff carried on some farming activities as a hobby. The losses sustained by the plaintiff on his non-business farming are therefore not deductible in any amount.

For the reasons given, the plaintiff's action will be dismissed with costs.

Appeal dismissed.