Sherman McClure, June N. McClure v. Minister of National Revenue, [1988] 2 CTC 2140, 88 DTC 1504

Taylor, T.C.J.: —These are appeals, heard on common evidence, in Vancouver, British Columbia, on April 25, 1988, against income tax assessments for the years 1981 and 1982, in which the Minister of National Revenue disallowed the "restricted farm losses” of $5,000 for each appellant for each taxation year. The taxpayers had filed their income tax returns on the basis that they were partners in a farming business. No question was raised by the Minister on that point — a partnership. The only difference in the documentation filed for June McClure, was that of the amount of her salary as a school teacher during the years in issue, otherwise it was the same as that for Sherman McClure, certain portions of which are indicated below:

Notice of Appeal

A. Statement of Facts

— The Appellant is a farmer who resides on a ranch in Endako, British Columbia.

— The Appellant and his wife purchased the ranch in 1975. Since that date, it has been expanded from its original 110 acres to 590 acres, of which approximately 300 acres have been cleared.

— It has always been the intention of the Appellant and his wife to establish a farming business. Their goal is to become a self-sufficient cow-calf operation through producing enough hay-crop to sustain the cattle on the ranch.

— The Appellant and his wife have proceeded to implement their plan by, inter alia, clearing the land and constructing fencing and access roads and a log house, woodshed, workshop, machine shed, pig house, pig pen, bridge, sewage lagoon and water holding pond.

— Due to the high start-up costs of establishing a farming business, the Appellant and his wife were also employed as school teachers in the 1981 and 1982 taxation years.

— The Appellant . . . submits that he was in the business of farming and is therefore entitled to the deductions permitted in Section 31 of the Income Tax Act, S.C. 1970-71-72, c. 63 as amended.

And from the reply to notice of appeal:

— in 1974 the Appellant purchased 110 acres of bushland, and since that time has devoted considerable time and energy to the construction of his residence on the land:

— the bulk of the Appellant's time and energy spent in his non-teaching activities has been dedicated to the construction of his principal residence but not to the practice of farming;

— in 1980 the taxpayer purchased 160 acres of land and leased an additional 320 acres of land, but during 1981 and 1982 did not use this property in any farming business;

— since 1979 the Appellant has reported the following farm sales and expenses:

		1979		1980 1980		1981 1981		1982		1983 1983		1984 1984
Sales
Actual
Personal	$	555.15	$ 9,032.18		$	1,308.66	$	1,028.00	$	1,500.00	$	1,100.00
Consumption		400.00						688.46		763.43		750.00
Optional
Inventory
Other
Total Sales	$	955.15	$	9,301.18	$	1,308.66	$	1,716.46	$ 2,263.43		$1,850.00
Expenses
Operating	$4,037.47		$	7,345.26	$12,458.14		$15,648.56
Livestock
Purchases		350.00		9,764.73		1,337.32		1,067.70
C.C.A.	4,734.00			1,602.00
Optional
Inventory
Other				5,319.00	17,330.00
Total
Expenses	$9,121.47		$24,030.99		$31,125.46		$16,716.46		$22,763.43		$16,851.58
Net Loss	$8,166.32		$14,999.81		$29,816.80		$15,000.00		$20,500.00		$15,001.58
50%	4,083.16			7,500.00	14,908.10			7,500.00	10,250.00			7,500.79
Partnership
Loss Claimed	3,291.58			5,000.00		5,000.00		5,000.00		5,000.00		5,000.00

— the Appellant could not expect a profit from any cattle operation as the cost of livestock and feed exceeded his sales other than personal consumption in the following amounts:

	Sales other			Cost of		Gross
	than Personal		Livestock		Profit or
Year	Consumption		and Feed		(Loss)
1979	$	555.15	$	827.33	($	272.18)
1980	9,031.18		10,213.78		( 1,182.60)
1981	1,308.66			1,337.32	(	28.66)
1982	1,028.00			1,067.90	(	39.90)

— the Appellant, during the relevant periods, raised very little livestock and could not reasonably expect to receive a profit from this operation;

— during the relevant periods the Appellant did not sow crops on any land that had been cleared;

— during the relevant periods the Appellants did not have a clear objective as to the direction of their potential farming activity would take;

— the expenses incurred by the Appellant were personal in nature and could not have reasonably been expected to have been incurred for the purposes of earning income from a farming operation;

— the farming operation was not viable;

— the capital committed to the operation was dedicated to the construction of the Appellant's principal residence and various yard buildings;

— The Respondent relies, inter alia, upon paragraph 18(1)(a) of the Income Tax Act.

— The Respondent submits that he properly determined that the Appellant was not entitled to any farm expenses in 1981 and 1982 on the basis that the Appellant had no reasonable expectation of profit from any farming activity carried on by him.

