Her Majesty the Queen v. Service D’administration Champlain Inc., [1990] 2 CTC 485

Pinard, J. [Translation]: —

Introduction

This is an appeal by the plaintiff from a decision of the Tax Court of Canada which invalidated notices of reassessment issued by the Minister of National Revenue denying the taxpayer the right to deduct the total amount of its losses resulting from its farming activity and to limit these deductions to a maximum of $5,000 a year, pursuant to subsection 31(1) of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the "Act").

On November 8, 1982 the Minister of National Revenue issued notices of reassessment for the defendant's 1977, 1978, 1979, 1980 and 1981 taxation years. After the latter filed notices of objection against these assessments, the Minister upheld them by a notice of ratification dated April 29, 1983. This ratification explained as follows the reason for ratifying the assessments:

The Minister of National Revenue has examined the facts and reasons stated in your notice(s) of objection and hereby ratifies the said assessment(s) as being made in accordance with the provisions of the Income Tax Act, for the following reasons:

that the taxpayer's chief source of income was neither farming nor a combination of farming and some other source, and that accordingly its losses for the years resulting from all the farming businesses operated by it are deemed to be $5,000 a year in accordance with the provisions of s. 31(1) of the Act.

On July 26, 1983 the defendant appealed from the assessments to the Tax Court of Canada, whose judgment on February 6, 1986 led to the plaintiff's present appeal.

The fact that in the action at bar the parties agreed that the evidence would consist strictly of that submitted to the Tax Court of Canada does not make the instant proceeding any less a de novo proceeding.

The issue therefore turns on the defendant's right to deduct for income tax purposes all its losses resulting from its farming activity in the 1977, 1978, 1979, 1980 and 1981 taxation years.

Facts

The prime mover and principal shareholder of the defendant during the years at issue was Mr. Marcel Roy, a graduate of the École des Hautes Études Commerciales of Montréal.

In 1966 Marcel Roy began looking after handicapped persons and the elderly who were no longer independent. His active participation in the various organizations concerned with such persons and the experience acquired led him to form Gestion Marcel Roy Inc., which is a shareholder in the following three companies: Centre d'Accueil Richelieu, Service d'Alimentation Mercier and the defendant, the latter being the owner of Appartements Métropolitain Inc. The organization chart of the companies controlled by Marcel Roy is as follows:

Marcel Roy Gestion Marcel Roy Inc.

Service d'Administration	Centre d'Accueil	Service D’Alimentation
		Mercier
		— Centre d'accueil
		Richelieu
		— Résidence Richelieu
	Branches	(Anjou)
Appartements
Métropolitain
Inc.		— Résidence Richelieu
		(Dorchester)
		— Résidence Richelieu
		(St-Jean)
		(Sold in 1979)
		— Manoir Montréal

Other companies whose activities are connected with those of the foregoing companies controlled by Marcel Roy were also formed by the latter's brothers: Services de Loisirs Champlain Inc., Service d'Ambulance Champlain Inc., Service d'Entretien Mercier Inc., Service de distribution Richelieu Inc., and so on.

Since its incorporation in early 1973 the defendant's main activity has consisted, as its name indicates, in providing a management service for all these corporations. The number of its employees during the years at issue has varied from 40 to 60.

The management service provided by the defendant has involved in particular accounting, paying employees, preparing contracts, billing and payment of accounts. The services to the some 900 residents of the establishments for the elderly and the handicapped at the relevant time were provided primarily by the other corporations thus managed by the defendant: for example, Service d'Alimentation Mercier Inc. handled meals, Service de Loisirs Champlain Inc. recreation, Service d'Ambulance Champlain Inc. transportation of residents and Service d'Entretien Mercier Inc. maintenance.

In 1971 Marcel Roy personally bought a farm located at St-Liboire, some 40 miles from Montreal, for $21,000. At that time the farm had an area of 104 acres and had several buildings as well as a number of animals, that is, about 20 cows, 20 pigs, some chickens and some other small animals.

