David F. Hoeft v. Minister of National Revenue, [1993] 2 CTC 2289, 93 DTC 941

Kempo, T.C.C.J.:— These appeals concern the respondent's application of subsection 31(1) of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72,

c. 63) (the "Act") to the appellant's farming operations respecting his 1980 to 1988 inclusive taxation years.

This issue has been previously litigated respecting the appellant's initial foray into farming (on “the Estevan farm") during his 1977, 1978 and 1979 taxation years; see The Queen v. Hoeft, [1989] 1 C.T.C. 350, 89 D.T.C. 5144 (F.C.T.D.). The appellant's claim for exemption from the restricted loss provision of subsection 31(1), as it applied to his Estevan farm for the 1977 to 1979 years, failed essentially because it was found (at page 355 (D.T.C. 5147) of the decision) that he was unable to bring his farm within the test of potential profitability during that time so as to have been a chief source of income for him.

The attendant 1980 to 1988 inclusive taxation years concern a larger and different farming venture located near Southey, Saskatchewan ("the Southey farm") which commenced in the fall of 1979 and which is still in operation. The analysis and applicability of subsection 31(1) of the Act remains unchanged, however, arising from the guidelines of Chief Justice Dickson (as he then was) in Moldowan v. The Queen, [1978] 1 S.C.R. 480, [1977] C.T.C. 310, 77 D.T.C. 5213. The approach attributable to the matter is succinctly capsulized by Marceau, J.A., speaking for the Court, in Connell v. The Queen, [1992] 1 C.T.C. 182, 92 D.T.C. 6134 (F.C.A.), at page 182 (D.T.C. 6134) thusly:

. . .once it is established that farming is for the taxpayer a business and not merely a hobby, that he is engaged in farming as an activity from which he can derive income and eventually profit, the question of whether farming is, in his case, not only a source of income or a "sideline" source of income but a chief source of income either alone or in "combination" with "some other source”, is a question of fact that must be resolved having regard to all the surrounding circumstances.

The Southey farm was not viewed by the respondent as a mere hobby. Rather, it was perceived as a subsidiary or sideline occupation or business to that of the appellant's purported chief and primary occupation and income source which was as an officer in the Royal Canadian Mounted Police force.

The financial aspects of the appellant's farming activities and employment income, as updated from 1988 and on, follow:

[Chart not reproduced.]

The Estevan farm was sold in the fall of 1979 following the purchase of the Southey farm. As it was smaller in scope and utilization and was the appellant's first significant farming experience and commitment, it provides only background information to the Southey operation.

The evidence adduced on behalf of the appellant through an expert witness provided the following relevant statistical background information respecting farm economics generally in Saskatchewan during the 19803. These were provided as a backdrop to and explanation for the appellant’s purported inability to realize a profit from the Southey farm, and ostensibly to show that his situation was likened to those farmers similarly situated and afflicted by external events beyond their control.

Inflation had the effect of dramatically increasing farmland prices as well as borrowing costs and operational expenditures. The rise in farm cash receipts did not keep pace with and correspond to rising costs. Realized net farm income, which included subsidy program payments, was graphically illustrated as follows:

[Graph not reproduced.]

Interest Rates: The bank's prime commercial lending rates (mortgage lending rates often being somewhat less) were already in a steady climb from 1978 to the fall of 1979 (when the Southey farm was purchased) at which time it was 13 per cent in September and then 15 per cent in October. During the spring months of 1980 it peaked at 17.25 per cent, dropping thereafter to within the 13 per cent range in the fall. By late December of 1980 however the rate was up to 18.25 per cent, it peaked at 22.75 per cent during the summer of 1981 and then settled back to the 18 per cent range in mid-November of 1981, thereafter progressively falling to 15 per cent and lower during the fall of 1982. Apart from modest rises, the interest rate remained stable at between 10 per cent to 12 per cent during 1984 to the spring of 1990 at which time it was at 14.75 per cent. Overall, the interest rates for the 1980 decade were much higher than during the previous 20 years.

Grain prices dropped from a 1980 high of $5.63 per bushel to $2.86 in 1986, rising again to $4.68 by 1989.

