Dr. John v. Hover v. Minister of National Revenue, [1993] 1 CTC 2585, 93 DTC 98

Bowman, T.C.C.J.:—For the 1984, 1985 and 1986 taxation years, the appellant was reassessed on the basis that his chief source of income was neither farming nor a combination of farming and some other source of income. Accordingly, the Minister of National Revenue 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 losses from the business of farming carried on by him to $5,000 in each of those years.

The appellant challenges the assessments on two bases:

1. He alleges that section 31 of the Act, insofar as it has been applied to him in his 1985 and 1986 taxation years, is of no force or effect because it is contrary to section 15 of the Canadian Charter of Rights and Freedoms; and

2. he alleges further, with respect to all three years under appeal, that section 31 of the Act has no application because his chief source of income was a combination of farming and some other source of income, viz., the practice of dentistry.

The Charter question

Section 31 of the Act creates a separate classification of farmers whose chief source of income is neither farming nor a combination of farming and some other source of income. Persons, natural or corporate, who fall into this category — essentially category Il farmers in the classification enunciated by Dickson, J., 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 at pages 487-88 (C.T.C. 315, D.T.C. 5216) — are denied the right to deduct farming losses in excess of $5,000 against income other than farming income. It is this restriction that the appellant submits contravenes his right of equality under subsection 15(1) of the Charter. That section came into effect on April 17, 1985, and reads as follows:

15(1) Every individual is equal before and under the law and has the right to the equal protection and equal benefit of the law without discrimination and, in particular, without discrimination based on race, national or ethnic origin, colour, religion, sex, age or mental or physical disability.

The French version is as follows:

15(1) La loi ne fait acception de personne et s'applique également à tous, et tous ont droit à la même protection et au même bénéfice de la loi, indépendamment de toute discrimination, notamment des discriminations fondées sur la race, l'origine nationale ou ethnique, la couleur, la religion, le sexe, l'âge ou les déficiences mentales ou physiques.

The question is fairly justiciable. Section 31 of the Act, as well as its predecessor section 13, has been the subject of numerous cases and much learned commentary, a discussion paper issued by the Department of Finance, and occasional legislative proposals which have come to naught. It has been criticized as being unfair, draconian, inappropriate to the fiscal objectives which it seeks to achieve and incomprehensible. It has been the subject of one unsuccessful challenge under section 7 of the Charter in Fleming et al. v. M.N.R., [1986] 2 C.T.C. 2192, 86 D.T.C. 1628 (T.C.C.). This is however, the first time that section 15 has been invoked.

It is the position of the appellant that the legislative impact on him of section 31 of the Act is discriminatory in the sense in which that expression is used in Law Society of British Columbia v. Andrews, [1989] 1 S.C.R. 143, [1989] 2 W.W.R. 289. In a broad sense it might be said that any fiscal law that dictates different treatment for different classes of persons discriminates among those classes. Yet the Act abounds in such distinctions. Farmers are treated differently from those engaged in manufacturing who in turn receive a different treatment from those engaged in the resource industry. Employees are treated differently from persons in business. Married persons are accorded treatment that differs from that accorded to single persons. [1]

It must be recognized that taxing statutes have economic and social objectives that far transcend the mere raising of money and it is difficult to conceive of any way in which a modern industrialized state such as Canada could avoid making such distinctions in its fiscal legislation. Such distinctions may appear superficially to be arbitrary and possibly unfair and the appellant has raised squarely whether the category to which the Minister's assessment under section 31 relegates him in the fiscal scheme of things infringes upon his right of equality under the Charter.

In considering this question, one cannot view section 31 in isolation or attempt to excise it from the complex code that governs farmers generally under the Act. It is not only category II farmers that are singled out for special treatment. Farmers generally enjoy a variety of advantages not accorded to other taxpayers such, to mention only a few, as the right to use the cash basis of accounting, family farm rollovers, accelerated capital cost allowance on certain property, current deductibility of certain expenses that would otherwise be regarded as capital, block averaging, and the exemption from the requirement to make quarterly instalments. Many more examples might be cited but they serve to illustrate the virtual impossibility of striking down as discriminatory one aspect of a complex code of fiscal legislation dealing with a particular segment of the community without doing violence to the overall scheme envisaged by Parliament. As stated by McIntyre, J. in Andrews at page 168 (W.W.R. 303):

It is not every distinction or differentiation in treatment at law which will transgress the equality guarantees of section 15 of the Charter. It is, of course, obvious that legislatures may—and to govern effectively—must treat different individuals and groups in different ways. Indeed, such distinctions are one of the main preoccupations of legislatures. The classifying of individuals and groups, the making of different provisions respecting such groups, the application of different rules, regulations, requirements and qualifications to different persons is necessary for the governance of modern society.

For the appellant to succeed on this aspect of his case he must establish that the discrimination of which he complains is based upon the enumerated grounds set out in section 15 of the Charter or grounds analogous thereto. The appellant's contention is that the "discrete and insular minority” (see U.S. v. Carolene Prod. Co., 304 U.S. 144 at 152-53, referred to in Law Society of British Columbia v. Andrews, supra.) to which he belongs is that group of farmers who have other sources of income and that the very fact of their special treatment under section 31 is sufficient to make the special treatment of such a group discriminatory on grounds analogous to those enumerated in section 15.

