Paul Gagné v. Her Majesty the Queen, [1989] 1 CTC 199

Pinard, J. [Translation]:—The case at bar is an appeal by the plaintiff of a decision by the Tax Court of Canada which had upheld notices of tax reassessments from the Minister of Revenue Canada serving to deny this taxpayer the right to deduct the total amount of his farming business losses, limiting said deductions to a maximum of $5,000 per year, pursuant to subsection 31(1) of the Income Tax Act.

This litigation thus involves the plaintiff's right to deduct the total losses of his farming business for taxation years 1978, 1979, 1980 and 1981 for income tax purposes.

The Law:

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

31. Loss from farming where chief source of income not farming.—(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 marking 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.

And in French:

Article 31: Pertes provenant d'une activité agricole ne constittuant pas la principale sourced de revenu.

(1) Lorsque le revenu d'un contributable, pour une année d'imposition, ne provient principalement ni de l'agriculture ni d'une combinaison de l'agriculture et de quelque autre source, aux fins des articles 3 et 111, ses pertes, si perte il y a, pour l’année, provenant de toutes les entreprises agricoles exploitées par lui, sont réputées être le total formé

(a) de la moins élevée des sommes que représentent:

(i) la fraction du total de ses pertes pour l’année, déterminées en faisant abstraction du présent article et avant toute déduction en vertu des articles 37 ou 37.1, et provenant de toutes les entreprises agricoles exploités par lui, qui est en sus du total des revenus, ainsi déterminés, qu'il a tirés pour l'année de toutes ces entreprises, ou

(ii) $2,500 plus la moins élevée des sommes suivantes:

(A) /2 de la fraction du montant visé au sous-alinéa (i) qui est en sus de $2,500, ou

(B) $2,500, et

(b) la fraction, si fraction il y a,

(i) de la somme qui serait déterminée en vertu du sous-alinéa (a)(i) s'il y était fait abstraction des mots "et avant toute déduction en vertu des articles 37 ou 37.1”,

qui est en sus

(ii) de la somme déterminée en vertu du sous-alinéa (a)(i),

et aux fins de la présente loi, la fraction, si fraction il y a, du montant déterminé en vertu du sous-alinéa (a)(i), qui est en sus du montant déterminé en vertu du sous-alinéa (a)(ii), constitue la "perte agricole restreinte" subie par le contribuable pour l’année.

This legislative provision has often been considered in and its text criticized by the courts over the past few years. The most widely recognized authority on its interpretation, however, remains a decision of the Supreme Court of Canada in Moldowan v. The Queen, [1977] C.T.C. 310; 77 D.T.C. 5213. In this case, Dickson, J., who has since become Chief Justice, rendered the following opinion, at page 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) 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.

Somewhat further on in the same decision, Dickson, J. established as follows (at page 314 (D.T.C. 5216)) the required test for determining if the farming business truly constitutes 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, Urie, J., of the Federal Court of Appeal, in The Queen v. Graham, [1985] 2 F.C. 107 at 112; [1985] 1 C.T.C 380 at 388 concurred with these comments of Dickson, J. and added the following in specific reference to the above paragraph:

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 working" 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 this latter case, the Federal Court of Appeal, in a majority decision, held that the judge of the trial division ( [1983] C.T.C. 370; 83 D.T.C. 5399) had not erred in law in his two-step application of the test defined by Dickson, J. when he decided that the taxpayer fell into the first category above. The Court of Appeal thus refused to intervene in an issue involving the interpretation of fact.

The Facts

The plaintiff, who comes from a rural area, is a teacher by profession. On or about June 13, 1977, following the death of his father, he decided to purchase, for $10,000, his former family farm, located in Plantagenet, which had been abandoned for about 25 years, and where he intended to conduct a farming business, which would eventually become a strawberry field.

At the time of this purchase, the plaintiff, prior to leaving his position as co-ordinator of physical education for the Carleton Elementary School Board, confirmed that he was hired as geography teacher in the secondary school of Plantagenet for the 1977-78 school year.

As a result of his change of duties, the plaintiff's salary went from $18,500 to $14,300. During the proceedings, he explained this reduction by the fact that he had left an administrative position to become a mere teacher, specifying: "That enabled me to prepare for my second vocation,” obviously alluding to the operation of a strawberry field on his former family farm.

However, the plaintiff did not delay in specializing in order to get to the top of the salary scale in his career as a teacher. Thus, from 9:00 p.m. to 11:00 p.m. on weekday evenings, for two and a half years, he took courses in Ottawa, located some 45 minutes from Plantagenet. The plaintiff took these courses in the 1979-80 and 1980-81 school years, as well as during the summer of 1982. Consequently, his teaching salary, which was $23,816.86 in 1978, gradually rose to $49,936.80 in 1987. Moreover, the plaintiff also acknowl edged that during that time he had occasionally done some additional evening work as an instructor for a volleyball team.

