Norman McGinnis v. Minister of National Revenue, [1989] 1 CTC 2048, 89 DTC 52

Brule, T.C.J.: —This is an appeal by the taxpayer involving two issues. In 1982, 1983 and 1984 the appellant claimed farm losses of $4,026.41, 4,630.29 and $4,071.72. In 1983 and 1984 the appellant claimed losses from a water well-drilling operation of $9,950.92 and $6,776.95 respectively. All claims were disallowed by the Minister, thus giving rise to this appeal.

Facts

During the years in issue the appellant owned a quarter section of land 20 miles west of Spruce Grove, Alberta. In 1979 he had sold an adjacent quarter section but subsequently re-acquired this. He holds both parcels today.

The appellant worked full-time off the farm, and indeed never lived on the farm. A house placed there by the appellant was occupied by one of his sons. Since 1981, a hay crop was grown which was probably seeded in 1980 according to evidence given. It was only fertilized in one of the three years in issue. It was not ploughed in this period. One crop of hay was realized each year and according to the Minister’s reply to notice of appeal, the following figures, not disputed, were obtained:

(The differences between the losses shown in the table above and those claimed by the appellant, supra, are as a result of the appellant reducing the losses by applying a restricted farm loss factor as set out in the Income Tax Act.)

The second issue under appeal involved a well-drilling operation. In 1976 a company, Triple M. Drilling Ltd., was formed for this purpose. The operation was not too successful and in 1983 the appellant stated that the bank who had loaned the company money and considered the equipment as security forced the appellant to take over the operation on a personal basis. This resulted in his seeking personal losses in 1983 and 1984.

By his evidence the appellant said that no wells were drilled in the two years under appeal.

Appellant's Position

The agent for the appellant relied principally on written reasons for the appeal which had been filed with the Court.

As to the farming losses it was claimed that the Minister disallowed these relying on paragraphs 18(1)(a) and 18(1)(b) of the Income Tax Act. This section, it was said, has no application to business losses, farming or otherwise.

It was contended that gross farming income had been shown and that at least part of the expenses had been made to produce income. The Minister’s argument that the farming operation showed no reasonable expectation of profit has no application as this concept is not defined nor mentioned in the Income Tax Act. The agent stated there was a profit and taxed when land was sold in 1979. These losses were business losses and should be allowed.

As to the drilling operation the same principle was put forth, namely that the losses were of a business nature; paragraph 18(1)(a) has no application and the appeal should therefore be allowed.

In the alternative the appellant felt he should be able to deduct interest earned on deposits used as collateral to secure loans for the purchase of the drilling equipment. He pointed out that the present situation was similar to that successfully appealed in Said M. Attaie v. M.N.R., [1985] 1 C.T.C. 2331; 85 D.T.C. 613.

Minister's Position

Counsel for the Minister argued that there was no reasonable expectation of profit in either issue and that the appeal should fail. He mentioned that as early as 1979 the appellant had a feasibility study made to turn the subject property into a golf course, which he did in 1986. In the interim it was suggested that there was no attempt to operate the land as a viable farm but rather to maintain it in a form suitable for a golf course.

The drilling operation had no active business in the years under review and therefore no reasonable expectation of profit. It was suggested that the appellant took over the equipment, and the amount owing for it, from the company in order to attempt to get the benefit of the business losses personally.

Analysis

Dealing first with the farming losses it has well been established that “a reasonable expectation of profit" is essential for concessions to be granted under the Income Tax Act. See William Moldowan v. The Queen, [1977] C.T.C. 310; 77 D.T.C. 5213. Also where no reasonable expectation of profit for the years in issue was shown the appeal was dismissed (Lloyd Hooker v. M.N.R., [1987] 2 C.T.C. 2380; 87 D.T.C. 653).

In the case of Victor Croutch v. The Queen, [1986] 2 C.T.C. 246; 86 D.T.C. 6453 the Court held that where there was no reasonable expectation of profit and no evidence of any plan to make the operation profitable while sustaining losses for a period the farming operation did not constitute a business. No relief was given under section 31 of the Act. The expenses incurred by the taxpayer constituted personal and living expenses.