I am, notwithstanding Mr. Shea's thorough and articulate submission, unable to accept this argument. There is a world of difference between persons who are accorded unequal treatment under the law because of personal characteristics over which they have no control such as race, colour, sex, age, citizenship or mental or physical disability and persons who voluntarily choose a form of economic activity which carries with it a mix of fiscal advantages and disadvantages. The latter do not, in my view, form a discrete or insular minority in the sense in which the expression has been used in Andrews. It is not open

where he said, in speaking of the Charter, that "It seems to me to that it comes very close to trivializing that very important constitutional law, if it is used to get into the weighing and balancing of the nuts and bolts of taxing statutes."

The Charter is the supreme law of Canada. It is fair to say that the Income Tax Act has an impact on more Canadians than any other federal statute. I have difficulty in seeing how the Charter is trivialized by subjecting so important a piece of fiscal legislation in appropriate cases to the scrutiny of the courts under the Charter.

to such persons to invoke the Charter to enable them to avoid the fiscal burdens of the economic endeavour that they have chosen and yet retain the benefits. To give effect to such a contention would be to distort the purpose of the Charter. [2]

I have therefore concluded, on this aspect of the case, that the appellants rights of equality under section 15 of the Charter have not been infringed by the Minister's application to him of section 31 of the Act. It is therefore not necessary for me to consider the respondent's alternative argument that, if I had found discrimination under section 15, such discrimination is justified under section 1 of the Charter.

The section 31 question

I turn now to an analysis of the Minister’s conclusion that section 31 of the Act restricts the appellant's farming losses in the years in question. That conclusion is based upon the premise that the appellant's chief source of income in 1984, 1985 and 1986 was neither farming nor a combination of farming and some other source of income. Counsel for the appellant did not contend that the appellant's chief source of income was farming, but contended that it was a combination of farming and dentistry.

One preliminary point should be dealt with immediately. In the course of his argument on section 15 of the Charter, counsel for the respondent contended that in each case, including this one, in which section 31 is applied, the Minister makes a determination under subsection 31(2) of the Act. Counsel did not stress this argument in his submissions on the section 31 issue but since the point was raised it should be mentioned. Subsection 31(2), as well as its predecessor subsection 13(2), has been in the Act since its introduction in 1952. It has not been used in many years. The application, in the ordinary course of assessing tax, of subsection 31(1) of the Act is not tantamount to a formal determination under subsection 31(2). Subsection 31(2) confers upon the Minister certain discretionary powers, the exercise of which is subject to review in accordance with the principles set forth in M.N.R. v. Wright's Canadian Ropes Ltd., [1947] C.T.C. 1, 2 D.T.C. 927 (P.C.). Had a formal determination been made different considerations might apply. None having been made the court treated the appeal as an ordinary appeal from an assessment and considered whether, on the evidence, the assessment was correct or incorrect, and not as a review of the correctness of the procedures and principles followed by the Minister in making a determination. See Vincent v. M.N.R., [1966] S.C.R. 374, [1966] C.T.C. 147, 66 D.T.C. 5123; cf. M.N.R. v. Robertson, [1954] C.T.C. 110, 54 D.T.C. 1062 (Exch. Ct.).

Facts

The appellant lives and works as a dental surgeon in Lethbridge, Alberta. He also operates a farm ten miles west of Lethbridge. He has practised in the dental field since 1975. He began his farming operation in 1984 which has to this date involved various crops, buffalo, Arabian horses and Charolais cattle.

The appellant testified that he had always loved farming. As a child he spent a significant amount of time on farms. He lived on his parents’ farm until he was six years of age. As he grew older, he spent many summers on his grandparents’ farm or on the farms of friends of the family.

He attended the dental school at Loma Linda University in southern California, U.S.A. He appeared to me to be a very energetic, industrious and highly motivated person. He put himself through dental school and graduated in 1974, a year ahead of his class at the age of 23, all the while participating in a variety of sports.

In 1975, he joined his father's dental practice in Lethbridge and worked for him for about a year and then he set up his own practice operating as Vince Hover Professional Corporation. It is a highly specialized practice of reconstructive dentistry. He stated that his dental patients consisted of some of the most successful farmers and agriculturalists in Alberta. He discussed with them in some detail the business of farming in Alberta. He testified that he liked the lifestyle of farming and that the stress of the dental practice, especially with respect to the risk of contracting communicable diseases, his back condition, and his injury to his hand all influenced his desire to enter the farming business.