It is noted in this "farm loss" case, that the Minister relied upon paragraph 18(1)(a) of the Income Tax Act, rather than section 31 of the Act, supra. However, counsel for the Minister had to meet the thrust of the proposition put forward by counsel for the appellants, based on section 31 of the Act, and the jurisprudence related thereto.

Turning back to the specifics of these appeals, counsel for the appellants, at the commencement of the trial noted for the Court, that the major issue, was the taxpayers' right to claim the amounts at issue as "start-up costs" of the farm. In argument both parties noted that this specific aspect of the "farm loss” cases — "start-up costs" as such — had not been greatly explored in the jurisprudence. The emphasis placed on the "start-up costs" point by counsel occasioned the Court to reserve the matter and consider it at length. Other than that, it can be said with little hesitation, that the financial information alone outlined above, leaves little basis in my mind for agreement with the taxpayers' claims in these appeals, and I would see little purpose is still another detailed review of the case law on the issue of "reasonable expectation of profit". The following comments selected from the notice of appeal, supra, are indicative of the embryonic stage of the operation, and from a part of counsel’s proposition that the term "start-up costs" is not only appropriate but applicable and sufficient in this matter:

. it has been expanded from its original 110 acres to 590 acres . . .

It has always been the intention of the Appellant and his wife to establish a farming business. Their goal is to become a self-sufficient cow-calf operation through producing enough hay-crop to sustain the cattle on the ranch.

The Appellant and his wife have proceeded to implement their plan. . .

Due to the high start-up costs of establishing a farming business . . .

With the exception of the year 1980 (see financial schedule above) the operation of the farm over many years revolved around small crops of grain, a few chickens, some pigs etc. The financial results shown for 1980 (see schedule above) came from an entry into a cattle operation, which was quickly curtailed due to cost, unsuitable pasture land, lack of fencing etc. The appellants reverted immediately to a programme of getting the basic facilities — land, pasture, buildings, fencing, etc. — in place before considering another such venture. It is essentially the nature and characterization of these efforts which is the subject of this appeal. Perhaps the appellants learned something from that 1980 experiment, and indeed perhaps they learned a good deal from the entire experience, but that is not the issue — self-educational activity is not in my mind synonymous with economic productivity. The lives of the appellants and their children were anything but comfortable — it can only be described as harsh and difficult. Few people would have endured the existence which the circumstances, climate and evident tasks dictated. To that extent, the Court does recognize their efforts and commends them — but that again is not the issue before us. The details of the "Operating Expenses" were:

The following are portions of the argument of counsel, and I will deal with the testimony and evidence directly related to these comments, rather than reviewing all of the testimony and documentation filed.

Counsel for the appellants:

The McClures had start-up losses, in terms of the length of the start-up losses, it’s my recollection of the evidence that Mrs. McClure said that they expected to make a profit initially within five years of moving to British Columbia, from 1975 to 1980. As they got settled on the initial Lot 4077, acquired the other 480 acres, the south-east quarter and north half, they realized that their expectations had been optimistic, and about 1979, when they legally acquired the balance of the property, the 480 acres, they thought then that it would take them about ten years.

So, their expectation was for about ten years of start-up, until a point of profitability, and that would be until 1989, [Emphasis mine.]

And it’s certainly clear from the evidence that Mr. and Mrs. McClure started from scratch. There was nothing there, other than, as I say, some stumps where there had been trees when they took over the entire 590 acres. It is our submission, and anticipating the Respondent's argument, the argument that I expect my learned friend will make, is that these start-up costs were too long, that it was simply too long to be reasonable, and therefore the expectation of profit cannot be said to be there in 1979 or at the beginning of the farming business. It's our submission that in order to say that start-up costs are too long, either you have to say that progress is no longer being made, in terms of reaching the goal of profitability, or that there is no hope of profitability. [Emphasis mine.]

. . . in reading many of the farm loss cases, I could not find any cases where facts similar were denied a restricted farm loss. [Emphasis mine.]

But, having started from that really quite general proposition, the jurisprudence has developed most recently, and most importantly, through the Gorjup case in the last 14 years, 13 years, but the Matthews case is included as a reference and is really, in my estimations, a basic or grandfather start-up costs case.

In terms of summarizing the argument on the question of reasonable expectation of profit, and was the ranch therefore a business, it’s certainly our submission that there was a reasonable expectation of profit, in terms of the meaning of those words in the jurisprudence, and the legislation, and that the farming business, the ranch was carried on as a business. There was a business for those years, that it was not personal and living expenses, but merely the construction of a residence with a view to having a certain rural lifestyle.

