Frank Moauro v. Minister of National Revenue, [1992] 1 CTC 2129, 92 DTC 1071

Hamlyn, T.C.C.J.:—In his income tax return for the 1985, 1986 and 1987 taxation years, the appellant claimed net farming losses with respect to a horse racing operation as follows:

By concurrent notices of reassessment, the respondent applied the provisions of section 31 of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the "Act") and accordingly restricted the appellant's net farming loss for each taxation year to $5,000. By way of an appeal to this Court, the appellant stated:

I feel my major source of income is farming and as such Section 31 does not apply. I have substantial involvement in my horse racing business personally and also operate two farming corporations. The income from the farming corporations is not a fixed wage, but is a contract for service with the remuneration being based on the success or failure of the farming operations.

As such I feel my full income is from farming and in the years of the losses that the losses should not be restricted.

Facts

Vegetable Farm

Frank Moauro came to Canada from Italy when he was 12 years old; he is now 68 years of age. His family commenced farming (vegetables) upon arrival and eventually engaged in share crop farming. Mr. Moauro received little formal education; as a youth he went to school for a few months each year and the balance of the time he worked on the family farm. Through the years he acquired his own farm operation and continued to grow his crops. Eventually he incorporated his farm operation (Frank Moauro Farms Ltd.) at the instigation of his accountant and later he acquired shares in another corporation (Glenriver Investments Ltd.). The shares of the companies are divided between the appellant, his wife and his son. Frank Moauro Farms Ltd. is considered primarily to be the appellant's company whereas Glenriver Investments Ltd. is considered to be his son's company. Both companies are engaged in the business of farming and each company owns a farm .The two farms are divided by a road between them but they are operated as one. The work routine of the appellant after the incorporation was exactly the same as it was prior to the incorporation and remains the same today. The appellant works up to eighty hours per week on the farm cultivating, planting, harvesting, marketing, packing and delivering the vegetable crop. The vegetables are grown in greenhouses as well as outside. The vegetable farm has prospered and grown and employs several people.

Notwithstanding the incorporations and the size of the operations the appellant sees himself and acts as a" hands on" everyday hard-working farmer.

Horse Racing

The appellant has been involved in horse racing (standardbreds) for 25 years. He originally had partners in various horses but for the last 15 years has operated alone. The part of the appellant's activities related to horses is conducted away from the vegetable farm. The appellant has engaged a trainer and the horses are stabled at the trainer's premises. The appellant devotes up to 20 hours per week on his horse racing activities. He buys and sells horses, assists the trainer and races his stock. Although he races his horses in both Canada and the United States, the primary racing venue is in Windsor and Dresden, Ontario.

In each year he has expended large sums for the purchase of racing stock. The appellant stated in the later years he has attempted to upgrade his horse inventory by researching horse breeding and buying better horses. He maintains the value of his horse inventory has increased substantially.

One horse, Johnny's Scooter, is now standing at stud in the United States. This horse had shown great promise; he had excellent racing times and some success. Several potential buyers expressed interest in the horse and the appellant was offered $500,000. The appellant chose not to sell the animal as he felt he would do better by continued racing. The horse suffered a hoof injury and the appellant chose to convert the use of the horse for breeding rather than aggravating the injury and possibly losing what he deemed to be an achieved value for the animal.

Financial Records and Tax Returns

The Maouro family does not maintain separate bank accounts; all money transactions including personal transactions flow through the companies' bank accounts. At the end of the year the accountant for the family and the companies prepares the financial records. The accountant allocates the sums as he constructs the records from the bank records. The appellant has never changed his method of doing his activities including banking. Money was taken as needed for farm related expenses and personal expenditures.

The appellant has never received fees as a director or officer of either corporation, although he holds these capacities.

His horse racing financial records are maintained on a "cash basis” and the cost of his inventory (horses) is entirely recorded as an expense in the year of purchase. Both procedures are approved of in the Act. Using these legislatively approved recording procedures he has never shown a profit with respect to his horse racing activities.

In his 1985, 1986 and 1987 income tax returns, the appellant stated he was a manager of a farm corporation and reported earned income from employment.

This reporting however has caused the appellant some difficulty. He feels he never received income as an office holder or income from employment and further he believes, in relation to his companies, he is not an employee but an independent farmer contractor under a contract for services.

Position of the Parties

The appellant's position in this case is that he is in the business of farming and farming is his chief source of income.