Having acquired some capital to start up a farming business, he began to look seriously for a farm in 1980. In 1984, after nine years in the dental profession, in furtherance of his ambition to take up farming, he sought out and purchased land close to his dental practice. One main criterion was that the land have irrigation or water rights; he did not want to be totally dependent on the weather. His first property, consisting of about 610 acres, was purchased from a Mr. Art Berte for $525,000. The Berte property had two dilapidated houses which were used to house farm employees. Although an irrigation system was already in place on the Berte property, he testified that he planned to expand the number of acres under irrigation from about 100 acres to about 500 acres. In fact, he managed to increase the productivity of the Berte property by almost doubling the amount of land under irrigation to about 200 acres; he cleared and levelled the land at a cost of $12,000 and to add to the two existing irrigation lines, he bought two more with irrigation pumping units for a total expenditure of approximately $50,000.

Within the next six months or so of having bought the Berte property, he proceeded to acquire additional adjacent lands known as the Davis and Crawford properties. The Davis property consisted of 160 acres of dry arable land which was purchased for about $125,000. The Crawford property consisted of 125 acres of pasture land and was purchased for $145,000. It was bought as part of a long-term plan for a horse operation. During the years in question, he received only a few thousand dollars in income each year from this property by allowing his neighbours to graze their horses on it. He testified that he did not have the cash at that time to bring this land to its full potential. I have no difficulty in accepting this statement in light of the large amounts of money that he had been spending on the farming operation. In sum, he had thus acquired a land base of about 900 acres. Of this 900 acres, only 460 are under cultivation — approximately 200 acres are irrigated and 260 acres are used for dry land cultivation.

In 1984, the first year of his farming operation, his actions were consistent with a man who was serious about farming. He testified that he planted canola because at that time it was a high revenue crop and he wanted to maximize the first year's revenue. Moreover, instead of investing in expensive equipment at that time for the relatively small acreage he had acquired, he hired his neighbour to do the initial seeding and combining. His canola crop for the year brought in income in the amount of $12,503.03. It did not produce the ex- pected income because of the unusually dry and windy weather that year — a phenomenon that persisted throughout the taxation years in question. On reassessment, the appellants farm loss was assessed to be $62,037.24 which was restricted by virtue of section 31 to $5,000.

Furthermore, the appellant testified that he became interested in setting up a buffalo operation; he wanted to utilize the pasture with livestock that he believed would produce twice the revenue that a cow-calf operation would and be less labour intensive. So, in the winter of 1984 he and his employee had put up the heavy type of fencing required to hold buffalo and then he acquired a small number of buffalo in the following years to test how they would manage on the land.

In the second year of his farming operation, 1985, he planted alfalfa with barley as a cover crop. He received revenue of $20,434.98 for forage crops out of an expected revenue of $50,000. He stated that he did not receive the maximum revenue for the alfalfa crop because it takes three years to bring alfalfa to maximum productivity. He testified moreover that he failed to achieve his projected revenues because of the decline in commodity prices, weather conditions and moratoria on irrigation. Insurance proceeds for the loss of crops in the amount of $17,892.59 in part supports his assertion. He had a total of $59,496 of gross farm income. On reassessment, his farm loss for 1985 was assessed at $221,861 which was again restricted to $5,000 by the application of section 31.

In the same year, he began his horse operation. He paid $36,791.40 and acquired two Arabian mares, one of which was pregnant, and one other horse which was used around the farm. In the following year he purchased syndicated shares in two stallions. His syndicated shares were later sold and applied to the purchase price of the other horses; by 1988 the market for Arabian horses had turned for the worse and he suffered some losses on syndicated shares in stallions. His horse operation has just recently shown some signs of profit. Three of his mares have been bred to a two-time U.S. National Champion stallion. One of his mares has won a $6,000 prize and there is a standing offer of $60,000 for the mare. The appellant had paid only $20,000. Eight offspring of the renowned champion horse are expected to fetch substantial revenues in the next year or two.

In 1986, the third year of his farming operation, his barley crop yielded $15,398.39 and his forage crop $31,085.85. He had income from breeding fees in the amount of $4,250. He received crop insurance proceeds in the amount of $9,923.65. His gross farm income for the year was $125,920.64 which was substantially below his projections. On reassessment his farm loss was assessed at $205,186 and restricted to $5,000.

In 1987, he received $3,024.52 for barley, $16,695.92 for hay, and $10,000 for breeding fees. He reported gross farm income of $67,603.85 and a farming loss of $291,711.53. He stated thatit was another dry year and the commodity prices dropped in half. Consequently, he only received between $60 and $70 per tonne of hay, whereas in the previous year he received almost double that amount per tonne.

Beginning in 1988, the appellant attempted to expand his buffalo operation and begin a Charolais cow-calf operation. Pursuant to these plans, he hired a Mr. Hubert Barry, an experienced farmer and ranch manager in the fall of 1988. Mr. Barry, in my opinion, is an experienced farmer. He has had his own farm for most of his life. Moreover, he had experience in making unprofitable farms profitable. The appellant and Mr. Barry signed what seems to me a somewhat unusual contract. It was a four year quasi-employment and quasi-partnership contract with an optional three-year extension. It was agreed that, as farm manager, Mr. Barry was to receive a modest salary with an opportunity to participate in the profits of the farm. Both the appellant and Mr. Barry testified that this arrangement was entered into with the view of keeping costs down and maximizing profits. Mr. Barry testified that he saw that the three-year option was necessary because it was those years in which he believed he would be able to share in the profits. He further testified that he still believes the farm will become profitable and is willing to stay on for the optional three years.