There was far too much effort, time, capital expended and far too much else realized in terms of the land that has eventually been cleared, granted the majority of the real results of the years after the years under appeal, in terms of the infrastructure, constructing the buildings, and the machinery required, that it would be certainly our strong submission that this was a business for those years. [Emphasis mine.]

Counsel for the respondent:

. . . it's important to go back because the area is somewhat novel, and look at what Moldowan says just in brief, and then from there attempt to show why the start-up costs in this case are really not even start-up costs they're something prior to startup costs.

. . . it was in 1974 that the first crop was put in, and that was a grain crop not a hay crop, and that's important also I would submit. And the fifth point is that to date, 1988, there are no cattle with the exception of one aberration in 1980, and I will mention that shortly. As such, the bulk of what we've had to look at in the evidence over the last day has been really geared to that start-up time, from 1975 through to 1988, because none of it is farming at the present time, I would submit. There is no farming activity to date. So, the only logical conclusion that can be drawn is that must be start-up of some nature.

The Minister’s position that it’s not start-up of a farming business, but it’s really Start-up of an activity which will permit the taxpayers to start their farming business, which is something slightly different. So, the Minister's position is that the McClures to date, and certainly in the years 1981 and 1982 were not farming. But, they were doing some other activity that may have lead up to a farming business, but at that point in time they were not farming. Ms. Watchuk has indicated that their goal was one of profitability, and I would submit that maybe it’s better to look at it in terms of their goal of being able to make a profit. Which I would submit are two different things.

In all of the cases that the Appellant has cited, I looked through them, and in every case the properties in question were subject to earning income. They were all in a workable state, and for the years under appeal in those cases, and I admit I've looked through them quickly, they either could support hay, they could support cattle, they did support cattle but they were losing money, but in every one of those cases and the Gorjup case included there was the ability to make the profit, make the money, but it was stopped by some particular reason. In this case there was no ability to make the profit, there just was no farm at this point in time. By the taxpayer's own admission there was no farm.

Analysis

I would first note, in connection with the quotations from the argument of counsel for the appellants, particularly the portions I have underlined:

(1) I am not aware that in order to say that start-up costs (whatever they are) are too long, that it is necessary to say "there is no hope of profitability”.

(2) While the instances of case law in which even the "restricted farm loss" has been denied by the Courts may be infrequent recently, it is my view that in the cases where the "restricted farm loss” has been allowed, the determination on those facts must have warranted it in accordance with the judgments of the higher courts, and not because it was completely automatic.

(3) Although the term "personal and living expenses" may be difficult to comprehend for appellants who have laboured long and hard in some endeavour, section 248(1) of the Income Tax Act leaves the Minister little option in describing costs not associated with the "business" by using that term.

Section 248(1):

"Personal or living expenses". —

'"personal or living expenses' includes

(a) the expenses of properties maintained by any person for the use or benefit of the taxpayer or any person connected with the taxpayer by blood relationship, marriage or adoption, and not maintained in connection with a business carried on for profit or with a reasonable expectation of profit.” [Emphasis mine.]

Section 30 of the Income Tax Act reads:

SEC. 30. Clearing land, levelling land and laying tile drainage.

Notwithstanding paragraphs, 18(1)(a) and (b), there may be deducted in computing a taxpayer's income for a taxation year from a farming business any amount paid by him in the year for clearing land, levelling land or laying tile drainage for the purpose of carrying on the farming business.

A substantial portion of the farm expenses for the years in question in these appeals, related to clearing and levelling of the land, and such amounts had been taken into account in the total farm expense, before arriving at the $5,000 restricted farm losses under dispute. In simple terms, as counsel for the Minister put it, section 30 of the Act permits a taxpayer in the farming business to charge off as a current expense, rather than a capital expense, such specific cost. I agree with that view of section 30 of the Act, but it does highlight the point that in dealing with farm businesses, the Income Tax Act does provide some particular areas of relief not regularly available to other taxpayers. The comment to be found in the Canadian Master Tax Guide, published by CCH Canadian Limited is quite explicit:

The taxpayer must be engaged in the business of farming and the expenditures to be deductible must be made for the purpose of carrying on such a business. [Emphasis mine.]

The operative words seem to be “business of farming” which is also reflected in Interpretation Bulletin 485. This would indicate that taxpayers may be unable to deduct certain costs during the year in which they were incurred if they were for the purpose of getting into the business of farming. That is arguably a narrow interpretation of the circumstances under which such levelling and clearing might be done — to establish a business. What other proper disposition might be made of them (if any) was not brought before the Court directly.