Drought conditions began in 1985 and worsened for the next three years. The 1988 year was the driest and the province was declared a drought area. While crop insurance programs were available offering protection for yield losses, the Gross Revenue Insurance Program (GRIP) which provided price protection was not introduced until 1991.

Sources of off-farm and farm income for farm families on 1-640 acres: in

1981 the average off-farm employment source was $16,742 with the average net farm income being $14,594. By 1986 the off-farm income amount remained the same but the average net farm income had dropped to $8,632. The percentage distribution of income with respect to such sources in 1981 was 37.7 per cent as to net farm income as compared to 43.2 per cent off-farm employment income. By 1986 the farm source had dropped to 25.2 per cent while the off-farm source had risen to 48.9 per cent.

A statistical analysis entitled Farm tax-filers' average net income by source and by level of gross farm income portrayed that for each year 1981 to 1990 inclusive Saskatchewan taxpayers who had earned gross farm income in roughly the same annual amounts as the appellant plus off-farming income had, unlike the appellant, reported profitable farm income, albeit in modest amounts.

The foregoing statistical information was received through the testimony of an experienced professional agrologist, Mr. Michael Pyiypchuk. He was qualified to give expert opinion evidence respecting agricultural economics generally in Saskatchewan. He has a farming background and part of his current activity involves helping and advising farmers respecting farm business arrangements, estate and tax planning. He holds the position of financial farm management specialist with the government of Saskatchewan.

Mr. Pylypchuk opined that agricultural subsidies and support programs precluded annual losses after 1984 which would have otherwise been the average experience. He said the principal factors contributing to operational losses were the farm debt levels coupled with unusually high interest rates between the late 1970s to 1985. With prices for farm land peaking during 1979 to 1982, those who borrowed money during that time to buy their farm were fastened not only to those high prices but also to rising interest rates, to rising operational costs because of inflation, to dropping commodity and farm land prices and then, from 1985 and on to ever worsening drought conditions. Farm bankruptcies increased in 1988. The established trend toward fewer and larger farms in Western Canada was continuing. While agreeing that the "average" farmer in Saskatchewan did experience positive net income from farming during these events, he stressed that farm incomes were squeezed by external factors to the point that off-farm income sources became essential in increasing proportions to support the farm and to gain a livelihood therefrom.

Further background type of information was adduced on behalf of the appellant through Mr. Gordon Bailey, a government livestock inspection supervisor. He supervises 100 cattle inspectors who are employed to protect livestock ownership. Mr. Bailey's testimony in the main concerned the raising and marketing of quarter horses. This was the focus and thrust of the appellant's farming plan at the outset and today.

Mr. Bailey explained that a Quarter horse is short, stocky and docile, is smart and quick, is relatively easy to train for cutting and general ranch work and is sought after for rodeo use. He asserted that this horse has capitalized on market expansion and demand more than any other breed in the west, especially for ranch work. He said a very strong world market exists for these horses in Italy, Germany and other European countries if they are well trained. The less quality ones are highly in demand in Japan for meat consumption.

Mr. Bailey added that prices for these horses have increased dramatically during the last few years and that the current average price for one that is well broken and trained is $3,500 which was unheard of in the late 19705. He confirmed that training efforts could command over 200 hours per horse to accomplish and that even then it may be only “green broke". He also confirmed that the work and commitment involved in keeping horses and cattle is “unending” and that on average it would normally encompass six hours daily.

Finally, he advised that cattle prices have been steadier and stable in the last few years and that in his opinion farm diversification remained essential to survival.

Background facts

The appellant's testimony regarding his background experience in farming as a youngster, and during the years 1973 to 1976 on a rented ten-acre farm, and then again during 1976 to 1979 on the 160-acre Estevan farm corresponds with the facts as found and reproduced on pages 3351-52 (D.T.C. 5144-45) of the judgment of Martin, J. in The Queen v. Hoeft mentioned earlier. There, of course, the issue concerned the deductibility of full losses for 1977 to 1979 concerning the Estevan farm. The decision is dated February 1989. It is readily apparent that the 1980 to 1987 Southey farm experience was scrutinized in order to give some objectivity or corroboration to the appellant's stated intentions respecting his overall farming objectives.