In the fall of 1988, the appellant entered into negotiations with Ross Adam, a major buffalo producer, operating under the name of Adam Ranches. The appellant was supposed to become a feedlot operator. He was to have fed buffalo to a specific weight and sold them back to Adam Ranches. The negotiations, however, failed because Adam Ranches could not provide "bank guarantees” to the appellant. Consequently, in 1989, the appellant sold the small buffalo herd he had acquired in previous years at a small loss and decided to concentrate on the Charolais operation.

In December of 1988, the appellant purchased 150 cow-calf units for $150,000 from a large producer of Charolais cattle, a Mr. Bill Wilson of Charwell Ranch. $75,000 of the purchase price was to be paid by way of 1,000 tonnes of hay at the rate of $75 per tonne on or before March 15, 1990. The contract provided for the buy-back of all the calves produced at meat market price plus $100 per head within three years. Pursuant to this contract with Mr. Wilson, they leased 500 acres from Katherine and Andy Lopushinsky of hay producing land closer to Charwell Ranch; this land was to provide hay for Charwell as partial payment for the 150 units of Charolais. The Lopushinskys and the appellant entered into a four-year lease contract starting from May 1 of 1989 in which the appellant agreed to pay $10,000 per year.

In preparation for the growth in the livestock operation, the appellant leased approximately 2,000 acres of Blood Indian Reserve land that bordered on his property to which he had easy access. He began to fence the leased Reservation lands in return for some cash credit against the lease payments. He had hoped to lease more cultivated land on the reserve in order to better utilize the $500,000 worth of farm equipment that they were in the process of acquiring. The lessors were pleased with the improvement that the appellant had made to their property and they agreed to lease him an additional 3,000 cultivated acres in time for the 1990 season. His plan was to grow wheat which he estimated to produce $420,000 in gross revenue.

In 1988, 1989, 1990 and 1991, the appellant continued to report significant farm losses ranging from $116,000 in 1989 to over $312,000 in 1990. It is noteworthy, however, that his cash revenue has been steadily increasing from a low of $137,351 in 1989 to a high of $312,430 in 1991.

By 1990, the appellant had made commitments to buy farm machinery and to lease the Indian Reserve lands. He had estimated that in 1990 the farm would bring in gross revenues in excess of $600,000. He estimated that his taxable farm income for that year would be approximately $150,000.

In the spring of 1990, Revenue Canada restricted his farm losses for prior years. The appellant testified that this created problems for him with the Royal Bank who were concerned over the potential large reassessment. The bank refused to extend any more credit and demanded that he pay down the debt. He reduced the debt from $700,000 to $300,000 by selling a great number of his Charolais which compromised his ability to make a profit. He now only has 100 head remaining. [3]

He decided not to continue with his plans on the arable land on the reserve because of Revenue Canada's decision to restrict his farm losses. As a result he states that he was forced to abandon the dry land which he had leased from the reserve. He lost the advantage of all the fencing he had put up on that property. By this time he had purchased almost half a million dollars in John Deere equipment. Consequently, he put aside all expansion plans, pending the outcome of this appeal.

I turn now to the question whether the appellant's ability to make a profit during the years in question was caused by moratoria on irrigation. The appellant testified that he believed that a moratorium was placed on irrigation from Oldman River some time in 1985 because too much water was being diverted for irrigation. In fact no moratorium was placed on the Oldman River until July of 1988. In 1984, he had approached Prairie Farm Rehabilitation Administration (PFRA) to aid him in obtaining expanded irrigation rights on the Berte property. PFRA assists farmers in making application to Alberta Environment, Water Resources Branch. Also involved in the application process is Alberta Agriculture which assists by performing an agricultural feasibility study. In April of 1988, PFRA submitted a plan for the appellant's irrigation project to Alberta Environment, Water Rights Branch. The appellant was informed at that time by Alberta Environment that an application for increased water diversion was now required.

By July 1, 1988, a moratorium was placed on the issuance of any further irrigation licences for the withdrawal of water from the Oldman River. Irrigation applications which were received in the Water Rights Branch of Alberta Environment prior to July 1988 were exempted from the moratorium. The appellant's application was not completed prior to July 1 of 1988. It was, however, given a priority and was held in abeyance until the moratorium was lifted in the spring of this year. In short, no moratorium stopped the appellant from applying for expanded irrigation rights on the Berte property prior to July of 1988. He testified that he was operating under the assumption that there was a moratorium since about 1985. The appellant could have completed an application for irrigation licence to the Water Resources Branch before the moratorium in 1988 but failed to do so.

The appellant testified that in respect of the Davis property he applied in 1984 to Lethbridge Northern Irrigation District (LNID) for irrigation rights. He testified that he secured permission pending the lifting of the moratorium. Officials came out to his farm and studied the soil and made out a favourable feasibility report. He testified that he had not heard of a moratorium prior to his having submitted an application, except in drought years. LNID placed a moratorium on issuing new irrigation licences in 1976. With respect to the Davis property, the only thing that held him back, he suggests, was finances.