I have reviewed with considerable interest certain portions of a publication by Canadian Tax Foundation (No. 69) of a paper prepared by D. Keith McNair, F.C.A., entitled The Meaning of Cost in Canadian Income Tax. In particular I would refer to pages 106 to 111 of that publication. While that section is dealing in the main with the determination of capital costs for depreciation purposes, it provides substantial enlightenment for the general subject which seems to come before the Court in this appeal — how to determine “cost”, when differentiating with the term "operating expenses". I quote therefrom:

In determining the actual cost of depreciable property, that is, the capital cost, it seems to be well established that items additional to the invoice cost of the particular property must be included. The Department of National Revenue, in an interpretation bulletin, deals with this matter in the following terms:

1. The term “capital cost of property" generally means the full cost to the taxpayer of acquiring the property. It includes legal, accounting, engineering or other fees incurred to acquire the property." [11]

“This statement corresponds closely to the generally accepted accounting view that “The recorded cost of a tangible capital asset should include all costs necessary to put the asset in a position to render service".* [12] The application of generally accepted commercial practices and accounting principles in determining the cost of assets has been supported in various decisions on the subject. The use of business and commercial principles was specifically approved in Denison Mines Ltd* [13]

Following these principles it would seem that, in addition to the basic invoice cost, the capital cost would also include transportation costs, assembly costs, installation costs and the various types of professional and other fees that may be incurred with respect to the acquisition. For example, in various cases the following costs have been included in the capital cost of assets acquired:

Architect's fees. [15]

The cost of laying foundation aggregates and grading and surfacing included in the capital cost of roads and parking areas. [16]

Cost of options as part of the capital cost of property subsequently acquired, [17] now included by the statute in paragraph 49(3)(a).

The cost of parts of the equipment that may have to be replaced annually or more often if they form an integral part of the equipment itself. Where the taxpayer attempted to charge off as expense the cost of tires mounted onto newly acquired logging vehicles, this was held to be contrary to accepted accounting practices [18] and the costs were treated as part of the capital cost of the vehicles.

The payment of a bonus to a money lender in respect of a loan made for the purpose of purchasing equipment was held to be as much a part of the capital cost of the equipment as the price paid to the vendor. [19]

The treatment by the taxpayer of interest expense and other costs of borrowing incurred during construction of substantial installations before the commencement of the business as part of the capital cost of those installations was held to have been proper, in the absence of a definition of ‘capital cost' and since that treatment was in accordance with generally accepted business and commercial principles. [20] The Act, in section 21, now provides statutory authority for inclusion of the cost of borrowed money in capital cost in certain circumstances.

Cost of work done on land in the form of blasting and removing of rock held to be part of the cost of a building erected on that land. [21] ^

. . . To that extent, the outlays were not made for the purpose of gaining or producing income and were made by the appellant not as trader of operator, but as owner. [24]

The expenditures were held to be part of the capital cost of the timber limit, even though the Regulations exclude from classes of property described therein property "that was not acquired by the taxpayer for the purpose of gaining or producing income". [25]

Where the taxpayer manufactures or constructs a depreciable property for his own use, generally accepted accounting principles require that the cost of that property should include all those costs necessary to put the asset in a position to render service.

. . . It was acknowledged that interest incurred in the years in which construction was taking place, and before the business started, was not deductible under the provisions of subsection 20(1), since there was no business with respect to which a computation of income could be made. On the other hand, the court found that, in the absence of a statutory definition of the expression “capital cost to the taxpayer of property," and in the absence of any authoritative interpretation of the words, the capital cost should include those outlays that the taxpayer incurred as a result of his decision as a businessman to use certain method in the acquisition of the property. The court referred to a number of American decisions, which were put forward by counsel for the Minister as authority for the proposition that interest should not be included in the cost of capital assets, [37] but nevertheless found that, for Canadian tax purposes, interest could be included as part of that capital cost. [Emphasis mine]

In addition, while it is a publication of a few years ago, and deals with the income tax law of Great Britain, certain useful principles arise from a perusal of

ELEMENTS OF THE LAW OF INCOME AND CAPITAL By

C.N. BEATTIE, Q.C., LL.B. of Lincoln's Inn, Barrister-at-Law CANADA AND U.S.A. The Carswell Company Ltd. Toronto

at page 81 :

Hobby trading

A trading loss cannot be set against other income unless it is shown that the trade is being carried on on a commercial basis and with a view to the realisation of profits. For this purpose the fact that a trade was being carried on so as to afford a reasonable expectation of profit is conclusive evidence that it was being carried on with a view of the realisation of profits. [16] The object of these provisions is to prevent the obtaining of tax relief against other income in respect of trades which are being carried on for reasons other than the purpose of making profits. In the case of farming and market gardening, the rights to set losses against other income is still further restricted. Such losses cannot be set against other income, even if the trade was carried on on a commercial basis and with a view to profit, if in each of the prior five years a loss was incurred (with certain exceptions where loss could not have been avoided even by a competent farmer or market gardener). [17] For the purpose of these provisions losses in the prior five years are computed without taking account of capital allowances, that is to say, a profit and not a loss would be taken as having been made notwithstanding that the profit might have been turned into a loss by deducting capital allowances therefrom.

