Syrico Corporation v. Minister of National Revenue, [1988] 1 CTC 2026, 88 DTC 1001

Tremblay, T.C.J.:—This appeal was heard on November 6, 1986 at the City of London, Ontario.

1. The Point at Issue

Pursuant to the notice of appeal and the reply to notice of appeal, the facts are as follows: until 1979, the appellant had been engaged in a dairy operation. It had to sell its dairy herd (103 animals) following the destruction of the farm buildings by a tornado the same year, i.e. in 1979.

The point at issue is whether the appellant is correct in the computation of its income to treat the disposition of its herd as disposition of capital property. It bases its contention on sections 29 and 39 of the Income Tax Act (hereinafter the Act).

The respondent, basing his own contention on sections 28 and 29 of the Act, treats the disposition of the herd, to the amount of $100,892, as income because animals are part of the farming business inventory.

As the appellant received from the purchasers $7,828 in 1979 and $93,064 in 1980, these amounts were included in the appellant's income for the said years.

However, the fair market value of the herd inventory on December 31, 1971, to the amount of $24,290, was taken into consideration thus diminishing the appellant's income.

2. The Burden of Proof

2.01 The burden of proof is on the appellant to show that the respondent's reassessments are incorrect. This burden of proof results particularly from several judicial decisions, including the judgment delivered by the Supreme Court of Canada in Johnston v. M.N.R., [1948] S.C.R. 486; [1948] C.T.C. 195; 3 D.T.C. 1182.

2.02 In the same judgment, the Court decided that the assumed facts on which the respondent based his reassessments are also deemed to be correct. In the present case, the assumed facts are described in subparagraphs 5(a) to (d) of the reply to notice of appeal as follows:

5. The Respondent, in reassessing tax as aforesaid, relied upon the following findings or assumptions of fact:

(a) those facts hereinbefore admitted or stated;

(b) the basic herd of the Appellant was livestock and inventory of its farming business;

(c) the fair market value of the Appellant's basic herd on December 31, 1971 was $24,290.00;

(d) the Appellant in selling its cattle, sold its basic herd and received proceeds of $100,892.00 of which $7,828.00 was received in 1979 and the balance of $93,064.00 was received in 1980.

3. The Facts

3.01 The facts admitted and stated by the respondent in the reply to notice of appeal as alleged in subparagraph 5(a) quoted above (para. 2.02) are as hereinafter.

3.01.1 Facts admitted

The facts admitted by the respondent in paragraph 1 of the reply to notice of appeal referred to the notice of appeal. The said paragraph reads as follows:

1. The Respondent admits the allegations of fact set out in paragraphs 1 to 4 of the Notice of Appeal except that he does not admit the facts set out in subparagraphs 4(f), 4(g)(iii), 4(h)(iii) and 4(i)(ii) as these paragraphs relate to the portion of the appeal relating to interest income in the 1980 taxation year which was withdrawn by the Appellant's letter of August 15, 1986.

The notice of appeal reads as follows:

NOTICE OF APPEAL TO THE TAX COURT OF CANADA in the matter of the reassessment under the Income Tax Act of Syrico Corporation (formerly Everhope Farms Limited), 354 Arthur Street, Elmira, Ontario N3B 2P4.

(1) The taxpayer was reassessed on October 26, 1983 by the Honourable the Minister of National Revenue, through the Kitchener District Office, for the 1979, 1980 and 1981 taxation years.

(2) On January 23, 1984, the taxpayer filed Notices of Objection to these reassessments.

(3) On July 27, 1984, the Honourable the Minister of National Revenue notified the taxpayer of his action taken as a result of the objection filed by the taxpayer. This action consisted of issuing new Notices of Reassessment dated July 27, 1984, assessing tax in the following amounts:

1979	$ 1,865.42
1980	11,222.71
1981	6,592.48

(4) The following is a statement of facts relevant to the reassessments for the years 1979 to 1981:

(a) The taxpayer had a fiscal period end of October 31, and computed income on the cash method described in Sec. 28 of the Income Tax Act;

(b) The taxpayer, until 1979, had been engaged in a dairy operation. In that year a tornado went through the area and demolished the buildings used in this operation. As a consequence, the taxpayer decided to get out of the dairy business and to that end arranged to sell his dairy herd. The entire herd was sold before October 31, 1979 but most of the proceeds were not received until after the fiscal year end;

(c) Prior to 1972 the taxpayer had established a basic herd. The balance of animals in the herd at the time of the sale was 87 mature animals;