The appellant made much of the fact that irrigation was crucial to his farm and I do not question that this was indeed so. Yet he appears to have been uncertain of the details of any moratorium that was in place and he neglected to pursue actively his application for irrigation licences, whether as the result of dilatoriness, lack of finances, other pressures or carelessness.

The appellant testified that because of the moratorium he failed to put his planned 500 acres into alfalfa production because he could not irrigate the extra 300 acres of the land. The appellant expected that had he been able to irrigate the extra 300 acres, subject to weather and market conditions, he would receive $50,000 per hundred acres of hay which would have generated a quarter of a million dollars.

When the appellant bought the farm, his plan was to reduce the number of hours worked in the practice of dentistry by 25 per cent so as to protect his longevity and staying power in the dental practice. He wanted to restrict his practice to his field of expertise which was reconstructive dentistry. At the time he began farming, in 1984, about 50 per cent of his dental practice time was devoted to reconstructive dentistry and 50 per cent to general dentistry. He wanted to increase his work in reconstructive surgery to 80 or 90 per cent and to hire an associate to take over the general aspects of dental practice. He envisioned that he would work some four or five hours each weekday and then spend the rest of the time with the farm operation. He testified that he was forced to work more hours than he had planned because of the cash drain of starting up the farm and the poor conditions for farming during the taxation years in question. On the whole I accept the appellant's evidence as credible, notwithstanding certain inconsistencies with respect to the moratorium on water use, and notwithstanding his occasional lapses into hyperbole.

The appellant stated that during the years in question, he reduced the amount of time devoted to his dental practice in order to start up and conduct his farming operation. It was only because of problems with the bank brought on by Revenue Canada's decision to deny the appellant full losses that he has had to increase his hours in the dental practice and cut back on expansion plans in order to keep his farming operations viable. Throughout the period he had employees who assisted him in the farming operation.

During haying season he would spend more time on the farm than in the off-season. In my opinion, as a rough estimate the appellant spent on average somewhat less time on the farm than in his dental practice. The appellant has spent on average at least 15 to 20 hours a week on the farm itself. The hours would, of course, significantly increase during haying season. He testified that he also spent a significant amount of time in the dental office concerning himself with the farm. I daresay the statement is substantially correct. The taxpayer's family life changed. The amount of time that the appellant spends on the farm has had a negative impact on personal time devoted to his wife and children.

The appellant is a member of numerous dental organizations both in the United States and in Canada. He has attended continuing education courses and conferences to remain in good standing with the Alberta Dental Association. There seems to be no reason why an adverse inference should be made because he wished to keep abreast of the developments in dentistry. The appellant testified that he wanted to work part time in his field of expertise — reconstructive or implant dentistry — so long as his health would allow him.

By 1984, the appellant had invested approximately $200,000 in setting up his dental practice. His investment in the farming operation is several multiples of this figure. In fact, in the three years under appeal, his capital investment in the farm is as follows:

His investment in fencing and equipment since that time would bring the figure to upwards of $1,700,000.

The appellant has made investments in oil and gas and various investment properties in other provinces and in the United States. But it should be noted that his investments in these areas were significantly wound down after he entered into the farming business.

From 1984 to 1991 his employment income from Vince Hover Professional Corporation ranged from a low of $157,000 in 1989 to a high of $370,964 in 1987.

On the basis of these facts I must decide whether, in accordance with the principles enunciated in Moldowan the appellant has established that his chief source of income is a combination of farming and dentistry. It is no easy task.

I take as my point of embarkation the statement of Mr. Justice Marceau in Connell v. The Queen, [1992] 1 C.T.C. 182, 92 D.T.C. 6134 (F.C.A.) where he said:

As we understand the analysis 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"), made by Mr. Justice Dickson (as he then was) in the now famous Moldowan case, 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.

[Emphasis added.]

His Lordship then observed that in weighing and analyzing the basic factors referred to by Dickson, J. in the Moldowan case, of time, mode of living and profitability, a court must assess them cumulatively rather than disjunctively, in accordance with the decision of the Federal Court of Appeal in The Queen v. Morrissey, [1989] 1 C.T.C. 235, 89 D.T.C. 5080. By this I understand the court to mean that no single factor may be taken as determinative in isolation. The approach is consistent with, and reminiscent of that adopted by the Supreme Court of Canada, admittedly in an entirely different context, in M.N.R. v. Algoma Central Railway, [1968] S.C.R. 447, [1968] C.T.C. 161, 68 D.T.C. 5096, where Fauteux, J. quoted with approval the following statement of Lord Pearce of the Privy Council in B.P. Australia Ltd. v. Commissioner of Taxation of the Commonwealth of Australia, [1966] A.C. 224 at page 264:

The solution to the problem is not to be found by any rigid test or description. It has to be derived from many aspects of the whole set of circumstances some of which may point in one direction, some in the other. One consideration may point so Clearly that it dominates other and vaguer indications in the contrary direction. It is a commonsense appreciation of all the guiding features which must provide the ultimate answer.