The pertinent facts as found by Martin, J. accord with the appellant's evidence before me. They appear on pages 3351-52 (D.T.C. 5144-45) of the decision.

The defendant, who is now 40 years of age, joined the Royal Canadian Mounted Police in April of 1970 and will be eligible for a pension from the force in 1990. Although he had little experience in farming as a youth he became interested in that life prior to his marriage in 1972. By helping out friends of his who operated farms he began to learn how to operate one himself.

At the time of his marriage in 1972, his wife, who was brought up on a farm and who obviously retained a genuine love of that type of life, had her own quarter horse and was, apparently, anxious to resume the farming style of life. She apparently provided what little incentive the defendant needed to decide on- adopting that lifestyle. Having made the decision, the defendant purchased his own quarter horse the next year and rented a small ten-acre farm which he and his wife operated from 1973 to 1976.

In 1976 the defendant bought a 160-acre farm in the Estevan District of Saskatchewan. The farm consisted of 80 acres of crop land, 60 acres of pasture and 20 acres of hay together with a 105-year old residence, a barn and some outbuildings. The defendant rented the 80 acres of crop land for a three-year period on a /3-2/3 split on the crop. The property was acquired for $53,000. The defendant put up as a collateral for the full $53,000 loan his and his wife's horse plus one other horse together with three cows and five calves and, presumably, the farm.

By 1977, the defendant considered that his farming activities had increased to such an extent that he could claim full farming losses rather than the restricted annual loss of $5,000. It was during that year that the defendant had a serious accident which rendered him incapable of doing any work around the farm for a period of about six and one half months. During that period what farm work was done was done by his pregnant wife.

During the three-year period that he operated the farm at Estevan the defendant purchased a small farm tractor, a cultivator, a pick-up truck, a few cattle and one or two horses. His statements of farming income and expenses for the 1977 to 1979 taxation years indicated that he also purchased four or five calves for feeding and subsequent sale and that he bought an additional horse.

In April of 1979 the defendant was transferred to Southey, a community about 155 miles south of Estevan. The defendant actually moved to Southey on July 6 with a view to finding another farm. That he did on September 8, 1979. It consisted of a 320-acre farm with a house, barn, outbuildings and farming machinery which he purchased for $115,000. He had some difficulty in disposing of his Estevan farm but he finally sold it by the end of the September 1979 for $75,000.

As the new farm was not set up for raising cattle and training horses no new cattle were purchased to feed over the winter although one quarter horse filly was purchased in that year.

Over the years from 1973 to 1988 the defendant tried his hand at selling eggs, raising chickens, growing alfalfa, raising calves for sale, raising turkeys ana other aspects of farming but his main interest appears to have been establishing himself and his wife as quarter horse breeders. He explained that in order to establish a horse as a quality quarter horse it is necessary to enter it in accredited competitions with a view to obtaining points towards the horse's qualification as a champion quarter horse. Given a horse of fair quality it seems to follow that the more shows or competitions in which the horse competes the greater the chances are that it will be awarded points. This explains why so much of the defendant's time was taken up preparing for, going to and from and attending horse shows.

The following commentaries of Martin, J. respecting the Southey farm operation appear at page 353 (D.T.C. 5146):

In December of 1981 the defendant said, in his brief to the Tax Court, that it generally takes a three or four year period for a farming operation to show a profit but that the Southey operation, being a new one and having high start-up costs and being done in a period of high interest rates, would require five or six years to turn a profit.

For some unexplainable reason there accompanied his brief to the Tax Court a detailed statement of his projected farm income and expenses for the next five years (1981 to 1985) in which he projected substantial profits for each of the five years and a cumulative profit over the five-year period of $86,925. In fact, as the record indicates, he had substantial losses in each of the five years and a cumulative loss over the period of $79,005. He also had further losses of $40,000 over the next two years.

The defendant accounted for his losses by reason of poor markets, bad weather and high interest rates and, at the hearing before me, once again predicted that within five years he would have a profitable farming operation. However he gave no estimates or projections or supporting data to warrant his optimism, perhaps wisely so in the light of his other projections.

