Bernard Gray v. Minister of National Revenue, [1988] 2 CTC 2123, 88 DTC 1520

Rip, T.C.J. [Orally]:—Good afternoon. I have prepared some notes. I intended to be very short in preparing reasons for judgment, however I am afraid I got carried away in certain spots. The reasons for judgment are as follows.

Bernard Gray, the appellant, appeals income tax assessments for 1980, 1981 and 1982 taxation years, in which the Minister of National Revenue, the respondent, limited losses from a farm business carried on by him in each year to $5,000, in accordance with the provisions of subsection 31(1) of the Income Tax Act, which I refer to as the Act, on the basis that his chief source of income in those years was not from farming or from a combination of farming and income from employment with Electrolux Canada Limited, which I will refer to as Electrolux:

Subsection 31(1) reads as follows:

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 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.

Mr. Gray carried on the business of farming during the years in appeal. The question for me to find is whether, as determined by the respondent, the income received by Mr. Gray from his employment with Electrolux was his chief source of income, and if the farm business which he carried on concurrently with his employment, was a sideline business, or, as claimed by the appellant, he looked to his farm for his livelihood, and that farming was his chief source of income, and that his employment with Electrolux was a sideline employment, and therefore, all the losses incurred by you, from farming in the years in question, were properly deducted in computing his income for each of the years.

In the alternative, the appellant submits that his chief source of income was a combination of farming and employment, which also would result in him being permitted to deduct all of his farm losses.

In the Supreme Court of Canada judgment in Moldowan v. The Queen, [1977] C.T.C. 310; 77 D.T.C. 5213, Mr. Justice Dickson, as he then was, envisaged three classes of farmers under the Act. At page 315 (D.T.C. 5216),

(1) A taxpayer for whom farming may reasonably be expected to provide the bulk of the 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),

which was the same as today's subsection 31(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 question at bar is whether Mr. Gray is a category (1), as he says he was, or a category (2) farmer, as the Minister of National Revenue says he was in the years in appeal.

Mr. Gray was born in 1933 in Kelliher, Saskatchewan. His parents farmed a mixed operation, and he worked on the farm in his youth. He left the farm in 1953, when he got married, and obtained employment as an engineer with the Canadian Pacific Railway in Regina. In 1954 he purchased a quarter section of land about ten miles from Regina, and started raising horses, cattle, poultry and hogs. The Canadian Pacific changed its engines from steam to diesel. In the years 1956 through 1958 he was periodically laid off. During the lay-offs he spent at the farm. Eventually, he lost his job at Canadian Pacific.

In 1959 he answered an advertisement placed by Electrolux and obtained a job in sales as a sales trainee. He continued farming and improving the farm. As a field trainee with Electrolux he kept his own hours, and devoted much of the time to his farm.

In 1964 he was promoted to a branch manager with Electrolux in Saskatoon. He was very successful in his new position, increasing sales from 40 units to 200 units per month.

He had sold his machinery and farm in Regina in 1965, and in 1968 he moved back to Regina as branch manager there, with the possibility of employment as division manager. His success in Saskatoon was repeated in Regina during August to November 1968. After this brief period he was asked by his employer that it might be more favourable for him from an economic point of view to look to work in a larger city, where he would have increased income and opportunity. In December 1968 he moved to Winnipeg to head a depot, a potential branch office, with Electrolux. He soon became a branch manager in Winnipeg.

Once in Winnipeg, he wanted to return to farming. While discussing possible purchase of land in 1971, he learned of the possibility of purchasing and purchased for $300 a horse with a good pedigree. He described himself as having a good feel for horses. He said he was fascinated by thoroughbreds. As a child he had been taught how to raise a horse, and what qualities to look for in a horse.

Mrs. Gray was also raised on a farm, and joined her husband in desiring to live on a farm. The horse he purchased in 1971 was a two-year-old filly which he named Lady Sharon. He bought this horse at stables about five minutes from his home at the time. He recognized this horse as a good racehorse, and trained her for racing. However, before she could race her first race, she pulled a muscle and was sent to a farm in Saskatchewan to recuperate. She hurt herself badly on the farm, and had to return to Winnipeg. Her racing career ended, but she was maintained for breeding purposes.

Lady Sharon was bred to a horse Icy Song, which had come second in the Queen's Plate, and gave birth in 1974. The stud fee at the time was $350. Mr. Gray purchased four and a half acres of land near Vermette, Manitoba, not far from Winnipeg, for $30,000, in 1975. At the same time, he appears to have obtained an option to acquire contiguous property of 18 acres from the vendor.