In 1975 Marcel Roy conveyed the farm to the defendant. The twofold objective of buying and operating this farm was first to sell its production to the various corporations managed by the defendant, to be consumed by the residents, the elderly and the handicapped, and second to provide recreation for the latter.

In pursuance of the recreation objective, the farm offered inter alia the following services: repair of equipment and furniture in the workshop, temporary storage of furniture and surplus equipment and a recreation service involving activities organized in the common room located on the farm.

The defendant's objective as regards actual farming activities was concerned between 1972 and 1976 primarily with milk production which, after the purchase of 50 to 60 milk cows and the investment of nearly a quarter of a million dollars to build a stable, had to be abandoned because of the inexperience and ignorance of the defendant and its employees, who discovered that there was a whole array of regulations prohibiting the sale and pasteurization of milk otherwise than by dairies. In fact, the milk production could never be consumed by the beneficiaries of the corporations managed by the defendant.

The attempt to grow vegetables in greenhouses during the same period also proved a failure after the defendant had bought two greenhouses for $25,000 each and built a warehouse to process the vegetables. It finally appeared more profitable for the corporations managed by the defendant to buy their vegetables directly on the market.

From 1976 onward the defendant decided to get into pork production; however, after two years and the purchase of some 700 pigs, it had to give up this production because it was unable to obtain the necessary government quotas to slaughter pigs at the slaughter house. The beneficiaries of the corporations managed by the defendant were thus unable to consume the pork produced by it.

In 1977 and 1978 the defendant, after buying 600 hens, realized that it could not have them slaughtered or sell their eggs without first obtaining the necessary permits and quotas. As it found the cost of such permits and quotas to be prohibitive, the defendant also gave up this type of production, so that like milk, vegetables and pork, the eggs and hens could not be consumed by the beneficiaries of the corporations managed by the defendant.

From 1976 onward the defendant also bought beef cattle; in 1981, however, after realizing that this type of operation was not profitable, the defendant gave up trying to sell this production to the corporations managed by it.

From 1981 onward, the farm operations primarily involved the raising of thoroughbred cattle for sale at auction or directly to other producers. Despite this new approach the evidence in the record shows that substantial losses were suffered in subsequent years, namely accounting losses of $130,157 and $265,826 for 1982 and 1983 respectively.

During the years at issue, the accumulated investments of the defendant were set out as follows:

During the same period the defendant's expenses before capital cost allowance were set out as follows:

A breakdown of gross income and net income for the years 1975 to 1981 is given in Exhibit 1-2 in the record, both for the defendant's management services and its farming operations. Like the foregoing figures, these are not in dispute. Exhibit 1-2 indicates in particular that the total gross income for management services from 1975 to 1983 inclusive was $4,889,765, while that for farming was only $738,346. These exhibits indicate that during these years the total net income connected with the defendant's management services and rental operations was $1,279,229, while for the same period farming suffered a total loss (calculated for tax purposes) of $1,349,286. The accounting loss for the defendant's farming operations in each of the years concerned is set out in Exhibit 1-4 as follows:

Farm Loss From Financial Statements

	(accounting loss)
1975	—	( 66,980)
1976	—	(140,340)
1977	—	(187,341)
1978	—	(188,778)
1979	—	(203,319)
1980	—	(138,169)
1981	—	(101,181)
1982	—	(130,157)
1983	—	(265,826)

Law

Subsection 31(1) of the Income Tax Act provides:

31.(1) Loss from farming where chief source of income not farming. Where a taxpayer's chief source of income for a taxation year is neither farming nor a combination of farming and some other source of income, for the purposes of sections 3 and 111 his loss, if any, for the year from all farming businesses carried on by him shall be deemed to be the aggregate of

(a) the lesser of

(i) the amount by which the aggregate of his losses for the year, determined without reference to this section and before making any deduction under section 37 or 37.1, from all farming businesses carried on by him exceeds the aggregate of his incomes for the year, so determined from all such businesses, and

(ii) $2,500 plus the lesser of

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

(B) $2,500, and

(b) the amount, if any, by which

(i) the amount that would be determined under subparagraph (a)(i) if it were read as though the words "and before making any deduction under section 37 or 37.1" were deleted,

exceeds

(ii) the amount determined under subparagraph (a)(i);

and for the purposes of this Act the amount, if any, by which the amount determined under subparagraph (a)(i) exceeds the amount determined under subparagraph (a)(ii) is the taxpayer's “restricted farm loss" for the year.