(d) The taxpayer treated the disposition of the basic herd animals as the disposition of a capital property. The gain on disposition was calculated by deducting from the total proceeds the value of the basic herd animals at December 31, 1972. The amount of this gain less a reserve claimed under subsec. 40(1), based on the portion of the proceeds not due until the 1980 fiscal year, was reported in 1979. The amount of the reserve was reported as a gain of the 1980 fiscal year;

(e) The taxpayer claimed the mandatory deduction under Sec. 29 of the Income Tax Act in 1979;

(f) The proceeds of insurance payments to the taxpayer from the tornado relief fund and proceeds from the sale of livestock were invested temporarily by the taxpayer until it was able to locate and negotiate the purchase of another farming operation. The income produced by this investment was reported incorrectly in 1980 as Canadian investment income, and was reported in 1981 as part of its active business income; (not admitted by respondent)

(g) On October 26, 1983, the taxpayer was assessed. The matters relevant to these appeals in the reassessments are as follows:

1979

(i) The full amount of the proceeds of disposition were included in the taxpayer's income. The taxable capital gain, reported in 1979, on the disposition of the basic herd was deleted from the taxpayer's income;

1980

(ii) The taxable capital gain, reported in 1980, on the disposition of the basic herd was deleted from income;

1981

(iii) Interest income produced from the temporary investment of insurance, tornado relief funds and livestock, was added to Canadian investment income and deducted from reported active business income; (not admitted by respondent)

(h) On or about January 23, 1984, the taxpayer filed Notices of Objection to the reassessments requesting the following relief:

1979

(i) That the proceeds of disposition of the basic herd should be treated as being on account of capital rather than as income;

1980

(ii) In any event, that the proceeds of disposition of the basic herd should be included in 1979 only to the extent actually received in that year, and that the balance should be included in 1980;

1981

(iii) That interest income should be treated as active business income and not as investment income; (not admitted by respondent)

(i) The Honourable the Minister of National Revenue notified the taxpayer of the action taken by him with respect to the Notices of Objection, by way of further reassessments dated July 27, 1984. The relevant portions of these reassessments provided the following:

(i) that the proceeds of disposition of the basic herd to the extent of $93,064 should be transferred from 1979 income to 1980 income:

(ii) that the 1981 interest income was treated as part of active business income. (not admitted by respondent)

(5) The taxpayer requests that the following relief be granted by the Court:

(i) that for the 1979 year the part of the proceeds of disposition of the basic herd included in income of that year, amounting to $7,828, be deleted from income; (not admitted by respondent)

(ii) that for the 1980 year the part of the proceeds of disposition of the basic herd included in the income of that year, amounting to $93,064, be deleted from income; (not admitted by respondent)

(6) The reasons for the taxpayer's request are:

(i) the basic herd is a capital property; (not admitted by respondent)

(ii) the interest received by the taxpayer on the temporary investment of surplus funds is incidental to its active business, and should be treated as part of its active business income.

3.01.2 Facts stated

The facts stated by the respondent are substantially the following ones:

The Appellant computed the gain from the sale of this cattle as follows:

	1979
Proceeds	$100,891.65
Less fair market value on V-day (Dec. 31, 1971)	24,290.00
Capital Gain	$ 76,601.65
Less Reserve for proceeds not received	70,658.42
Net Capital Gain	$ 5,943.23
Taxable Capital Gain	$ 2,971.62
Less fair market value of herd on Dec. 31, 1971
pursuant to section 29	24,290.00
Net Amount deducted from income resulting
from sale of basic herd	($21,318.38)
	1980
Prior Year's Reserve	$ 70,658.00
Capital Gain	$ 70,658.00
Taxable Capital Gain	$ 35,329.00
Less	$ 21,318.38
	Income $ 14,010.62

The Respondent reassessed the disposition of the herd as follows:

	1979
Proceeds received in 1979 from sale of cattle	$ 7,828.00
Less fair market value on Dec. 31, 1979 of
basic herd	24,290.00
Net deduction from income	$ (16,462.00)

	1980
Proceeds received in 1980 from sale of cattle	$ 93,064.00
Less fair market value of basic herd (previously
deducted in 1979)	nil
Profit realized in 1980	$ 93,064.00
Net profit assessed on sale of cattle for 1979
and 1980	$ 76,602.00
(gain of $93,064.00 in 1980 less $16,462.00
deduction in 1979)

The failure to match revenues with costs results from the use of the cash basis of reporting as contemplated by sections 28 and 29 of the Income Tax Act, R.S.C. 1952, c. 148, as amended (the "Act").