Mr. Gray's goal was to develop and breed horses to be amongst the best in North America. He would raise horses to breed and to sell. From the time a single horse was bred, to the time one could determine whether or not it had potential to be a good racehorse is estimated by Mr. Gray to take three years. A breeder starting off in business must establish a reputation for his line, which requires him to prove the capability of his horses to win races. Thus, the person who wishes to start in the breeding business must establish that the horses he breeds are capable of winning races. This was why Mr. Gray had interest in racing some of his horses.

At the end of 1979 Mr. Gray owned ten horses, one of which was a quarter horse used to work with the thoroughbreds. Four of the horses were purchased, the others were bred on his farm. He chose carefully the horses to breed with his fillies. He reviewed literature and traced lineage. He was aiming for superior stock.

In the meantime, Mr. Gray was progressing at Electrolux. He was promoted to division manager in 1974, regional manager in 1976 and national vice-president of sales in 1979. His income from the former two positions depended solely on sales of people working under him. As division manager he dealt personally with branch manager, and as regional manager his prime responsibility was with the division managers, although he did see branch and other people at the same time.

His time was his own. Electrolux set up monthly sales quotas, and as long as he achieved or surpassed the quotas, Electrolux was content. He was not tied down to any fixed schedule with Electrolux. As he gained more responsibility he said less actual work was required by him for Electrolux. He described himself as able to make decisions quickly and efficiently, and to motivate people.

As division manager he would spend approximately one month away from Winnipeg for sales meetings, and another day in Winnipeg for sales meetings. He would spend one or two hours twice a week at the office, on Monday and Thursday mornings. Otherwise, his time was spent on the farm. His secretary always knew where to reach him if necessary, and it was not inconvenient for him to work from the farm or his home. Apparently the telephone was a very useful instrument in carrying on his responsibilities with Electrolux.

In 1977 he started racing the filly who dropped from Lady Sharon in 1974. The horse won three races. In 1979 two of his horses were claiming races for $10,000 each. Both these horses were from Lady Sharon. In Mr. Gray's view, it proved he had a good breeding horse in Lady Sharon. In subsequent years his stock of horses gradually increased in quality and quantity, primarily from his own breeding program, so that during the years in appeal he owned 12 horses in 1980, 10 in 1981 and 1982.

At the time of trial he owned nine horses having a value, according to his estimates, of $115,000. Some horses were sold, and others were claimed in races during the years.

The appellant testified farming was his life. He required his job at Electrolux to raise his family of seven children, and finance his farm. He wanted to do, and did, a good job for his employer, but he said he never lost sight of the goals he set for the farm, to train, race and breed horses. In particular, to breed the horses. He was available at all times for the horses. He could always be reached by phone if working for Electrolux at that time. He gave instructions on how to train the horses, which horses to keep together, separate, cleaning of paddocks. He engaged part-time help, and was assisted by his children, in particular, two of his sons who lived on the farm.

Mr. Gray's daily work routine was as follows. He would awake at approximately 5:30 to 6:00 in the morning, and make decisions in respect of the farm, between 6:00 and 10:00 a.m. He would make the plans for the day. Electrolux had no daily plans. If he had meetings with Electrolux, they were usually at 9:00 in the morning, and were prearranged.

He estimated his time from the house to the farm, prior to the years in issue, was about a 25-minute drive. His office secretary at Electrolux always knew where he was. The meetings he had on Monday and Thursday mornings were in respect of sales reports, and were with various staff. In particular, Thursday morning had to do with various sales reports which were required by Electrolux, and these were usually in and available by 10:30 in the morning. On other days, he was in telephone contact with his secretary.

Between 9:00 and 10:00 in the morning, when he was not on the farm, he would go to the division and people knew they had to be in the field after 10:00 a.m. in order to sell. So, basically he did things early in the morning to enable his salesmen to be selling on a door to door basis as soon as possible. In respect of the farm business, he was always available, and as I stated earlier, if the Electrolux business required him, he would be contacted at the farm. After he was finished with his meetings on Mondays or Thursdays, or any other time, usually after 10:30, he would drive to the farm.

In 1978 he was prepared to exercise the option to acquire the 18 acres, but the vendor, that is the vendor of the original four and a half acres, a widow, was not yet prepared to sell. Instead Mr. Gray acquired an option to purchase 14 acres of land, contiguous to the widow's land, and moved on to the land as a tenant with his family. He sold his house in Winnipeg. He was using the paddocks for his horses on the 18 acres he had on option, and which still belonged to the widow.