In a similar vein the Federal Court of Appeal stated in The Queen v. Poirier, [1992] 2 C.T.C. 9, 92 D.T.C. 6335 at page 10 (D.T.C. 6336):

It must be remembered that it is the cumulative impact of the various factors for determination that governs, not any one factor taken disjunctively: Morrissey v. The Queen, [1989] 2 F.C. 418, [1989] 1 C.T.C. 235, 89 D.T.C. 5080 (F.C.A.) and Connell, supra (F.C.A.).

Although the Moldowan case has been quoted to a greater or lesser extent in virtually every farming loss case since 1977 it assists in focusing on the criteria to be considered to set out the relevant passages from the reasons for judgment of the Court, bearing in mind the admonition that the words of the court are not to be parsed and analyzed with the same degree of particularity as one would employ in the interpretation of a statute. Rather they are guidelines of high authority that lower courts must endeavour to apply to the particular facts before them. I propose therefore to set forth the relevant passages from Moldowan and to attempt to apply them to the facts in this case.

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, 28 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.

It was not pleaded or contended by the respondent that the appellant did not have a "reasonable expectation of profit”. The relevance of the expression in the context of section 31 is that to obtain even the limited deduction granted by section 31 the taxpayer must have a business. Without a reasonable expectation of profit no business exists. That is not in issue here. 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 (see Morrissey at pages 241-42 (D.T.C. 5084)). Here, however, the facts do not support such an inference. The appellant's gross farm income increased each year. In 1988 he hired a farm manager, Mr. Barry, an impressive witness with outstanding qualifications. Mr. Barry's testimony persuaded me that the operation had the potential of yielding significant profits, even in comparison to Dr. Hover's income from dentistry.

I was somewhat less impressed with the evidence contained in Exhibit A-14 which purported to show that by 1991 the farming operation would be profitable, providing that the interest paid were excluded from the calculation. As a comparison with the appellant's income from his dental practice the document is not particularly helpful in that the farming income was computed on a cash basis whereas the income of his dental practice carried on by Dr. Hover's corporation was computed in accordance with the accrual method of accounting. Moreover, Dr. Hover personally was an employee of his corporation.

To revert to the passage from Moldowan quoted above, it is patent on the evidence that Dr. Hover was not in operating his farm merely indulging in a hobby. Indeed I I find it inconceivable that a person of his drive and intelligence would have devoted the time, energy and capital to the farming operation without reasonably expecting to earn substantial profits. One cannot draw an adverse inference from the lack of profit in the early years given the magnitude of the intended operation. The start-up costs were necessarily high and a combination of factors such as the drought and the fall in commodity prices contributed to the lack of profitability in later years. It is impossible to determine what his profits might have been had he not been forced to abandon the leasing of the Indian Reserve lands by the bank's withdrawal of financing resulting from the impending section 31 assessment. It does however seem probable that the operation of the Indian Reserve lands could have yielded substantial profits.

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.

Each of the tests cited by Dickson, J. — whether viewed disjunctively or, as we are instructed to do, cumulatively — leads to the conclusion that 1984 marked the commencement of a shift in the content of the economic activities undertaken by Dr. Hover with a view to earning his livelihood. Prior to 1984 his economic activities and the focus of his life consisted exclusively of dentistry. His objective in making the shift was ultimately to devote a preponderance of time and attention to farming with dentistry playing a subordinate role. The years in question marked a transition in which those activities consisted of a combination of farming and dentistry, the two being necessarily financially interdependent. His commitment of time and capital, his expectation of profit and the dramatic change in his work habits and his dedication to the farming operation, on the evidence, support this conclusion.

At pages 486-87 (C.T.C. 314, D.T.C. 5216):

There has been difference of opinion on whether the word “ combination” in subsection 13(1) requires some “connection” by way of physical relationship or integration or interconnection between farming and the subordinate activity which provides another source of income. Paragraph 3(f) of the Income War Tax Act of 1917, as amended, made reference to” connection” in defining the permissible deductions from income derived from the chief business, trade, profession or occupation of the taxpayer in determining his taxable income. Paragraph 3(f) read:

(f) deficits or losses sustained in transactions entered into for profit but not connected with the chief business, trade, profession or occupation of the taxpayer shall not be deducted from income derived from the chief business, trade, profession or occupation of the taxpayer in determining his taxable income.

The word "connected" is not found in section 13 of the present Act. As Thorson, P. said, obiter, in Simpson v. M.N.R., [1961] C.T.C. 174, 61 D.T.C. 1117, there is no reason why there must be such a limitation. I share this view. See also Dorfman v. M.N.R., supra, at page 154 (D.T.C. 6134) and James v. M.N.R., [1973] C.T.C. 457, 73 D.T.C. 5333 at page 464.

It is clear that "combination" in section 13 cannot mean simple addition of two sources of income for any taxpayer. That would lead to the result that a taxpayer could combine his farming loss with his most important other source of income, thereby constituting his chief source. I do not think subsection 13(1) can be properly so construed. Such a construction would mean that the limitation of the section would never apply and, in every case, the taxpayer could deduct the full amount of farming losses.