Losses which cannot be relieved against other income by reason of the above provisions can still be carried forward and set against future profits of the same trade.

Generally Accepted Accounting Principles (G.A.A.P.), should be taken into account according to the case law along with other relevant considerations for determination of profit. Such G.A.A.P. are of assistance particularly in distinguishing between "capital" and "current" costs in the preparation of financial statements. Without a demonstrated business operation, there may be little reason to make any distinction between “capital” or "operating" costs, unless it is intended to invoke the provisions of section 111 of the Income Tax Act during some taxation years. The prospect of describing such costs arising out of a "non-business" [1] so that the capital base would have reference to the costs necessary to put the asset "in a position to render service" (underlining mine — see earlier reference by D. Keith McNair), sometimes does not meet with much public approbation, and it is difficult to conclude that G.A.A.P. are being followed very religiously in a proposition such as that in the appeals in this matter.

It may be that the term — "start-up costs” had its origin in case law antedating William Moldowan v. The Queen, [1977] C.T.C. 310; 77 D.T.C. 5213 (S.C.C.), but if so that was not brought to my attention by counsel. In Moldowan, supra, there is only one reference to "start-up costs”, on page 315 (D.T.C. 5216), as follows:

“. . . 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. [Emphasis mine.]

There is also a term "start-up losses" at page 5215 as follows:

. . . The factors will differ with the nature and extent of the undertaking: Matthews, [1974] C.T.C. 230; 74 D.T.C. 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. [Emphasis mine.]

The reference there to “a productive going operation" as the contrast to "begins a tree farm on raw land" does not indicate to me that based on that phrase alone a taxpayer should consider his costs entitled “start-up losses" as deductible without regard to their origin. Any "start-up losses” incurred from a productive going operation would not be in the nature of cost for establishing an economic base from which to commence the productive going operation — it would already be there. Such losses (if any occurred) would be from the operation of the farm itself. In argument, counsel for the appellants referenced Matthews, supra, as a stable base for the introduction and deductibility of "start-up costs”, but I find in Matthews, supra, no such term — either “start-up losses" or for that matter "start-up costs”. However it may be deduced from Matthews, supra, (and I take the argument of counsel to touch on this point) that the portions of Matthews, supra, to be considered when reviewing Moldowan, supra, were to be found on pages 234 through 236 (D.T.C. 6196 through 6197) (including the financial schedules):

The plaintiff did not suggest that the capital cost allowance claimed was not expressly permitted. The outlays resulting in the 1969 loss appear, prima facie, not to be of a capital nature. I find that the deduction of the loss claimed was not precluded by paragraph 12(1)(b).

There is a valid question as to the capacity for profit in circumstances where the capital investment in the land is most unlikely to be recovered out of those profits over a reasonable period of time.

. . . On the other hand the improbability of recovering the cost of the land and the inadequacy of the return on its value is not entirely unrealistic in the commercial sense.

The conduct of a business whose profits are not expected to reimburse the capital cost of an asset that is not subject to waste or depreciation in the process of production nor to obsolescene by the passage of time or the development of technology does not violate ordinary commercial principles so as to lead to the conclusion that the business is not being carried on for profit or with a reasonable expectation thereof.

It is apparent that "tree farming” on the scale in question involves relatively few revenue years over a long period of time, perhaps much longer than normal human life expectancy. Equally, it may be inferred that, given a number of "tree farms" or a very large one with a number of plots in varying stages of maturity, a more or less frequent recurrence of revenue years could be achieved, after, of course, a rather lengthy initial waiting period if the undertaking were started from scratch.

Each case where the realization of profit is so postponed will have to be examined on its own merits to ascertain that the profit is not merely notional and that the expectation of profit is indeed reasonable. I am, however, satisfied, in this instance, that the Defendant was, during his 1969 taxation year, carrying on the 'tree farming’ operations on both the Holland and North Gwillimbury properties as a business with a reasonable expectation of profit and that deduction of the losses claimed was proper. [Emphasis mine.]