In 1979, Mr. Gray, after turning down two previous invitations by Electrolux, agreed to become national vice-president of sales, after discussing this matter with his wife. He was granted a guaranteed salary of $110,000, in addition to eligibility for bonus based on sales. He would be eligible for early retirement at age 50, and full pension at two-thirds of his last year's income at age 55. He and his wife considered the offer and accepted, even though he had no intention to cut back on the farm, or to move the farm operation to Toronto, where he would be posted. Electrolux had offered to purchase the farm from him, but he refused.

Mr. and Mrs. Gray and one of their daughters moved to Toronto, where they rented an apartment. The other children remained on the farm. His eldest son, age 21, in 1979, together with the person who had worked part- time previously, worked the farm on Mr. Gray's instructions. He was on the phone to the farm almost daily.

In addition, he was able to spend approximately eight to ten days a month on the farm, even though he was living in Toronto. As vice-president, he still was able to determine his own schedule. He was not needed in Toronto at all times. He says he worked hard at both jobs, giving quality to both.

As vice-president, he supervised five regional managers: one in British Columbia, one in Alberta, one in Manitoba, one in Ontario, and one in Quebec. When he travelled west, he would arrange to spend a day in Winnipeg, and planned his return on Friday so that he could spend the weekend on the farm. The other officials of Electrolux knew of his farm activities, and how he carried on his duties for Electrolux. There was no objection from Electrolux.

Mr. Gray's gross farm income, net loss, from farming, net employment income from 1976 to 1986, is set out in Exhibit A, which I would set out in my reasons. Mr. Gray is of the view that as vice-president of sales he could have exceeded quotas and increased his bonus income, but that was not his goal. His goal, he said, was to breed horses, and build up the quality of his stock. The possibility of earning more money from Electrolux, he added, "did not excite me".

In mid 1980, there appeared changes at Electrolux, and a new president was appointed. Eventually Mr. Gray's position, but not his earnings, was downgraded, and he moved back to the farm. Back on the farm he exercised his option to acquire the 18 acres, which he purchased for $85,000. He and his family moved from Toronto into the house on the 18 acres, in October 1980.

His new position at Electrolux was regional midwest manager, supervising Manitoba, Saskatchewan and Maritime regions. He would be away from Winnipeg about three days a month. He continued his past practice of daily routine, rising at 5:30, 6:00 in the morning, when he would feed the horses, check them for injuries and generally make sure they were in good condition, and then turn them to paddock. He had five phones on the farm, with two separate lines, so that he would be available for both farm and Electrolux business.

He did not go into Winnipeg everyday. Mondays and Thursdays only were set days, and the other days as required. In addition, he would attend at the offices of Electrolux on statutory holidays and some Saturdays, to meet with his managers. Many times he would go back and forth between Winnipeg and the farm in a single day. Most of his work for the month at Electrolux would be performed during the first week of the month, when he would make sure that the quota could be reached.

His secretary, Miss Barbara Thibeault, always knew where he was, and during the years in appeal, was able to get in touch with him, if necessary. She corroborated Mr. Gray's evidence as to his absence from Electrolux offices to work on the farm.

By 1980, Mr. Gray had acquired sufficient expertise, so that a veterinarian was not required to assist, for example, in the birth of a foal. He was also conditioning horses in preparation for racing. This has cut down his costs. He now pays $2,000 to $3,500 for stud fees. He determines what stallions his horses will breed with by reviewing records, stud fees and the like. Apparently all horses that race in North America are on a computer, and their records are easily retrieved.

In July 1982 Mr. Gray was reduced to division manager for Manitoba. In September 1983 he and other employees of his rank were terminated by Electrolux. Prior to the firing by Electrolux, he had sought other employment, although not successfully. Litigation with Electrolux ensued, and eventually a settlement was reached.

Mr. Gray since set up a corporation with two of his sons for the sale of central vacuum cleaners. He is responsible for the financial end of the business, and he says he has all the time necessary for the farm. In 1981 he exercised his option to acquire the additional 14 acres for $80,000. Two acres have been subdivided and sold in 1987 for $86,000. Mr. Gray says he realized from the outset of his farm operations that any success would be in the long term. Breeding requires time and patience. He says you must build a good stock and reputation, and profit will follow.

He has projected a net profit for 1989, before capital cost allowance, of approximately $40,000. I say approximately, because the projection will have to be revised to take account of expense items omitted. His profit projection for 1989 is based on the potential success of a horse, Primed Property, bought in 1985, a son of Lady Sharon, which he values at $35,000. This horse has already won two allowance races against similar stock. That is, high quality stock. His trainer, whom Mr. Gray considers conservative and prudent, has a high regard for this horse.