This legislative provision has been considered several times and its wording criticized by the courts in recent years. However, the highest authority on its interpretation is still a judgment of the Supreme Court of Canada, in Mold- owan v. The Queen, [1978] 1 S.C.R. 480; [1977] C.T.C. 310; 77 D.T.C. 5213. In that case, Dickson, J., as he then was, expressed the following opinion at page 315 (D.T.C. 5216; S.C.R. 487-88):

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 carries 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 carries 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.

A little earlier in the same judgment, Dickson, J. defined as follows (at page 314 (D.T.C. 5215; S.C.R. 486) the test required to determine whether farming is really the chief source of income within the meaning of subsection 31(1) of the Act:

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.

Subsequently, in The Queen v. Graham, [1985] 2 F.C. 107; [1985] 1 C.T.C. 380; 85 D.T.C. 5256, at 388 (D.T.C. 5263; S.C.R. 112), Urie, J.A. of the Federal Court of Appeal adopted the observations of Dickson, J. and, referring specifically to the last paragraph cited above, added:

It would thus appear that the reasonable expectation of profit from the farming operations having been conceded (and such a concession was a proper one having regard to the evidence objectively) the next step in the determination of the “chief source of income” is to consider the taxpayer's “ordinary mode and habit of work” employing tests of the kind suggested by Mr. Justice Dickson in the last two sentences of the quotation, supra. These, of course, involve a weighing of the facts objectively and relatively.

In the latter case a majority of the judges of the Court of Appeal arrived at the conclusion ([1983] C.T.C. 370; 83 D.T.C. 5399) that, in holding that the taxpayer belonged to the first class mentioned above, the trial judge had made no error in applying in two stages the test defined by Dickson, J. The Court of Appeal therefore refused to intervene on a question of fact.

In a more recent case, Morrissey v. Canada, [1989] 2 F.C. 418; [1989] 1 C.T.C. 235; 89 D.T.C. 5080, Mahoney, J.A. of the Federal Court of Appeal, speaking for the majority, interpreted Moldowan as follows, at pages 241-42 (D.T.C. 5084; S.C.R. 428-30):

Moldowan also says, dealing with the difference between classes 1 and 2, “While a quantum measurement of farming income is relevant, it is not alone decisive”. While the determination that farming is a chief source of income is not a pure quantum measurement, it is equally not a determination in which quantum can be ignored.

The appellant has admitted that the respondent was farming with a reasonable expectation of profit. That means he was farming as a business and is conclusive that he was not a class 3 farmer. It also implies that farming was a potential source of income and calls for an enquiry whether it was potentially a chief source of income either alone or in combination with another source. In considering subsection 31(1), it seems to me that potentiality, rather than actuality, is the question in all cases since the provision applies only where there is a loss in a taxation year. That is not, of course, to say that actual profitability in other years may not be evidence of the potential for profit in years of losses.

Moldowan suggests that there may be a number of factors to be considered but we are here concerned only with three: time spent, capital committed and prof itability. In defining the test as relative and not one of pure quantum measurement, Moldowan teaches that all three factors are to be weighed. It does not, with respect, merely require that farming be the taxpayer's major preoccupation in terms of available time and capital.

On a proper application of the test propounded in Moldowan, when, as here, it is found that profitability is improbable notwithstanding all the time and capital the taxpayer is able and willing to devote to farming, the conclusion based on the civil burden of proof must be that farming is not a chief source of that taxpayer's income. To be income in the context of the Income Tax Act that which is received must be money or money's worth. Absent actual or potential profitability, farming cannot be a chief source of his income even though the admission that he was farming with a reasonable expectation of profit is tantamount to an admission which itself may not be borne out by the evidence, namely that it is at least a source of income.