As I read Matthews, supra, the learned justice was putting forward the proposition that the taxpayer once having established his tree farm (land, seed, seedlings, planting, etc.) with very limited annual costs from then on, need only wait and in the fullness of time, the trees would reach maturity, or at least to the size required for economical harvesting. One can hardly quarrel with the perspective — barring a completely unforeseen disaster — hail, flood, or tornado for example, the growing trees would continue to grow — nature would take care of that — and revenue, and presumably some profit calculated by the taxpayer Matthews seemed inevitable — even if some years down the road. Any other interpretation does not commend itself to me. The distinction is made in Matthews, supra, between "capital" . . . in order to “acquire land”, and "operating expenses" starting with "treeplanting".

There is no reason to assume from the related wording in Moldowan, supra, that the learned justice therein intended anything greater than can be found in Matthews, supra. The reference to "start-up losses" in Moldowan, supra, is important, but it should not be disconnected from that portion which follows — "as the man who begins a tree farm on raw land" (Emphasis mine). "Raw land”, in that context, I would contend, is not land in its native state, such as in the appeals before us, but rather land still unproductive, but capable of immediate utilization as a base of an economic operation. It is difficult to see how the reference to either Moldowan, supra, or Matthews, supra, can stretch the term "start-up losses" to include costs which are not directly related to the operation of tree farming.

Continuing the review of "start-up costs" in more recent case law, we find in The Queen v. Gorjup, [1987] 2 C.T.C. 129 (F.C.T.D.) at 136 and 138; 87 D.T.C. 5348 at 5353 and 5355:

What, then, was the state of affairs of this farm after 1976 and before 1984? The Crown maintains that no business existed there in the true sense of the word. Counsel urges me to find that all of the work done up to 1984 was merely preliminary, consisting of preparing the land to support a cattle farm. She has brought forward several cases which hold that farmers are not entitled to deduct "start-up" losses which are incurred not while operating a business, but in preparing a property for use as a farm at some time in the future. (See, Craddock et al. v. M.N.R., [1986] 1 C.T.C. 2006; 86 D.T.C. 1014 (T.C.C.), Dreger, Kadatz et al. v. M.N.R., [1985] 1 C.T.C. 2131; 85 D.T.C. 142 (T.C.C.); Karpish v. M.N.R., 86 D.T.C. 1782 (T.C.C.) and Lorenz v. M.N.R., [1984] C.T.C. 2110; 84 D.T.C. 1118 (T.C.C.).

Both counsel asked me to consider expanding on the meaning of start-up costs. Here again I believe it depends almost exclusively on the factual situation in place. Here, for example, everyone, experts and laymen alike, concede that it takes much more time, effort, capital, and dedication to be successful in a purebred cattle operation. For that very reason start-up costs must be allowed over an extended period of time, even to 15 years mentioned by one of the witnesses. Another operation, not depending upon purebred cattle and establishing credibility should no doubt be limited in the amount allowed as start-up costs.

In these instant appeals, counsel for the appellants, at first urged on the Court that the learned justice in Gorjup, supra, rejected such a proposition and therefore it should be rejected here also. I do not see that such a proposition was rejected in Gorjup, supra. As I read it the justice did not appear to specifically deal with the proposition. The two signal cases from the Federal Court upon which Gorjup, supra, is substantially based are The Queen v. Paul E. Graham, [1985] 1 C.T.C. 380; 85 D.T.C. 5256 (F.C.A.) and Harold S. Hadley v. The Queen, [1985] 1 C.T.C. 62; 85 D.T.C. 5058 (F.C.T.D.). It is not evident to me that in Hadley, supra, or Graham, supra, the learned justices felt required to rely for support on the question of "start-up costs", as that is put before the Court in this matter; and in neither case was the issue of whether there was a "reasonable expectation of profit” seriously disputed. In Hadley, supra, it had already been accorded by the Minister, and in Graham, supra, it was simply never an issue (See Gorjup v. M.N.R., [1985] 2 C.T.C. 2194; 85 D.T.C. 530). The major reference to “start-up costs” comes out of the dissenting opinion in Graham, supra, as follows from pages 393-4 (D.T.C. 5267):

. . . Finally, I am not oblivious of Mr. Justice Dickson's last observation to the effect that a man should not be disentitled to deduct the full impact of start-up costs. But, I do not think that the concept of start-up expenses can be extended to a period reaching over several years. during which the taxpayer plans to build up slowly, through gradual development expansion and acquisition, an operation that will finally yield a significant profit.

I make no further comment thereon.

I do not interpret that quotation by the learned justice in Gorjup, supra, to imply that the period of time — no matter how extended — for attaining of a profit, has any bearing on the primary responsibility of a taxpayer to demonstrate a viable and supportable economic unit of production is in existence, during the taxation period. Nor do I see that "start-up costs" in that comment represent something different than the expenditures incurred in direct pursuit of “a reasonable expectation of profit.” from a business operation.