Finally, the plaintiff, still referring to his teaching career, confirmed that he had made up his mind long before to retire in 1992, so that he will be able to benefit from a full pension. The plaintiff explained that, from the time he was hired in Plantagenet, he could not be discharged without valid cause, although he was free to quit of his own accord. Because of the amount of his pension, he would be penalized if he continued to teach after 1992.

As for the use of the land he had acquired, the plaintiff said that he had planned to exploit it in stages and to do so over the long-term. In fact, between 1977 and 1984, he invested some $78,000 to purchase farming equipment and to instal an irrigation system. These costs would now amount to $113,000. Between early April and late October of those years, he has devoted nearly as much time to this development as he did to his teaching. However, his most intense period of work on his land, the last week in June and all of July, occurred at the same time as school vacations. From November until late March, when he was not teaching, preparing his courses, or working on his specialization classes, he was primarily involved in cutting trees on his property, in the evenings and on weekends.

The land in question has 5 acres frontage and 20 acres depth, for a total surface area of 100 acres. In 1978 and 1979, the plaintiff cleared and prepared five acres that he was then able to sow in 1980, for his first strawberry harvest in 1981. In 1982, he seeded ten acres, five of which he had started clearing and preparing in 1979. In 1983, ten acres produced strawberries and the plaintiff was able to sow 15 acres of land. In 1984, and during every subsequent year through the present time, the productive area was limited to 15 acres. Finally, the plaintiff stated that he was currently clearing and preparing 20 additional acres of land, and anticipated that he would have 35 productive acres in 1991.

As to the profitability of his farming activities, considering his planned rate of development and unforeseeables, primarily associated with the weather, the plaintiff has not yet made any profits, and has incurred the following annual losses:

Despite the above figures, the plaintiff's accountant has made the following projections of income, based, however, on information supplied by the plaintiff:

The plaintiff based his optimism on the fact that he had now acquired all of the necessary equipment, that operating costs had levelled off, that he could count on an annual harvest from the 15 acres and that he was currently clearing and preparing an additional 20 acres that should become productive in 1991.

Now taking these facts into account in the light of the principles and criteria defined in the Moldowan decision, above, we should begin by stating that the defendant acknowledges that the plaintiff might eventually expect to earn a profit from his farming. That goes without saying, as the Minister of Revenue decided to place the plaintiff in the second category defined by Dickson, J., in which a taxpayer is still allowed to deduct up to $5,000 annually for losses from a farming business.

Furthermore, I made an effort, during the proceedings, to observe and listen to the plaintiff's testimony. I also asked him a few questions. There is no doubt that he is an intelligent, well-organized, hard-working individual. But that is not the issue. Rather, the question is one of determining if, during the years 1978, 1979, 1980 and 1981, farming activity was the major concern of the plaintiff and if his career as a teacher was truly a secondary job that could constitute a purely subsidiary and auxiliary interest. Considering, on the one hand, the plaintiff's reasonable expectation of income from his employment as a teacher, and eventually, that of his farming work, and, also considering, on the other hand, the typical style of work of the plaintiff, I am of the opinion that these two questions may be answered in the negative.

There is, in fact, no doubt in my mind that as of the time he decided to acquire the old family farm, the plaintiff intended to subordinate its development to that of his career as a teacher and to his planned retirement in 1992. This was apparent, first of all, from his spontaneous declaration during the proceedings to the effect that the continuation of his teaching career enabled him to prepare for his "second vocation.” Moreover, his additional activities and efforts to specialize and reach the top of his pay scale, as a teacher, to the detriment of the time required to clear his land, clearly denote that his prime interest was devoted to his source of income, which was full-time teaching.

Thus, despite the effort, time and funds which he devoted to the farming business, I am rather inclined to conclude that this latter activity, during the years at issue, constituted a secondary activity that the plaintiff intended to develop at the right pace so as to retire with maximum earnings from his teaching career and which he did not intend to make his main career until his retirement, in 1992, when he would become eligible for a full pension. I do not, in fact, believe that the legislature intended to encourage this kind of planning other than by allowing the deduction of losses resulting from a farming business up to an annual maximum amount of $5,000. The fact that this farming business began more than ten years ago does not qualify it in this context as a “chief source of income” in the sense defined by Dickson, J. in Moldowan, and it seems to me to be additionally corroborated by the fact that this activity did not enable the plaintiff to earn any profits, however small, through the present.

For all of these reasons, and in consideration of the burden of proof on the plaintiff, I must dismiss this action with costs.

Action dismissed.