The recent case of Morris I. Boddington v. M.N.R., [1988] 1 C.T.C. 2195; 88 D.T.C. 1146, following Moldowan, supra, set out that the existence of a reasonable expectation of profit could only be decided by objective testing. It was necessary that the appellant prove on a balance of probability ii that there was a reasonable expectation of profit.

The decision in Luc Jourdenais v. M.N.R., [1987] 2 C.T.C. 2055; 87 D.T.C. 440 suggested that the appellant had no intention of having his farm placed in a profitable position, but rather was improving the property. This situation may well be applied to the present case wherein the golf course contemplated for the property as early as 1979 was, in fact, put in place in 1986. The years in issue in this appeal fell within that period. Similarly in Collin Craddock and Philip Giffen v. M.N.R., [1986] 1 C.T.C. 2006; 86 D.T.C. 1014 the Court held that expenses incurred were in reality costs to improve the capital asset of the property so that a business might be carried on some time in the future.

The present situation would appear to fit into all the jurisprudence set out above and accordingly this part of the appeal fails. The gain made on the sale in 1979 was of a capital nature and quite different from operating profits.

Losses from the alleged drilling operation constitute the other issue in this appeal. No drilling activity took place in the years in question and only a few in other years. It was said that the largest numbers of wells were drilled in 1986 and the operation in that year resulted in a substantial loss. Again there must be a reasonable expectation of profit before expenses may be deducted from other income. In the case of James D. Pike v. M.N.R., [1981] C.T.C. 2628; 81 D.T.C. 546 it was said at page 2630 (D.T.C. 547):

While I do not eliminate the prospect that under specific circumstances losses may be deductible in one year where there is clearly no reasonable expectation of profit in that same year, I do suggest that the onus on the taxpayer to put himself within the narrow parameters permitting such deductibility is a difficult task. Without attempting to define with precision those parameters, the appellant might be expected to show that he had pre-determined a clear, established pattern which allowed for those losses, and followed it, that he had provided the financing of such losses during the early years, and that the record of similar ventures almost assured him the ultimate realization of profit.

In the 1988 case of Warren Chequer v. The Queen, [1988] 1 C.T.C. 257; 88 D.T.C. 6169, the Court set out at page 259 (D.T.C. 6170):

There exists a burden of proof on every taxpayer who claims a deduction of net losses resulting from a business adventure, to establish that there was, at the time that he engaged in and carried on with the business, a reasonable expectation of profit. The reasonableness of the expectation must be viewed objectively and cannot merely consist of an expectation which the taxpayer in good faith entertains to the effect that a profit will eventually be realized.

Further, Addy J. said at page 260 (D.T.C. 6171):

It is difficult for me to conceive of a case where a taxpayer could have failed more dismally to establish objectively that there was a reasonable expectation of profit. His expectation could best be described as a pious wish.

Here there was no expectation of profit and perhaps the expenses claimed in connection with the drilling operation were simply a means to write off interest which the appellant had to pay to the bank. His testimony was that the bank insisted that he take over the ownership of the equipment personally from the company. It is not too conceivable that the bank did not already have the appellant's personal guarantee when the equipment was in the company and a change to personal ownership would thus not be necessary. Also the appellant said in evidence that he intended to make a profit, and if he was not in business the equipment would not have been insured. Again I’m sure the bank would have insisted on insurance, but in any event no insurance expense was shown in either of the years under appeal in the appellant's income tax returns. It was suggested by counsel for the Minister that perhaps the transfer to personal ownership was an attempt to gain a write-off which would not otherwise be available if the equipment was in the company.

The argument for the issue of drilling expenses is not valid. The alternative argument based on the Attaie case, supra, is also not valid. The Court decided the Attaie case based on the Federal Court of Appeal decision in Phillis Barbara Bronfman Trust v. The Queen, [1983] C.T.C. 253; 83 D.T.C. 5243, which decision was reversed by the Supreme Court of Canada, [1987] 1 C.T.C. 117; 87 D.T.C. 5059. Accordingly, the interest earned on deposits by the appellant cannot be used to compensate for interest paid to the bank on the drilling equipment.

The result is that this appeal on both issues is dismissed.

Appeal dismissed.