The detailed farm income and expense projections for the period 1981 to 1985 introduced during that hearing were not adduced into evidence here. Instead, what was tendered was the testimony of the appellant and of his banker to the effect that two written projections were made contemporaneously with the event. The first and formal one was in 1979 to obtain the Credit Union mortgage for the purchase of the Southey farm. The second and informal one was in 1984 when the appellant and the banker had discussed alfalfa growth in place of grain. These incidents will be referred to later.

Since 1973 the appellant's RCMP duties included investigations concerning theft of livestock and farm machinery. He testified that the knowledge gained through these duties had strengthened and enhanced the knowledge gained on his own farms, and vice versa.

The appellant enjoyed four RCMP career centres. These included Humbolt in 1970, Estevan in 1972, Southey in 1979 and again in 1984, and Regina in 1980 and again in 1990. He said no further transfers were expected due to the special needs of one of his children in Regina, and even if it were he said he would set up a farm at or near the new place. The RCMP employment income had increased over the years due to normal promotions and in 1990 by $5,000 because of overtime put into a murder case during Christmas.

Mrs. Hoeft testified that she has been involved in horses and horse showing since her teenage years, that she worked as a part-time nurse while on the Southey farm with her employment income going to domestic expenditures. She did the yard work, chores, some field work assistance and horse/cattle attendances.

The Southey farm

This 320 acre parcel located approximately 35 miles away from Regina was acquired in September of 1979. It was then a grain farm unsuitable for cattle or horses because it was unfenced and uncorralled and the barn lacked stalls. It was divided by a roadway. The structures in 1979 included a 785 square foot house built in 1917, a garage, a barn, a cattle shed and granaries. It had a good water supply. The purchase price was $115,000 allocated as to $98,000 for the land, $10,000 for the house and $7,000 for the old farm machinery and shop tools on hand.

During 1981-1982, 80 acres of pasture land located six miles away was rented for cattle pasturing and in 1982 another 80 acres located ten miles away was rented for horse pasturing.

The appellant sold all of his Estevan farm cattle with the exception of one milk cow. On possession of the Southey farm, the animals brought included the one cow plus six quarter horses made up of two mares, two geldings, one foal and the family’s pony. The Southey farm operation began in late 1979. The $115,000 purchase price was financed to the extent of $105,000 at 13 per cent interest with further cash infusions being required. More will be said about this later as severe undercapitalization continued to plague the venture to the close of the decade.

The farm business plan

(a) Generally

The 1979 plan, as expressed by both the appellant and his wife, encompassed the raising of quality quarter horses as well as mixed farming coupled with their desire to live on a farm such that when the appellant retired from the RCMP he could be a full-time farmer "augmenting his pension income with income from the farm". By 1992 the appellant had 22 years of service with the RCMP. He could have retired then with a pension however because there was a penalty clause if he retired before 25 years of service his choice was to wait until 1995.

At the outset (1979) the Southey farm income source was planned to be essentially from the sale of cattle, hay and quarter horses. The current plan (1992) respecting the future farm income source was to be derived from the sale of offspring from five good brood mares, the purchase and sale of more horses, the increase of the cow-calf operation to 15 cows and the continuance of alfalfa and hay production. No written financial projections in this respect were proffered. The appellant maintained that the farm’s firm capital base is now on hand along with a currently manageable interest rate so that on his retirement the farm would be at least self-sufficient if not modestly profitable. While he had originally anticipated the farm operations to have broken even by 1985, he said he did not anticipate the intervening rise in interest rates, drop in commodity prices and rising operational expenses. He urged that during the eight years under appeal he was doing all he possibly could to make a profit with what he had at his disposal. He confirmed the obvious which is that the farm's acquisition and continuance was impossible without the RCMP income and that this was a principal factor in his obtaining the 1979 credit union mortgage.

(b) The cash crop operation

During 1980 and 1981 the farm was share cropped on a one-third two-thirds basis because the appellant lacked the resources and machinery to do it himself. In 1982, with the purchase of a tractor and a cultivator, the appellant hayed, crop seeded and worked the land on his own. In 1983, 120 acres were summer fallowed and 120 acres were put into crop.