3.02 Mr. Peter Syrier, general manager of the appellant, testified that:

(a) he owns 4,997 from the 5,000 common shares of the appellant; the appellant was formed in 1969;

(b) until 1979, the year of the tornado, the appellant's business consisted in the production of milk; it was under a quota of 2,500 pounds of liquidmilk per day;

(c) usually the total herd size, including replacement stock, dry cows, lactating cows, calves, was between 150 and 175 animals; there were usually 70 to 75 lactating cows;

(d) the prime period of performance of a lactating cow is between six to ten years of age; to dispose of an animal, two standards must be considered: the record of performance (ROP) over a 305-day period and the classification; the latter is based on the physical characteristics of the animal;

(e) the normal method of adding to the herd is from the appellant's own production of calves; only in the event of some outside conditions (unbalance of progeny, disease, etc.), would compel it to purchase animals;

(f) the number of animals in the basic herd was 87;

(g) on August 7, 1979, a tornado occurred that destroyed the buildings: the big free stall dairy barn, the milk house, one silo, the milking parlour, the feed barn, one of the houses and the implement shed; they were partially insured.

(h) they strongly investigated the possibility of replacing the buildings in order to carry on the operation. The proposed cost of the barn reached approximately $600,000; it was decided not to build it, but to milk the cows in the facilities that the appellant had until October and then to sell the herd. There were 103 animals sold at the auction.

(i) the appellant had the right to keep the quota for a few months. During the winter 1980, the said quota was sold.

3.03 In cross-examination, Mr. Syrier testified that:

(a) he identified his signature on the appellant's tax returns for the 1979, 1980 and 1983 taxation years filed as Exhibits R-1, R-2 and R-3;

(b) he is not familiar with the intricacies of what is reported in the financial statements;

(c) the basic herd is just a number of animals; each animal of the basic herd that existed on December 31, 1971, can be replaced; however, the same number of animals has to be kept constant.

3.04 The second witness for the appellant, Mr. Montague James Smith, testified as follows:

(a) he has been a chartered accountant since 1978, and also a partner with the Ward Mallette firm since 1981 ;

(b) he was responsibile for the annual accounts and the preparation of the annual tax returns of the appellant;

(c) the appellant’s basic herd of 87 animals was considered as 87 mature animals, i.e. animals older than 2 years;

(d) the disposition of the herd in 1979 that related to the basic herd was treated as capital and the portion that did not relate to the basic herd was treated as income;

(e) the purchases of cattle during 1979 was recorded as an expense, and the sale of culled cows was reported as income.

3.05 In cross-examination, Mr. Smith:

(a) explained the way he proceeded pursuant to the formula as it is applied in subparagraph 3.01.2(a);

(b) admitted that in applying that approach the result is that there would never be a taxable gain on the sale of a basic herd, unless the proceeds from the sale of the herd were three times its fair market value on December 31,1971 as it is explained in schedule 1 of the reply to notice of appeal.

It reads as follows:

SCHEDULE 1

COMPUTATION OF GAIN ACCORDING TO APPELLANT

Assume Basic herd value of $50.00 or x on		hypothetical
December 31, 1971 and proceeds from sale of
$150.00 or 3 x
Proceeds of sale of basic herd	3 x	$150.00
ACB of Basic Herd
(Based upon fair market value of Basic Herd
on December 31, 1971)	x	50.00
Capital Gain	2 x	$100.00
Taxable Capital Gain	x	50.00
Less fair market value of Basic herd on
December 31, 1971 pursuant to section 29	x	50.00
Taxable Gain on Sale of Basic Herd	nil	nil

Pursuant to that formula, the deduction of fair market on V-Day value (Dec. 31, 1971) was taken twice.

The first time it was taken, it was an adjusted cost base. The witness explained: “I think in this case though, because of the nature of the asset being sold, which is a dynamic asset, a dairy herd, that it is appropriate to match that 1971 value on an equivalent mature basis with the herd dispersal of 1979" (TS, p. 46). The witness admitted that there is no specific provision in the Act that provides such calculation.

The second deduction is provided for in section 29 of the Act.