As well, Dr. Elder, the veterinarian for Mr. Gray's horses, testified also, and has experience in horse training, also corroborated Mr. Gray's evidence as to the quality and potential of this horse.

Mr. Gray had anticipated similar success with another horse, Perseverance, also from Lady Sharon. But due to an injury to this horse, she ceased to become a race horse, and is now a breeding mare. She is now valued, according to Mr. Gray's estimate, at no less than $25,000.

Mr. Gray has travelled to vacation areas for sales meetings and seminars for Electrolux. During the period 1982 to 1987 he has taken only seven days' holidays. He acknowledges not spending sufficient time with his children in earlier years, which he regrets. But because of what he called, “a strong and understanding wife”, the children grew up well, he stated. Mr. Gray is director of the Canadian Thoroughbred Society, and chairman of its yearling sales.

Mr. Gray stated that although he has not shown any profit since he started farming, he could easily have done so by selling one or more of his pedigree horses in any given year. But he said he was in for the long term, and not one to ruin the steady progression and growth of his grade.

In the Moldowan case, Dickson, J., as he then was, stated at page 314 (D.T.C. 5215-16) that,

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 reaction 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.

There has been a difference of opinion on whether the word “combination” in subsection 13(1) requires some “connection” by way of physical relationship or integration or inter-connection between farming and the subordinate activity which provides another source of income. Paragraph 3(f) of the Income War Tax Act of 1917, as amended, made reference to "connection" in the finding of permissible deductions from income derived from the chief business, trade, profession or occupation of the taxpayer, in determining his taxable income. Paragraph 3(f) reads,

(f) Deficits or losses sustained in transactions entered into for profit, but not connected with the chief business, trade, profession or occupation of the taxpayer shall not be deducted from the income derived from the chief business, trade, profession or occupation of the taxpayer in determining his taxable income.

The word "connected" is not found in section 13 of the present Act. As Thorson, P. said obiter, in Simpson v. M.N.R. [1961] C.T.C. 174; 61 D.T.C. 1117, "There is no reason why there must be such a limitation.” I share this view. See also Dorfman v. M.N.R. supra at page 154 [6134] and Bert James v. M.N.R. [1973] C.T.C. 457 at 464; 73 D.T.C. 5333 at 5337.

It is clear that the "combination" in section 13 of the present Act 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 that subsection 13(1) can be properly so construed. Such a construction would mean that the limitation of this section would never apply and, in every case, the taxpayer could deduct the full amount of farming losses.

In the appeal of The Queen v. Graham, [1985] 1 C.T.C. 380; 85 D.T.C. 5257, the Federal Court of Appeal confirmed the finding and the reasons of the trial judge, [1983] C.T.C. 370; 83 D.T.C. 5399. Mr. Justice Cattanach of the Federal Court-Trial Division held that Mr. Graham was a full-time farmer, notwithstanding his employment with Ottawa Hydro. Cattanach, J. found that, and this is at page 378-79 (D.T.C. 5406),

(a) The acreage and facilities Mr. Graham owned was capable of supporting the hog operation he envisaged as his ultimate objective.

(b) Mr. Graham was raised on a farm.

(c) Mr. Graham had obtained an expertise in what he was doing.

(d) Mr. Graham changed his occupational direction when he moved to a rural area, with the ultimate objective of farming.

(e) His labour on the farm was prodigious.

(f) His gross revenue from the farm exceeded his employment income during the years in appeal.

(g) He invested and devoted all of his resources to his farm operation.

(h) His personal involvement was dedicated to farming to the maximum.

(i) He devoted his employment income to farming.

(j) The farm operation generated a substantial cash flow.

Many of the factors, but not all, which influenced the trial judge in Graham are present in the case at bar: (a) the acreage and facilities Mr. Gray owned during the years in appeal were capable of supporting the operation he envisaged as his ultimate objective; (b) he was raised on a farm; (c) he obtained an expertise in his field; (d) he devoted much time to the farm, and one must infer his labour was prodigious; (e) he used the income from employment for the farm; most of his investments in the farm was [sic] selffinanced with his earnings; (f) his personal involvement was dedicated to farming to the maximum; (g) his farm operation had the potential, if he did not wish to carefully follow his plan for his objective of cash flow; he could have sold horses rather than retain them.