The respondent's position is that the appellant's chief source of income is neither farming nor a combination of farming and some other source of income and that his farming losses are restricted pursuant to subsection 31(1) of the Act.

The respondent pleads in the alternative that the appellant's horse racing operation was not a business carried on for profit or with a reasonable expectation of profit and therefore the expenses incurred with respect to the race horse operation were not outlays or expenses incurred for the purposes of gaining or producing income from a farm business.

Analysis

Prior to incorporation the appellant was clearly a vegetable farmer. Farming was his chief source of income.

The first issue is whether after incorporation the appellant is an employee or an independent farmer contractor.

Jurisprudence

Independent Contractor or Employee

In The Queen v. Kuhl, [1973] C.T.C. 846, 74 D.T.C. 6024, two brothers incorporated a farm business with another person. Prior to the farm incorporation, the brothers were engaged in the business of farming. Mr. Justice Walsh (F.C.T.D.) stated at page 855 (D.T.C. 6029):

Certainly, the taxpayers here were not employees or servants of the company in the generally accepted sense of the term. Their work was not supervised nor their hours controlled in any way by the company, but, on the contrary, it was they who controlled and directed the operations of the company. There was no contract between them and the company providing for their employment or setting out the terms and conditions of it, and there is no indication that they even ever formally met as directors of the company and adopted a resolution providing for the amount of remuneration they should receive from the company in any given year, all such discussions having apparently taken place informally between them. In practice, they seem to have been only responsible to each other for doing their fair share of the work.

and further at page 857 (D.T.C. 6031):

The defendants herein were not, as stated, entitled to any Fixed or ascertainable stipend or remuneration. They had no contract of employment and if the company had suffered a loss would have received no remuneration (although, at the same time, benefiting from the separate existence of the corporation, they would not have been responsible for its debts).

. . . They are therefore independent contractors engaged in the business of farming for whose services the company has contracted.

This decision has been followed and has not been judicially varied in several cases including Murray v. M.N.R., [1987] 2 C.T.C. 2284, 87 D.T.C. 559, a case in which the appellant was engaged in the business of fishing throughout his adult life. He reached a point where he was in a position to purchase his own vessel and he later incorporated his fishing business. The appellant was the principal shareholder and directing mind of this corporation from which he received dividends. He first leased then sold the vessel to the corporation. He was paid for his services on the vessel on a predetermined share-of-the-catch basis as were the other crew members. The Court found that although it was possible for a crew member to enter into an employment contract, the evidence did not support that finding. Judge Sarchuk concluded there was no employment contract and expressed his views as follows at pages 2287-88 (D.T.C. 561):

The evidence clearly establishes that the crew hired by Cape Beale were all independent contractors. There is not a shred of evidence to support the proposition that Murray was treated any differently. In his capacity as master of the vessel his duties were not supervised by Cape Beale and Murray was totally and completely in control of the methods and means of doing his job; perhaps as a master of a vessel even more so than in other circumstances might be the case.

There was no employment contract and there is no evidence that Murray was entitled to any fixed or ascertainable remuneration. Each crew member, including Murray, was paid on the basis of results. If they fished efficiently their earnings would likely increase. If weather or poor conditions or bad management or bad work disrupted their pattern they bore the brunt of the loss, or they bore a portion of the loss.

I see none of the incidence of a master/servant relationship in this situation.

Mr. Justice MacGuigan reviewed various tests applied by the courts in distinguishing an entrepreneur from an employee in Wiebe Door Services Ltd. v. M.N.R., [1986] 2 C.T.C. 200, 87 D.T.C. 5025. In his reasons for judgment, at page 206 (D.T.C. 5030), MacGuigan, J. referred to the comments of Cooke, J. in Market Investigations Ltd. v. Minister of Social Security, [1968] 3 All E.R. 732, [1969] 2 Q.B. 173 at pages 738-39. Cooke, J. stated:

The observations of Lord Wright, of Denning L.J., and of the judges of the Supreme Court in the U.S.A, suggest that the fundamental test to be applied is this: “Is the person who has engaged himself to perform these services performing them as a person in business on his own account?” If the answer to that question is "yes," then the contract is a contract for services. If the answer is" no" then the contract is a contract of service. No exhaustive list has been compiled and perhaps no exhaustive list can be compiled of considerations which are relevant in determining that question, nor can strict rules be laid down as to the relative weight which the various considerations should carry in particular cases. The most that can be said is that control will no doubt always have to be considered, although it can no longer be regarded as the sole determining factor; and that factors, which may be of importance, are such matters as whether the man performing the services provides his own equipment, whether he hires his own helpers, what degree of financial risk is taken, what degree of responsibility for investment and management he has, and whether and how far he has an opportunity of profiting from sound management in the performance of his task. The application of the general test may be easier in a case where the person who engages himself to perform the services does so in the course of an already established business of his own; but this factor is not decisive, and a person who engages himself to perform services for another may well be an independent contractor even though he has not entered into the contract in the course of an existing business carried on by him.

In relation to the companies the appellant supplies his service without a fixed wage. There is no evidence of an employment contract. His income is geared to the financial results of the company and he takes from the company only that which he needs. He controls how and when he provides service to the company. The service he provides is that of a farmer and he operates daily as a farmer running his own farm operation. This appellant is not an employee in the traditional sense. He does not receive his income in his capacity as an officer or director of the farm corporations. The appellant conducts himself in relation to the company not as a servant in a master/servant relationship but as one who provides service to the corporation as an independent contractor. He controls his activities. He took the risks of the success or failure of his farm activities and his business activities are clearly related to the success or failure of the farm corporation.

The appellant is therefore an independent farmer contractor.

There are two further issues to be examined. The first relates to a reasonable expectation of profit in relation to the appellants farm activities and the second is a determination of the appellants chief source of income.

Jurisprudence

Reasonable Expectation of Profit

The leading case in farming operations is that of the Supreme Court of Canada in Moldowan v. The Queen, [1977] C.T.C. 310, 77 D.T.C. 5213. The Supreme Court of Canada dismissed the appeal, but in doing so, described a two-level test which would determine whether the taxpayer was entitled to a deduction in respect of the losses. The first level is the determination of whether there is a reasonable expectation of profit and the second level is that of ascertaining if the chief source of income is that of farming or farming and some other source. Once it is determined that a taxpayer has a reasonable expectation of profit from his farming business, the Court must decide if farming or farming and another source of income is the taxpayer's chief source of income.

Subsection 248(1) of the Act provides a definition of farming:

“farming” includes tillage of the soil, livestock raising or exhibiting, maintaining of horses for racing, raising of poultry, fur farming, dairy farming, fruit growing and the keeping of bees, but does not include an office or employment under a person engaged in the business of farming.

It is clear that both vegetable farming and horse racing are within the definition of farming as enunciated in subsection 248(1) of the Act.

The appellant also devotes considerable attention to his horse racing operation. To that activity he brings years of experience and knowledge of all aspects of standardbred horse breeding and horse care. His method of operation was and is to constantly improve the quality of his horses by changing his inventory.

The historical pattern of losses was found to be rooted in his continuous acquisition of new horses. His election of the cash method of financial record keeping and the categorization of horses as inventory wherein he deducted the cost of horses in the computation of income always placed him in a loss position. His accountant who gave evidence indicated that if the cost of new horses was removed from the calculation for the years in question he would be showing a net gain position for some years. The taxpayer gave evidence that some of his racing stock increased considerably in value. Moreover, his insurance records indicated some of his horses (those he saw fit to insure) have enhanced value. The taxpayer's evidence throughout showed that he was continuously trying to make the horse operation more viable by constantly adjusting and changing horses; if a horse did not justify further investment he sold it. His decision in relation to "Johnny's Scooter" in hindsight was a mistake; but it did confirm his intended course of action.

Given the conclusion that the appellant is an independent farmer contractor, his income as reported on his annual income tax returns, clearly shows that his independent farmer contractor activities in relation to vegetables are profitable.

His current financial records in relation to the horse operation with the use of the cash method and cost inclusion of new inventory in the year of purchase as expended show a clear direction towards profit:

Summary of Horse Racing Activity and Horse Purchases, 1985 to 1990

	Gross Revenue	Total Expenses	Net Loss	Purchases'
1985	$26,321	$67,276	$40,955	$30,992
1986	38,458	60,735	22,277	18,340
1987	35,141	54,005	18,864	18,564
1988	27,582	32,681	5,099	—
1989	53,978	56,478	2,500	16,856
1990	66,967	69,944	2,977	12,000
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