Grain prices were low in the fall of 1983. After consultations with his banker and neighbours, the appellant seeded alfalfa as well as hay the next year. This change to alfalfa was done in the hopes of increasing gross income potential which was expected to be the primary source of cash income. The anticipated return was in the range of $1.75 to $2.50 a bale times 40 to 50 bales per acre times 120 acres. If my arithmetic is correct this amounts to a range of $8,400 to $15,000 per crop year.

The appellant said the unpredictable happened during the 1985 season. Alfalfa requires a lot of moisture and drought conditions began. An early spring freeze after seeding coupled by adverse frost conditions in the fall made things even more difficult. Crop production fell far below expectations. At that time there were no alfalfa stabilization programs or hay subsidies to protect revenues. Apparently alfalfa growth assistance became available to the appellant to the extent of $12,000 each year for the first time in 1989. Drought conditions worsened during 1986 and 1987. In 1989 a crop freeze was again experienced.

The appellant said he had utilized another 90 acres on which to grow oats and grain on a rotation basis for winter feed for the animals and that the alfalfa crop was principally for cash-crop purposes.

(c) The feeder-calf operation

During the fall of 1982 nine feeder calves were purchased bringing up the numbers to 13. The intention was to feed and sell them at a profit. However during the fall of 1982 the appellant had to sell all of his cattle (some sales being premature to be profitable) in order to pay the interest debt which had become due on the credit union mortgage. The quarter horses were retained for the reason that cattle sales opportunities were more accessible with better prices to be had. This cattle liquidation apparently had precluded the loss of the whole farm. The farm's debt and borrowing details will be explored later.

The appellant said there were two reasons why he stayed out of the cattle industry until 1986. The first related to a physical injury and the second was that his then overall financial situation repressed his borrowing ability. In 1986 two dairy calves were purchased to begin a cow-calf operation with the intention of ultimately having 15 cows.

(d) The quarter horse operation

Six horses were on hand on commencement, and in 1982 a stud was purchased for the five mares then on hand. Before then a colt, that became a grand champion in Manitoba, was sold by the appellant for $1,000. However by 1982 colts were attracting only $250 each. The 1980 price had fallen within the range of $250 to $300. Apparently by 1992 prices were $700 - $800 each with yearling prices not being as good. Revenues were generated by horse sales and stud fees during the period under review.

The horse inventory was reflected as follows (the monetary values were provided by the appellant):

As noted earlier, the plan was to have five good brood mares producing profitable sales of offspring. No details were presented respecting acquisition/ production costs with anticipated net income expectations therefrom.

(e) Other

Chickens were raised for sale along with turkeys for the Christmas market.

Capital committed

(a) The farm house

I have segregated this item because, according to the evidence, considerable time, effort and money was expended respecting its improvement. This occurred at a time when, according to the appellant at least, interest rates and operational costs were high alongside dropping values for crops and cattle. As noted earlier, the appellant testified that one of the reasons he stayed out of the cattle business for the period 1983 to 1986 was due to his borrowing constraints.

There can certainly be no quarrel with the reasonableness of the needs of the appellant and his family for decent housing. That is not the issue in this appeal which is whether during this time period his farm operation as a whole was capable of being viewed, objectively, as his chief source of income either alone or in combination with his RCMP employment income.

On acquisition the house was valued at only $10,000 as it was old and of a dimension of 780 square feet. That year a small addition was made to enlarge a bathroom.

In 1980, with the assistance of a private loan in an undisclosed sum, a 450 square foot addition was made providing for a larger living room with a field stone fireplace. In 1984 a basement and new furnace were added to the house which was also re-insulated, re-sided and re-windowed. All of this resulted in the house size being doubled to approximately 1990 square feet at a total cost of some $25,000. From what I was able to gather from the loan application documents in Exhibit A-13, approximately $10,700 had been borrowed from the Credit Union in 1984 for this purpose. The funding source for the balance expended in 1984 was not disclosed.

As to the time and effort expended, the appellant said he did most of the work himself apart from digging the basement.

The upshot of this is that in 1984 funds, time and effort were being directed to and expended on the house at a time when operational losses were continuing and recommencement of the cattle operation was decided to be held in abeyance because of financial constraints.