3.06 In re-examination, Mr. Smith explaining the deduction of the basic herd taken under section 29 of the Act said:

Essentially Section 29 mandated that the taxpayer had to take a deduction for this, for the full amount of the basic herd times its 1971 value since it had no animals on hand at the end of its 1979 year. That particular treatment, I think it is mandated under Section 79 that it has to be taken. It doesn't relate directly to the additional treatment we claimed relating to the disposal of the basic herd itself. [TS, p. 47]

4. Law — Cases at Law — Analysis

4.01 Law

The main provisions of the Act referred to by the parties in the instant case are subsection 4(4), sections 28, 29 and 39. Reference was also made to section 85F of the Act prior to 1972, the precedent to section 28 of the present Act. They shall be quoted in the analysis when required.

4.02 Cases at Law

Counsel for the parties referred the Court to the following cases at law:

1. Anderson Logging Co. v. The King, [1917-27] C.T.C. 198; 52 D.T.C. 1209;

2. Campbell v. M.N.R., [1952] C.T.C. 334; 52 D.T.C. 1187;

3. Irrigation Industries Limited v. M.N.R., [1962] C.T.C. 215; 62 D.T.C. 1131;

4. Sanders v. M.N.R., 10 Tax A.B.C. 280; 54 D.T.C. 203;

5. Armstrong v. The Queen, [1985] 2 C.T.C. 179; 85 D.T.C. 5396 (F.C.T.D.);

6. Jean Brown, Deceased v. M.N.R., [1958] C.T.C. 169; 58 D.T.C. 1109;

7. R. James Speers Corporation, Ltd. v. M.N.R., 18 Tax A.B.C. 218; 11 D.T.C. 583;

8. Chambers v. M.N.R., 36 Tax A.B.C. 242; 64 D.T.C. 623;

9. McCubbin Estate v. M.N.R., [1980] C.T.C. 2112; 80 D.T.C. 1113 (T.R.B.);

10. Farris v. M.N.R., [1963] C.T.C. 345; 63 D.T.C. 1221;

11. Joint Committee on Taxation — Basic Herds;

12. Ryall v. Hoare (1923), 2 K.B. 447; [1923], 8 T.C. 521;

13. Californian Copper Syndicate v. Harris (1904), 5 T.C. 159;

14. Ammonia Soda Co. Ltd. v. Chamberlain, [1918] 1 Ch. 266;

15. Kjear v. M.N.R., [1982] C.T.C. 2030; 82 D.T.C. 1026 (T.R.B.);

16. Anderson v. M.N.R., [1980] C.T.C. 2588; 80 D.T.C. 1501 (T.R.B.);

17. Harel v. The Deputy Minister of Revenue of the Province of Quebec, [1977] C.T.C. 441; 77 D.T.C. 5438 (S.C.C.);

18. Nowegijick v. The Queen, [1983] C.T.C. 20; 83 D.T.C. 5041 (S.C.C.);

19. Babineau et al. v. Babineau et al. (1981), 32 O.R. (2d) 545 (H.C.J.).

4.03 Analysis

Whereas it is the first time that this involved point at issue actually comes before a Court, I feel fully justified to give lengthy treatments of the arguments by both parties.

A. Appellant's submission

4.03.1 The first part of the argument of the appellant's counsel proceeds along the basis that there is a capital element to a livestock herd whether or not a basic herd has been established.

He quoted the Carter Commission and the following precedents: Ryall v. Hoare (para. 4.02(12)), Californian Copper Syndicate v. Harris (para. 4.02(13)), Anderson Logging Co. v. The King (para. 4.02(1)), Irrigation Industries Limited v. M.N.R., (para. 4.02(3)).

He retains the analogy, often used of the tree and its fruit: the fruit or its value was income and the tree or the proceeds of its disposition was capital and not income. In this case the milk is the fruit and the cows, the tree. He then quoted the well-known passage of Californian Copper Syndicate at pages 165-66:

It is quite a well settled principle in dealing with questions of assessment of Income Tax, that where the owner of an ordinary investment chooses to realize it, and obtains a greater price for it than he originally acquired it at, the enhanced price is not profit in the sense of Schedule D of the Income Tax Act of 1842 assessable to Income Tax. But it is equally well established that enhanced values obtained from realization or conversion of securities may be so assessable, where what is done is not merely a realization or change of investment, but an act done in what is truly the carrying on, or carrying out, of a business. The simplest case is that of a person or association of persons buying and selling lands or securities speculatively, in order to make gain, dealing in such investments as a business, and thereby seeking to make profits.

At page 166, he stated:

What is the line which separates the two classes of cases may be difficult to define, and each case must be considered according to its facts; the question to be determined being Is the sum of gain that has been made a mere enhancement of value by realizing a security, or is it a gain made in an operation of business in carrying out a scheme for profit-making?