The aspect of “combination” causes me concern. We have it on high authority that there is no reason why there should be any connection between farming and another source of income with which it is combined to create a chief source of income. We have it on equally high authority that a "combination" cannot mean a mere addition of two sources (see also Poirier, supra). I am faced therefore with the conceptual problem of determining whether two unconnected sources of income which bear no physical relationship to one another can be combined into one chief source. The Supreme Court of Canada dealt with the question in the following frequently quoted passage in Moldowan 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.

The portion of the passage quoted that causes me concern is contained in the description of a category Il farmer, in the words “farming and some subordinate source of income” (emphasis added) and in the subsequent portion:

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.

[Emphasis added.]

The same language was used by the Federal Court of Appeal in The Queen v. Roney, [1991] 1 C.T.C. 280, 91 D.T.C. 5148 at page 286 (D.T.C. 5153-54). At page 288 (D.T.C. 5155), Desjardins, J.A., speaking for the Court states:

In the light of the evidence before us, I do not think that the respondent, in the taxation year 1975, was a person whose major preoccupation was farming. He was someone who was testing the water, so to speak. For him, farming was a sideline.

The same cannot be said of Dr. Hover. Farming was for him no sideline nor was he merely testing the water. He had plunged fully and without reservation into the water. As early as 1984, and increasingly thereafter, it was for him a major preoccupation. [4] If Class ll farmers are those who carry on farming as a sideline business, as Moldowan and Roney suggest, I cannot conclude that Dr. Hover falls into that category. His commitment of time, capital, energy and dedication to farming precludes such a finding.

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 expenditures 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.

I have not cited all of the cases decided under section 31. They are legion. Each turns on its own facts. For example, a case bearing a superficial resemblance to this one is MacRae v. The Queen, [1988] 2 C.T.C. 233, 88 D.T.C. 6454 (F.C.T.D.); aff'd [1990] 1 C.T.C. 15, 89 D.T.C. 5526 (F.C.A.). Both appellants were Alberta dentists. There the resemblance ends. The trial judge, Jerome, J., whose findings of facts were not disturbed by the Federal Court of Appeal, found on the evidence that farming was a mere sideline operation with no realistic prospect of ever becoming a chief source of income, alone or in combination. Such a finding is not open to me on the evidence in this case.

In this case the appellant's dedication to farming, the time that he spent, although possibly less than that which he was obliged to spend in his dental practice, and his commitment of capital all lead to the conclusion that farming was not a sideline business but rather the central focus of his life. To achieve that end the practice of dentistry was an essential adjunct but one which while not subordinate in terms of the generation of cash was nonetheless subordinated to Dr. Hover's overall objective. Dr. Hover's situation is a far cry from that in Moldowan which Dickson, J. described as follows at pages 488-89 (C.T.C. 315-16, D.T.C. 5216-17):

In the instant case, it is common ground that the appellant was farming and that his farming constituted a source of income. There are concurrent findings below that farming was not his chief source of income. I would not disturb those findings. Additionally, I do not think it can fairly be said that appellant was a person whose chief source of income was a combination of farming and some other source of income in the sense I have indicated. He devoted considerable effort towards launching new ventures. Horse-racing consumed only several hours of his day and that for part of the year only. His commitment of capital was cautious. The nature of the enterprise is risky. It is difficult reasonably to plan to devote energies to it principally in the expectation of a steady living. He suffered constant and increasing losses with the exception of two years in which minor profits were made. Although none of the above is alone determinative, together they suggest only one business venture of several, with nothing distinguishing in the way of "a chief source of income.”

It is not surprising on these facts that Mr. Moldowan was unsuccessful. The observations of Dickson, J. do however illustrate the type of factors that should impel a court to dismiss a taxpayer's appeal against an assessment under section 31. None of those factors is present in this case.

A case which bears a much closer factual resemblance to the present one is Hadley v. The Queen, [1985] 1 C.T.C. 62, 85 D.T.C. 5058. In that case, Joyal, J. of the Federal Court-Trial Division found that the taxpayer, a chartered accountant and a successful automobile dealer, was entitled to deduct in full his farming losses, notwithstanding substantial income from other businesses, particularly the automobile business. The appellant spent a significant amount of time in his other businesses but he devoted a great deal of attention to the farming operation, and provided it with its commercial stimulus and direction. The enterprise failed and ultimately he disposed of it— something the appellant has not done and has given no indication of intending to do. His commitment of capital was substantial but not of the order of magnitude of the appellant's in this case. Joyal, J. considered the capital investment as an important factor as indicating a serious new commitment and new orientation sufficient to bring the taxpayer into the first category of farmer described by Dickson, J. At pages 68-69 (D.T.C. 5063-64) Joyal, J. said:

I also find in the considerations and factors outlined in the Moldowan case that they do not need all to be of equal value. Their individual importance depends on all the circumstances of an individual case. One such factor which might predominate over the others is the amount of capital the plaintiff committed to his farming venture. If the plaintiff argues new direction, new orientation, or new commitments to bring himself within the first category defined in the Moldowan case, the quantum element alone of his capital investment provides the plaintiff with pretty good credibility. It gives force to the several arguments advanced by the plaintiff's counsel and overcomes the incredulity which an ex post facto analysis of actual performance attracts to the case.