While undoubtedly the upgrading of the house would contribute to the capital value of the farm land as a whole and thus ordinarily enter into the net capital equity computation (see infra), it does not produce farm revenue. Rather, its personal use attributes predominate over its inferred business use attributes. No evidence was advanced to the effect that the progression of the farm plan was or had been compromised in any way by inadequate housing. However even if this was the case, the issue revolves around business income sources, with an objective examination being directed to the priorities and business decisions acted upon during the relevant time which were designed to produce significant profit. It has been frankly admitted that the appellant and his wife, initially and continuously, desired and pursued a rural lifestyle and that this was to be continued into retirement years.

(b) The farm operation

By October 1992 (the trial date), a 1344 square foot cattle shed had been constructed for the cattle intended to be purchased in accordance with the current plan for farm profitability. Also completed by then was land perimeter fencing, interior yard corrals and paddocks plus three stock waterers.

The oral testimony, the particulars in Exhibit A-5, the particulars in paragraph 20 of the notice of appeal and the balance sheets provided in Exhibit A-13 provide the foundation for the following summary:

[Chart not reproduced.]

While the appellant's capital equity may have fluctuated with the market values, the debt levels did not improve. Indeed the debt became higher by 1992. Interest as a percentage of net operational losses always exceeded 50 per cent as is graphically depicted in the next summary.

The following is a reproduction of appellant's Exhibit A-2 with the column entitled "MTG. INT. RATE" being added. The foundation for these particulars arises from the Credit Union mortgage loan documents within the appellant's Exhibit A-13. The figures respecting 1991, which I have also included, originated from the appellant's tax returns filed for that year Exhibit A-6.

[Chart not reproduced.]

This summary graphically illustrates the effects arising from initial and continuous undercapitalization. The initial terms of mortgage financing called for small monthly payments of $300 per month with a very large interest balloon payment being due on annual maturity which, in November of 1982, amounted to close to $18,000. The 1982 gross income was high because of cattle liquidation to pay the interest debt. While interest rates improved thereafter, recovery of the feeder-calf operation did not.

For the 11-year period 1980 to 1991 only two years showed a very modest profit, and for all but four years the interest costs alone exceeded gross income.

Mr. Gerry Harper began his employment with the Southey Credit Union in October of 1979 as its contract manager. He was born and raised on his parents' farm. He has taken courses in industrial accounting and management training and has enjoyed ten years of experience in rural credit unions. He confirmed that the initial mortgage loan amount exceeded the normal 75 percent loan to property value ratio and that the repayment schedule was outside the normal one of a semi-annual basis to coincide with anticipated farm receipts. A cash flow analysis was not done. The appellant's ability to make the 1980 interest balloon payment was premised on the sale of quarter horses. He agreed that the loan amount and its exceptional repayment terms would not have been proffered without the appellant's RCMP income which, together with anticipated farm revenue, factored into his ability to make the payments.

Mr. Harper confirmed that Mr. Hoeft had regularly consulted him for advice and suggestions on matters concerning the cattle, hay sales and alfalfa produc- tion as a cash crop, all with the view to a better operational return. He knew that many small farmers could not pay their mortgage interest payments by farm income alone, and that these people had to have off-farm income sources either to make a living or to maintain their living standards. It was his opinion that the farm was being managed and run as a business, and that Mr. Hoeft was trying to get ahead and improve it so as to free up some of his off-farm income.

Time committed

Mr. and Mrs. Hoeft testified with respect to the particulars which made up the time commitments in the following summary, Exhibit A-4.

[Chart not reproduced.]

These time efforts were admittedly premised on averages. For the period 1983 to 1986 Mr. Hoeft conceded error as no cattle were then on hand and that therefore approximately one hour per day for 345 days, or approximately 345 hours, should be deleted annually for those years. Further, Mr. Pylypchuk's independent time estimations (Exhibit A-12) with respect to crop seeding, haying and harvesting, being based entirely and solely on information provided by Mr. Hoeft, concluded:

11. Over 10 years the average number of hours spent per year is 168.32 in performing only the duties related to seeding, haying and harvesting. This does not include items such as maintenance and repair of machinery and buildings or maintenance and care of livestock.