I would also refer to two other related cases — Lloyd Hooker v. M.N.R., [1987] 2 C.T.C. 2380; 87 D.T.C. 653 and Matthew Epstein v. M.N.R., [1988] 1 C.T.C. 2152; 88 D.T.C. 1088, in which the point at issue in these appeals was also before the Court. In both situations, even though the Federal Court judgment of Gorjup, supra, was considered the underlying facts did not support the appellant's contentions and the appeals were dismissed.

While Justice Strayer in the recent judgment of Federal Court in The Queen v. J. Peter Connell, [1988] 1 C.T.C. 247; 88 D.T.C. 6166, was dealing with the “chief source of income” question some of the comments to be found at page 250 (D.T.C. 6168) have a relevance to the underlying question of "source of income" itself:

. . . the taxpayer blames this in part on depressed meat prices and, for part of the period after the tax years in question, on extraordinarily high interest rates. To a certain degree these and similar problems seem to arise frequently in agriculture and any realistic forecast of profitability must take them into account. While the taxpayer says he is optimistic for the future and expects his herd to become profitable, as mentioned earlier no data and no corroborating evidence was presented on this point. [Emphasis mine.]

One can conclude that even as he accepted the Minister's earlier implicit determination that there was a "reasonable expectation of profit”, by virtue of the allowance of the $5,000 restricted farm loss, the learned Justice had some difficulty seeing any evidence of that in the facts before him. A similar point can be found in Wesley H. Warden v. M.N.R. [1981] C.T.C. 2379 at 2389; 81 D.T.C. 322 at 328:

. . . The import of the remarks I have made is simply that it is a fundamental requirement that the costs involved be clearly shown to be “start-up costs”. That designates, as I see it, the existence and demonstration of a systematic and organized program for the earning of profit from a business, and proof that the initial outlays were an integral part of that process, taken into account in the planning, and capable of absorption by the appellant in anticipation of the eventual production of profits. In such a program, an appellant would clearly show that he has consciously decided to write off these start-up costs against a year or years of little or no income, rather than capitalizing them (if some form of asset accumulation is involved), or deferring their deduction until sufficient income is earned in order to absorb them. The absence of such a discernable and comprehensive program upon which to base a claim for deductibility of such losses as “start-up costs" will always put such a claim at considerable risk in my view. [Emphasis mine. I

The demonstration of a programme designed to establish a business, is hardly the same as earning a profit from a business, in my view.

From the quotation above from Gorjup, supra, I would reference Lorenz, supra, at page 2112 (D.T.C. 1119):

To characterize the expenses incurred by the appellant as "start-up" costs as argued by Mr. Seed, his agent, would require the appellant to show "the existence . . Of an organized program for the earning of profit from a business, and proof that the inital outlays were an integral part of that process . . . capable of absorption . . . in anticipation of. . . profits' (Vide Warden v. M.N.R. [1981] C.T.C. 2379; 81 D.T.C.) In this case there was no evidence that the appellant incurred the expenses claimed with a view to earning a profit at some reasonable time in the future.

It would appear that the judge in Lorenz, supra, did not reject the concept of the deductibility of start-up costs, but rather that a pre-requisite was:

. . . to show "the existence . . . of an organized program for the earning of profit from a business, and proof that the initial outlays were an integral part of the process . . . capable of absorption . . . in anticipation of. . . profits.

In Dreger, supra, at page 2132 (D.T.C. 143) we find:

. . . The losses in question here are not, as I see it, the start-up losses of a business. They are the losses from farming before the commencement of farming as a business.

This is somewhat more specific, and a distinction is being drawn between “start-up losses of a business" and "losses from farming before the commencement of farming as a business”.

We turn to Karpish v. M.N.R., [1986] 2 C.T.C. 2347 at 2350 (T.C.C.); 86 D.T.C. 1782 at 1783-84:

Viewing the whole of the evidence from an objective point of view, as the law requires, I can only conclude that the appellant has failed to discharge the onus of establishing that in the years under review he had a reasonable expectation of profit from his farming operations. [Emphasis mine.]

I do note that the above judgment has been appealed to the Federal Court of Canada, and that it also relied on Warden, supra, but the reference point and the connection is between "reasonable expectation of profit" and "farming operations".

Finally from Collin Craddock and Philip Giffen v. M.N.R., [1986] 1 C.T.C. 2006 at 2008-9; 86 D.T.C. 1014 at 1015-16:

Mr. Giffen stated that by design the early years of the farm were devoted to getting the property into shape for the breeding operation; these years, he said, were “years in which we were reconditioning the land so we could use it”.