The findings I have made with respect to the plaintiff's farming operations must be viewed within the framework of intentions and expectations. While it is true that the operations, as financially unsuccessful as they were, might indicate prima facie that the plaintiff should come within the second category of “sideline” operators as articulated by Dickson, J. in the Moldowan case, the plaintiff's intentions and expectations are, in my view, material to the conclusions I have drawn. To a great extent, in reviewing past history, a trier of facts must adopt something akin to an armchair approach as that expression is used in the interpretation of testamentary instruments. The intentions and expectations must be analyzed in the light of the taxpayer's activities and of the economic situation relating to beef farming which existed at that time.

Expert evidence by Dr. Martin is conclusive that in 1973, the profitability of the beef market was buoyant. Cattle prices in 1973 were high and indeed, the industry had enjoyed an experience of rising prices over six or seven earlier years. It appears in retrospect that the plaintiff was unfortunate enough to enter the business when beef prices were at their peak. Economic analysis discloses that in the first quarter of 1973, steer prices exceeded feed costs by $23.12 per hundredweight. The price decline during that period coincided with a rising prices trend in feed costs, so much so that by the end of 1976, the market price per hundredweight of steers was then $5.52 less than the cost of feeding them.

The plaintiff was facing an economically depressed industry, a situation which, over the years 1975, 1976 and 1977, saw cow-calf operators lose in excess of $83 million. Breeding stock operators, according to the evidence, were even larger losers.

In the circumstances, one must guard against the normal conclusion that the substantial investment made by the plaintiff could not possibly have been with a serious intention of achieving profitability. Furthermore, as I have found earlier in these reasons, the plaintiff is not the type of person who would gladly risk a million dollars in an operation on the simple expectation that in the event of losses, half of them would be absorbed by deductions from his other income.

One must also guard against adapting a statutory interpretation to the guidelines articulated by Dickson, J. in the Moldowan case. The words used by His Lordship in simplifying the wording of section 31 of the Act do not, a priori, fit every taxpayer into a procrustean bed of someone else's choosing. Indeed, His Lordship, in suggesting tests which might be applied from case to case, is careful to point out that such tests are “not exhaustive”, that some of them are both relative and objective, or that some of them are not to be measured purely in quantum terms. In a few words, His Lordship was not attempting to draft legislation.

It is my view therefore that the conclusion I have reached is on the basis of a factual situation which has unique and distinguishing features. Numerous precedents cited to me by counsel on both sides might be relevant or persuasive but I would doubt that any one of them would be conclusive. I prefer to be guided by the principles enunciated in the Moldowan decision. I think that my conclusion is in conformity with these principles and in keeping with the legislative intent of section 31.

I have quoted at length from the judgment of Joyal, J. in part because the observations that he made in Hadley could equally have been made here, and in part because it illustrates the approach that I have endeavoured to take in this case. The major difference between Hadley and this case is that the appellant here called no expert testimony. I do not regard this as fatal. The appellant, through his own testimony and that of Mr. Barry, has established that in the early years of his operations the prospects of profit over the long term were good, but that the economic conditions and the drought that prevailed in the late 1980s frustrated those expectations.

There is one other aspect of this case with which I have not dealt at length but which, out of deference to the submissions of counsel, merits comment. This is the question of start-up costs. The Department of National Revenue applied section 31 in Dr. Hover's first year of operations. Although the Income Tax Act makes no reference to start-up costs and the administrative practice seems inconsistent in this regard, Dickson, J. in Moldowan evidently regarded the fact that losses occur in the early years of a farming operation as a significant consideration. In two of the passages that I have quoted above, he stated :

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.

and

One would not expect a farmer who purchased a productive going concern to suffer the same start-up losses as a man who begins a tree farm on raw land.

Given the magnitude of the operation envisaged by Dr. Hover, the large expenditures required and lengthy period of time required before the business becomes fully operational, it would seem unreasonable to suggest that the farm should become profitable in the first several years or to deny him the full impact of the start-up costs.

Nonetheless, I am precluded by the judgment of the Federal Court of Appeal in Roney from placing too great a degree of importance on the references to start-up costs in the judgment of the Supreme Court of Canada. The Federal Court of Appeal stated 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.

Since I have concluded independently that Dr. Hover is a class I farmer I do not base my decision on the fact that his start-up costs were significant nor do they form a separate basis for my judgment. Their magnitude does however illustrate the serious nature of his commitment to farming and confirms my conclusion that farming was not a sideline but rather his major preoccupation.

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.

The appeals from the reassessments for 1984, 1985 and 1986 are therefore allowed with costs, and the reassessments referred back to the Minister of National Revenue for reconsideration and reassessment on the basis that section 31 of the Income Tax Act does not restrict the calculation of the appellant's loss from the farming business.

Appeal allowed.