Mr. Gray's gross revenue from the farm in the years in appeal did not exceed his employment income during the years in appeal. This is an important difference between Mr. Gray and Mr. Graham. However, Mr. Gray appeared to be a very prudent and efficient person, as seen from his success at Electrolux. He had a confidence in himself, realized what he wants, and has the prudent capacity to accomplish his goals.

In this respect, his efforts at farming were not much different from that of Mr. Hadley, the taxpayer in the reported case of Hadley v. The Queen, [1985] 1 C.T.C. 62; 85 D.T.C. 5058. Mr. Hadley, a successful businessman, had no prior farm experience and performed no physical labour on the farm, bringing only his organizational and analytical skills to the farm. He expected the farm would someday provide the bulk of his income. Mr. Gray was also successful in business. He had prior farm experience. He brought to the farm, and performed, physical labour, as well as his organizational and analytical skills.

Masson, [1987] 2 C.T.C. 2186; 87 D.T.C. 515, Livermoore, an unreported case as cited by respondent's counsel, did not in our view aid his client. Mr. Masson could not arrange his time schedule in any manner he wished. There was no evidence as to when the farm would be in a position to generate income sufficient to earn a living from it. No reasonable projections were produced in evidence. The court was asked to rely on Mr. Masson's hopes and beliefs.

Mr. Livermoore was a high school teacher. The reasons for judgment do not indicate Mr. Livermoore's business background, which I believe in Hadley, strongly influence the trial judge to serve as an indication as to whether or not the farm, as his other businesses, could produce sufficient income for a livelihood.

Mr. Gray, like Mr. Hadley, had proven talents of organizational ability that permitted non-farm activities to run successfully with minimum attention. In the years prior to Mr. Gray moving back to Winnipeg in 1980, he was willing to accommodate his employer's requirements in the crunch, notwithstanding his ability to fix his own hours, without any apparent opposition from Electrolux.

His move to Toronto indicates this quite clearly. It was only when he ceased to be vice-president of sales, and when he moved back to Winnipeg and committed himself to purchasing the 18 acres he optioned earlier, that in my view he changed his occupational direction. For the months of November and December 1980, therefore, his occupational direction was different from that at the beginning of the year.

Subsection 31(1) states, "Where a taxpayer's chief source of income for a taxation year. . .” and it continues. There is not in my view any requirement that the chief source of income be the chief source throughout the year.

If in the year the person has a chief source which is farming, or combined with farming and something else, then he falls within the exemption of subsection 31(1). If he had a chief source in the year, and that chief source was farming, that is sufficient.

In other words, in the beginning of the year his chief source of income may have been income from employment, but at the last two months of the year it is clear to me that his chief source was income from farming and from employment, a combination of both.

Accordingly, in my view, there is in my interpretation of this section, sufficient grounds to state that he be entitled to be categorized as a class one farmer throughout 1980. Now, during the years in appeal, Mr. Gray's primary efforts were directed to his farm. He was establishing a line of horses which required time and effort. He was not relying for the success of the farm on one or two horses. For this would be foolhardy and risky. But he was building up, through what he described, as a careful breeding program, a line of horses which would eventually obtain the highest reputation.

His evidence in his scheme or program of achieving his goal was not challenged in cross-examination, and I must accept his evidence. Indeed, the quality of his horses was corroborated by Dr. Elder. I found Mr. Gray to be a self-assured, reasonable man, who appeared to know exactly what goals he desired, and how to accomplish them.

Counsel for the Minister questioned Mr. Gray on the risk involved in his farming operation, in particular on his income projection for 1989 was dependent on the success of Prime Property winning a stakes race. Mr. Gray replied that even if Prime Property were not good enough for a stakes race, which he doubted because of his sire, the horse could win about $70,000 allowances races in 1989. He admitted an injury could ruin that horse's career, but all businesses have risk.

Now, I also note that in the Moldowan case, for example, in which the taxpayer was in the business of horse-racing and not horse breeding. In horse breeding, an injury can befall a horse who is then set down for racing, but can still continue in the breeding. Of course Prime Property is a gelding, and would not be available for breeding purposes.

Now, the income earned by the appellant from his employment in 1980, 1981 and 1982 was used to finance his farm and support his family. Without that income, Mr. Gray could not have carried on the farm business. At the same time, Mr. Gray’s primary efforts were directed not to his employment with Electrolux, which was a means to an end, but to his farm, the end. His chief source of income in years in appeal, in my view, was a combination of farming and employment income.

The appeals are allowed with costs. Thank you.

Appeals allowed.