(See also Mohl v. Canada, [1989] 1 C.T.C. 425; 89 D.T.C. 5236.)

Conclusion

Learned counsel for the defendant submitted essentially that for a taxpayer to deduct all his losses resulting from farming operations, those operations must simply be part of a combination of businesses and this combination must itself be the taxpayer's chief source of income.

While at first this proposition seems to be consistent with the actual wording of subsection 31(1) of the Income Tax Act, it is however inconsistent with the title of section 31. Further, the proposition is completely irreconcilable with the comprehensive interpretation given to the enactment in question by the Supreme Court of Canada in terms of the Act as a whole in Moldowan, supra. That case indicates that when a taxpayer s income is from a combination of farming and some other source, it must be determined whether the farming is the taxpayer's chief source of income and, as such, the court must in particular consider for each source of income the time spent on it, the capital committed and present and future profitability.

Accordingly, applying the rules defined in Moldowan and subsequently interpreted in Graham and Morrissey, supra, to the case at bar, it appears that while on the one hand the defendant's cumulative investments in its farming operation were larger than those made in its management services operation, on the other hand in 1978 the investments were almost the same in farming and in the defendant's other operations, and subsequently, up to 1981 inclusive, the amount of annual investment was smaller in farming compared to the other operations; but still more significant, the defendant at the relevant period spent much less time on its farming business, which was continually in the red, than on its profitable management services business.

With regard to the time spent on the businesses, Marcel Roy, the defendant's principal shareholder, had no experience of farming and devoted most of his time to the Centre d'accueil Richelieu Inc. and the defendant's management services operations. Further, he was employed and paid by Centre d'accueil Richelieu Inc. and received no salary from the defendant. It was instead his brother Jean-Paul who, in addition to looking after the activities of his three corporations, Hôpital Notre-Dame de Gatineau Inc., Foyer d'accueil Ste-Rose Inc. and Service de distribution Richelieu Inc., was responsible for managing the farm's physical premises.

As the taxpayer here is a corporation, the number of persons allocated by the latter to each source of income seems to me to be very significant. In fact the defendant, which as we know employed 40 to 60 persons during the years at issue, allocated only five or six of them to the farm. While it is true that because of available farm equipment work done by a mere five or six persons can be an indication of a major concern with farming, at the same [time] the work of some 35 to 55 other people assigned to the defendant's management services implies a much greater time devoted to this source of income, especially as during the years at issue the management services had the use of computer equipment costing over $240,000.

As to the actual and potential profitability of the various sources of income in question, the financial information submitted to the Court indicates that from 1975 to 1983 inclusive the defendant's farming operations continued to accumulate losses, year after year, while the management services business and rental operations generated a profit each year. In this regard, Exhibit 1-2 provides the following figures:

The evidence further disclosed that the gross income of the management services business increased continuously and substantially between 1975 and 1983, which was not the case with the income from farming, and in any case this was always considerably less. The lack of present and future profitability of this farming operation appears still more clearly when we realize that from 1977 to 1980 the annual salary expenses for the business by themselves exceeded its gross operating income:

Despite another change of direction after 1981, when the farming operations were centred primarily on the raising of beef cattle, the evidence still did not show either actual or potential profitability of the operation, since the defendant's projections in this regard for the 1982 and 1983 taxation years proved completely unrealistic:

As I see it, this situation justified the Minister of National Revenue in ceasing to allow the defendant to deduct in full the losses resulting from its farming operations beginning in 1977. In my opinion, not only was the defendant unable to shift the burden of proving that its farming operations were its chief source of income, but it seems clear that its chief source of income actually was its management services business.

The plaintiff's action will accordingly be allowed, affirming the validity of the notices of reassessment issued and ratified by the Minister of National Revenue for the defendant's 1977, 1978, 1979, 1980 and 1981 taxation years. Costs will be awarded to the plaintiff.

Crown's appeal allowed.