If the above is correct, only a small proportion of the average overall time purportedly expended on the farm operation related directly to cattle raising and field work. So the balance of time may inferentially be attributable to machinery and capital improvements, management duties, the raising and selling of chickens, eggs and turkeys plus the care, time and attention necessarily devoted to the quarter horse operation which, as noted earlier, could amount to six hours daily or at least 200 hours per horse to render it "green broke". The basic annual hourly expenditure for the horses alone could approach 2,070 hours (6 hours x 345 days) which is representative, on an average, of at least one-half of the time component.

It may reasonably be inferred that the bulk of the farm time was expended on the quarter-horse operation. No estimations were advanced respecting Mr. Hoeft's 1984 time involvement on the house renovations.

Profitability

As noted earlier, the cattle inventory was sold in the fall of 1982 to pay the interest debt and to save the farm. The foals were commanding only $250 each in 1982 and a stud was purchased in that year for the five mares on hand simply to keep this operation moving. At this time buyers were seeing horses as a luxury item.

Mr. Hoeft said he did not expect his start-up losses to be as high as they turned out to be and and that he had hoped to be at a break-even point in 1985. This failure was, he said, attributable to high interest rates, a drop in commodity prices plus rising operational expenses. Thereafter, the losses were said to be attributable to the drought effects on the alfalfa production, no insurance plans and no subsidies being available for hay.

The 1989 gross income amount of $22,227 included $14,000 received in respect of alfalfa insurance and the 1990 income included $11,000 in insurance proceeds. Apparently the 1991 loss would have been less if the hay and crops had been sold that year instead of 1992. By 1992 prices for yearlings were rising to the $600-$700 range. Mr. Hoeft acknowledged having maintained, over the 1982 to 1992 period, his horse herd at a consistent level in the hope matters would turn around.

Mr. Hoeft conceded that his losses would have been greater if capital cost allowances had been taken and that his RCMP income was essential to the support of the farm and of his family. He felt that the key to the turning of a profit on his farm was through better commodity prices, decent weather and debt reduction. He did not offer an explanation as to why $25,000 had been spent on housing improvements when the operational debt load was high, the cattle operation was in suspension and interest rates were so high that they were categorized as crippling.

Mr. Pylypchuk confirmed that he had not conducted any independent investigation into the Hoeft operation. Rather, his retainer was confined to the preparation of time estimates for the performance of crop farming operations as described by Mr. Hoeft. He did not engage in time estimates respecting either the cattle or the horse operations. Notwithstanding this, he opined that the Hoeft farm was a viable farm when taking all sources of income into consideration. He said many Saskatchewan farmers were in this situation. However he did concede, when pressed on cross-examination, that the definition of farm business viability encompassed the ability of the farm income alone to meet operating expenses and that, if the RCMP income was excluded, the Hoeft farm was not viable. This, he said, was due to its debt load. Mr. Pylypchuk stressed that during the early 1980s farmers were borrowing on the strength of their increased farm land equity which rose rapidly because of inflation. He did agree that there has been a trend towards fewer and larger farms in Western Canada since 1946. He conceded on cross-examination that during the 1980s many farmers had avoided debt by expanding only if they had funds on hand and that the average farm in Saskatchewan had enjoyed a positive net income for the period 1980 to 1990.

Analysis

The Federal Court of Appeal said in The Queen v. Poirier, [1992] 2 C.T.C. 9, 92 D.T.C. 6335, 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 respondents employment occupation. Farming comes closest to a rough equality on the time factor, but it lags far behind on the capital and income tests.

[Emphasis in original.]

The crux of Mr. Hoeft’s situation was two-fold: undercapitalization causing an unmanageable debt load and the decision to concentrate time, effort and expense on the Quarterhorses. The latter occurred during market turn downconditions. The former could not be overcome through commodity sales; it made and held the Hoefts vulnerable to all of the external events normally experienced by mixed farming ventures which include interest rate and weather variations. Here there was high ratio financing renewable annually with only a gradual long term pay down being contemplated.

