C. Gordon Hunt and Charles A. Hunt v. Minister of National Revenue, [1990] 2 CTC 2611, [1991] DTC 28

Sobier, T.C.J.: —These are appeals claiming full deduction of farm losses by the appellants, Charles A. Hunt and his father C. Gordon Hunt, with respect to the 1983, 1984 and 1985 taxation years. The two appeals were heard on common evidence.

Each of the appellants’ evidence covered part of his own appeal and the same part of the other's appeal. Each appellant was a partner of the other and each claimed the farm losses through their respective partnership interest.

The issue is whether the appellants were entitled to be classified as Class 1 or Class 2 farmers as was set out by Dickson, J. (as he then was) in Moldowan v. The Queen, [1977] C.T.C. 310; 77 D.T.C. 5213.

Prior to the time the appellants took over the farm, it had been leased to another farmer and according to the evidence the farm was in poor condition and one of their first tasks was to put the farm back in good running order and restore it to good condition.

The son is also employed as an iron worker. He appears to have steady employment in that occupation and his work takes him off the farm. The father is a retired teacher.

The evidence of the father was rather limited. He chose to read from a prepared text in an attempt to rebut points raised in the respondent's reply to notice of appeal rather than give factual evidence in order to discharge the onus placed upon him.

The father did give evidence that progressively through 1978, 1979 and 1980 more wheat was grown. In 1982 or 1983, their crops were hay and wheat. In 1978 they maintained a small herd of cattle; however, in 1983 two cattle were sold for a total of $2,000 and in 1984,13 cattle were sold for a total of $5,100 so that by the end of the 1984 taxation year, no cattle remained. The income generated from the sales of cattle were the largest items for those years. The reason given for the sales was that they could no longer afford to properly fence in the cattle.

Commencing in 1985, the appellants grew alfalfa for hay and this represented the largest source of income. In cross-examination, the father stated that in each year from 1977 to 1986 losses exceeded $10,000. The respondent in his reply to notice of appeal stated that the partnership had the following losses for the taxation years between 1977 and 1986.

Gross farm income for the years 1983 to 1989 were as follows:

During the initial years, there was certainly a change in the nature of the crops. There was wheat, wheat and hay, cattle and finally alfalfa and alfalfa seeds.

In addition, the appellants rented 60 acres of land near Peterborough for cash crops. They also purchased $30,000 of farm machinery and equipment including a tractor, a plough and logging winch. However, since grain prices dropped as a result of the embargo on the Russian wheat sales resulting from the invasion of Afghanistan, they were forced to sell the purchased farm equipment, in one case at cost and in another at a loss.

A truck was needed and one was purchased in 1987 or 1988. The farm was at this point growing five acres of lentils and is now certified as an organic grower.

The son was employed off the farm full-time as an iron worker. In 1983 and 1984, he worked at the Darlington Nuclear Facility but because in those years he worked the afternoon shift, he was able to spend four to five hours per day and weekends farming. He pointed out that he travelled to and from work on a bus and was therefore able to sleep at those times. In 1985, he was laid off at Darlington but went to work at Whitby Steel.

He gave as his off-the-farm income the following:

The increase in the off-the-farm income began in 1982 when he started with Ontario Hydro. This increase in outside earnings helped the son fund the farm operation. Without it he could not have paid off loans or pay for $4,000 worth of small alfalfa seeds necessary to begin production of alfalfa for hay. The increased income from the hay resulted from the ability to purchase these small seeds. Presently, the operation consists of alfalfa hay and lentils with the custom saw mill operation adding a good deal to the partnership income.

The father gave little evidence of his contribution to the farm workload.

The son gave evidence of the nature of the work performed by him on the farm including cultivating, sowing, harvesting alfalfa and other hay, moving rocks and stones and generally improving the farm property. But other than references to the types of crops and his philosophy of farming, the son also did not shed a great deal of light on his workload except for the two years he worked the afternoon shift at Darlington.

In order to be free of the provisions 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") and therefore entitled to deduction in full for farm losses, it must be established that a taxpayer's chief source of income must be farming or a combination of farming and some other source of income. Subsection 31(1) reads as follows:

(1) Where a taxpayer's chief source of income for a taxation year is neither farming nor a combination of farming and some other source of income, for the purposes of sections 3 and 111 his loss, if any, for the year from all farming businesses carried on by him shall be deemed to be the aggregate of

(a) the lesser of

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

(ii) $2,500 plus the lesser of

(A) /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.

The effect of this subsection is to limit farm losses which may be deducted in a taxation year to $5,000.

The leading authority on this question is Moldowan v. The Queen, supra. At pages 313-14 (D.T.C. 5215) of Moldowan, Dickson, J. (as he then was) states:

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 MNR, [1972] CTC 151; 72 DTC 6131. See also subsection 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] CTC 230; 74 DTC 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.

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 be 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.

On page 314 (D.T.C. 5216), His Lordship goes on to state:

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.

So that combining the father's pension income and the son's off-the-farm income with the partnership's farm income cannot be the combination.

On page 315 (D.T.C. 5216), Dickson, J. set out what are now the three classic classes of farmers when he said:

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. This 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.

As stated above Moldowan recognized that a person may have other pecuniary interests as well, such as income from investments or sideline employment or business.

In argument counsel for the respondent did not refer to any cases dealing with sideline employment. At the end of argument the Court pointed out to counsel for the respondent that there was a line of cases dealing with that question and that the Court would consider them. The Court has therefore considered Graham v. The Queen, [1983] C.T.C. 370; 83 D.T.C. 5399 (F.C.T.D.), affd [1985] 1 C.T.C. 380; 85 D.T.C. 5256 (F.C.A), Poirier, B. Estate v. The Queen, [1986] 1 C.T.C. 308; 86 D.T.C. 6124 (F.C.T.D.) and finally Bastien et al. v. M.N.R., [1985] 1 C.T.C. 2317; 85 D.T.C. 262 (T.C.C.).

In using the criteria set down in Moldowan the Court finds that the profit and loss experience in the years prior to the taxation years in question and the years subsequent to those taxation years indicate that the appellants do not have a reasonable expectation of profit. The intended course of action of the appellants was at best disorganized, and even now with lentils and alfalfa, the appellants are unable to demonstrate that there will be a reasonable expectation of profit. It is also clear that in those years when the so-called "profit" was made the full capital cost allowances were not taken. The operation was undercapitalized.

In none of the years 1977 to 1989 inclusive was there a profit from the farm operation after full capital cost allowances were taken.

From the evidence the Court was unable to conclude that farming was the centre of work routine of either the father or son or that they committed their energies and capital to farming as a main expectation of income.

As stated in Moldowan, 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, however quantum must be taken into consideration.

In taking all of the foregoing into consideration the Court finds that farming was not the chief source of income of the appellants, nor was farming and some other source of income [their] chief source of income. However, the appellants were not indulging in a hobby. The Court finds that the appellants are Class 2 farmers as defined in Moldowan, being persons who do not look to farming or farming and some subordinate source of income for their livelihood but carried on farming as a sideline business. Such persons are entitled to the deduction spelled out in subsection 31(1) of the Income Tax Act.

Accordingly the appeal is allowed in part and the assessments are referred back to the respondent for reconsideration and reassessment on the basis that the appellants are entitled to restrictive farm losses set forth in subsection 31(1) of the Income Tax Act.

Appeal allowed in part.