In my view Messrs. Giffen and Craddock were not in the business of carrying on farming in 1980 and 1981. What they were doing during those years was preparing the property for use as a farm at some time in the future. These were not "startup" costs of a business because in the years of the appeal the property could not support a business enterprise. In appeals of this type an appellant frequently explains that he is putting his property into shape so that it will be capable in the future of earning income and having a profit; it is argued costs of a current nature expended during this time are start-up costs. Because he is cautious, the taxpayer says, it may take years for the business to start actual operations and even years longer until a profit is earned. What the taxpayer is really saying is that his business operations cannot start until such time as there is sufficient capital available to support the business. In 1980 and 1981 Messrs. Giffen and Craddock were working to get the property to a condition which would support what they wanted to do with it. But they were not yet carrying on a business.

In these appeals Messrs. Giffen and Craddock are in effect saying that the business they wished to carry on could not start until the barn was rebuilt, the shed repaired, the house was in a proper state of repair and the arable land was susceptible of giving proper crops. In other words capital assets must first be improved to bring the farm property to a point where a business may be carried on. There was no evidence adduced to show that with the amount of capital invested in the farm property in 1980 and 1981 by Messrs. Giffen and Craddock, the property could reasonably be expected to yield a profit from farming.

Again, and this time with great clarity, a line of demarcation is drawn between "preparing the property for uses as a farm at some time in the future", and "carrying on a business".

I would read the above jurisprudence to indicate that the investment in capital does not become operating costs, nor does the cost of personal or living expenditures become business, merely by changing the identification to "start-up costs”.

I would contend the case law does not signify that the term "start-up costs" of itself, provides any special entitlement to deductibility under the Act, which could not simply be available as a result of a determination that such costs arose "with a reasonable expectation of profit" — simply from operating a business. Nor do I see that in calculating such a profit the capital acquisition and asset formation factor leading up to a “business”, may be so easily ignored in the calculation.

Summary

The terminology used by counsel for the respondent in this matter "pre- start-up costs" to describe the amounts under appeal, may be a bit novel, but I agree that where there is little or no indication of a stable, productive economic base from which to expect a profit, then it is difficult to see in such a situation — "a source of income”. I am not impressed with the view that “a source of income”, means merely that revenue can or will be generated. The operation should have the potential, not only of producing revenue, but the prospect — even the fairly immediate prospect in most cases — of showing an excess of revenue over expenditures. The word “income”, even in the phrase “source of income”, as I understand it, has a much closer affinity to "profit", than merely to "revenue" (see section 9 of the Act). The term “start-up costs" in my view, does not represent all outlays and expenses incurred to start a business, it does signify the accumulation of such outlays and expenses from the start of the business up to the point of profit. A "business", is an economically viable operation from which it can be determined at that point in time that there is a "reasonable expectation of profit". “Reasonable” is a term encompassing both objective and subjective considerations; "expectation", means something more than mere "hope",

— perhaps it is closer to "anticipation"; and “profit”, is a calculation taking into account the Act and G.A.A.P., with little need for subjectivity in my view. To that degree at least, the reference to paragraph 18(1)(a) of the Act in the pleadings by counsel for the respondent, supra, has certain merit. That section reads:

Sec. 18. General limitations.

(1) In computing the income of a taxpayer from a business or property no deduction shall be made in respect of

(a) an outlay or expense except to the extent that it was made or incurred by the taxpayer for the purpose of gaining or producing income from the business or property;

In these appeals, the case has not been made that there was an operation from which there could be a "reasonable expectation of profit” during the years under appeal. Equally, the losses, termed by the appellants as "startup costs", are not costs associated with such an operation, but rather costs associated with holding, improving, or establishing the capital and asset base from which to begin operations, or they might be termed "personal or living expenses". I am not persuaded that either the legislation or the case law provide support for their deductibility on a current basis, as claimed by these appellants. Whether some other treatment of these amounts, such as capital designation with the possibility of subsequent depreciation on some of the assets, could have been more appropriate was not raised, nor was the proposition made that some of the costs come under section 30 of the Act. It is not for the Court to determine what the costs involved in the appellants' claims did represent, it is sufficient to note that they were not "start-up costs", as Moldowan, supra, should be interpreted even in its most generous application.

Finally I would quote from the signal judgment of Madame Justice Reed in John D. Coupland v. The Queen, [1988] 1 C.T.C. 414; 88 D.T.C. 6252:

In my view, the Moldowan case sets out rules which are applicable in all cases, regardless of whether the business under review is farming or of some other type. Also, I do not accept that there is unfair treatment because a taxpayer must demonstrate that he is engaged in a genuine business enterprise before being allowed to deduct, for tax purposes, the expenses related thereto. This rule is designed to prevent taxpayers writing off personal expenses under the guise of business expenses. It is designed to promote equity as between taxpayers.

The appeals are dismissed.

Appeals dismissed.