There is little doubt that subjectively the Hoefts felt they were putting all they had, including time and all earnings, into the Southey farm. From an objective perspective, however, when employing the actual and potential profitability test to the 1980 to 1988 taxation years, the collective facts lead to the conclusion that farming was, apart from the time component, in a subordinate position to the RCMP employment source.

If the alfalfa crop, but for the adverse weather, had produced a net return of between $8,000 to $15,000 per year, there could have been a smaller net loss in 1987 and possibly a break even situation in 1988. The employment income enjoyed at that time was $44,657 and $45,099 respectively. Nonetheless, the debt situation did not improve over the 1980 to 1988 period. Inferentially, the anticipated cash-crop revenues may have carried the financing costs but they were not shown to have been sufficient to support the other operational shortfalls nor to have been a source for capital pay-down. The only sources for further capital infusions were from employment income and from further borrowings. In 1988 and in 1992 the debt was larger than the original debt.

Further, the 1984 commitment of time and capital to personal housing reflects a subordinate position attributable to business needs at that time as it deprived the farm of badly needed capital infusion.

Mr. Hoeft attributed his continuing operational losses to high interest rates which he said were unanticipated and beyond his control. The Southey farm was embarked upon with full knowledge of short-term high leverage financing at 13 per cent. The rate jumped to 18 per cent in 1982 causing cattle (which had been purchased) to be liquidated to save the farm. However thereafter the rate never exceeded 13 per cent and indeed remained consistently lower. This is aptly portrayed in the farm loss/profit makeup summary, supra. Even with lower interest rates in 1984 (10 A) and in 1985 f ^), Mr. Hoeft said he was unable to borrow to begin his feeder-cattle operation again. This happened in 1986 when the rate was nine per cent and after his house had been fixed up. I do not regard the above matters as falling within the category of unpredictable and non-foreseable events which nipped an otherwise good plan in the bud. The farm's undercapitalization was self-imposed as was the decision to take on a mortgage rate on an annual basis.

Having regard to all of the circumstances, the facts support the conclusion that throughout 1980 to 1988 inclusive taxation years, the farm began and remained in a subservient position to Mr. Hoeft's RCMP employment source and indeed was dependent upon it as was his personal and family needs.

Mr. Hoeft has a heavy burden in that he must establish on a balance of probabilities the reasonableness of the farm's predicted profitability, that it will be significantly profitable in comparison to his other income sources, and that such would occur within a reasonable time frame: see, The Queen v. Morrissey, [1989] 1 C.T.C. 235, 89 D.T.C. 5080 (F.C.A.), Gordon v. The Queen, [1989] 2 C.T.C. 277, 89 D.T.C. 5481 (F.C.A.), Roney v. M.N.R., [1991] 1 C.T.C. 280, 91 D.T.C. 5148 (F.C.A.), Connell v. The Queen, supra, and The Queen v. Poirier, supra.

In my view Mr. Hoeft has fallen short of establishing that during the 1980 to 1988 taxation years the Southey farm operation would have been, within a reasonable time frame, significantly profitable in comparison to his RCMP employment income. Indeed both Mr. and Mrs. Hoeft anticipated at the outset that, post retirement, the farm source would merely augment Mr. Hoeft's pension income.

The final aspect I wish to address is the appellant's position that the 1980 to 1988 losses represented start-up costs which at the outset were expected to end by 1985. The answer which is unfavourable to this position is found in Roney v. M.N.R., supra, at page 288 (D.T.C. 5155):

Start-up costs, contrary to what the trial judge said, cannot be considered as the basis for an alternative ground of decision. The permissible amount to be deducted depends on the class the taxpayer finds himself in. Indeed, Dickson, J., as quoted by the trial judge, said the following in Moldowan: "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."

Read in context however it is clear that Dickson, J. is referring to the class (1) taxpayer. This, in turn, brings us back to the issue I first dealt with. For the reasons given there, I have concluded that the respondent is not a class (1) taxpayer.

[Emphasis in original.]

Having determined that Mr. Hoeft has not shown the Southey farm to have been a chief source of income for him, the aspect of start-up costs cannot found a separate basis for judgment.

Conclusion

For the reasons given, the appeals are to be dismissed.

Appeals dismissed.