Counsel for the appellant submitted that his client "has realized a capital asset and further that the realization of this capital asset, that is the dispersal sale of his livestock herd, was not part of a scheme for profit-making” (TS, p. 55). One of the reasons for taking this position is:

First, the business of the taxpayer was producing milk for sale and did not include a business of trading in cattle. To the extent that animals were bought and sold, these transactions for the purpose of increasing the quality of the herd and represented in the case of sale, the sale of excess animals or animals whose production had declined below a certain standard or in the case of purchases, it was purchases that were necessary simply to make good shortfalls in the case of the breeding program of the taxpayer. That is, if too many bull calves were produced as opposed to heifer calves so there was not sufficient heifer calves to make up the addition to the herd that was required, then animals would be purchased outside and in addition where mature animals were sold, they were sold because of their decline below standard and in the very odd occasion if there was disease among the mature animals, those animals would be disposed of and would be replaced by purchases [TS, p. 56].

These kinds of purchases and sales, counsel for the appellant pleaded: were part of the normal activities necessary to maintain a dairy herd of high quality and did not represent a part of the, did not represent a trading business animals per se. The transaction in question, that is the dispersal sale of the basic herd, had none of the badges of trade that normally are associated with an adventure in the nature of trade [TS, p. 56].

Moreover, his method in dealing with cattle was not the method usually employed by traders of cattle, said counsel for the appellant. The purpose of acquisition of the herd was not to trade any cattle.

4.03.2 Referring to the distinction of fixed capital and circulated capital, and to precedents of Ammonia Soda Co. Ltd. v. Chamberlain case (para. 4.02(14)), and Sanders v. M.N.R. (para. 4.02(4)), he concluded that in the instant case, cattle are fixed capital despite the fact that there were fluctuations from year to year as Commissioner Fisher said in the Sanders case (para. 4.02(4)) at page 284 (D.T.C. 205). Moreover, Mr. Fisher said that the fact the appellant in his books designated the animals under the heading of "inventory" is not conclusive that it must be treated as inventory. Counsel for the appellant also insisted on the Armstrong case (para. 4.02(5)).

Mr. Justice Rouleau of the Federal Court, Trial Division, decided that the proceeds of the disposal of a racehorse named Stone Manor must be treated as a Capital gain.

Mr. Justice Rouleau at page 183 (D.T.C. 5398) stated:

Though downplayed by the defendant in argument, considerable attention at trial was devoted to the implications of the description of the horse as "inventory" in the plaintiff's 1981 tax return. It is alleged by the defendant that this provides an indication that the plaintiff was engaged in the business of buying and selling racehorses with the result that the excess of the price over costs should be regarded as profit from that business and taxed as income. I do not draw such an inference. The definition of "inventory" in subsection 248(1) is too broad to be of any great help and only defines the term of the purposes of the Act and not for the interpretation of the intent of a taxpayer. It is well established that a taxpayer can neither increase nor decrease his tax liability by the intentional or erroneous use of magic words in his accounts. . . . However, in the final analysis the task for this Court is to decide on the actual nature of the transaction and the substance of the matter on the basis of all the facts and circumstances. . . . On the basis of the evidence it is my view that in substance Stone Manor was not an item of inventory in the sense of a property held in the ordinary course of business for resale.

4.03.3 In conclusion of the first part of his argument, counsel for the appellant submitted that the appellant's livestock - without considering the existence or not of a basic herd — must be considered to be a capital property, the proceeds of which are dealt with under the section of the Act dealing with disposition of capital properties.

4.03.4 The second argument of the appellant concerns the basic herd. The concept of basic herd has existed in the Act only since 1972. However, this concept has been reflected since 1947 in the administrative directives issued by the respondent that influenced the application of the Act.

In the Brown case (para. 4.02(6)), Mr. Justice Dumoulin summarized at pages 170-71 (D.T.C. 1110) the story of the basic herd:

. . . on the 4th day of September, 1947 . . . the Respondent under the hand of his Deputy (the italics are mine) issued and published Directive No. 78 by the provisions in which a rancher could apply to the Respondent to have his cattle . . . on hand as at a certain date constitute capital for income tax accounting purposes, and on the sale of such animals, termed 'a Basic Herd', the proceeds would be Income Tax and Excess Profit Tax free in the hands of the recipient. This Directive was replaced by Directive No. 230 dated November 17th, 1948, which, in turn, was replaced by Directive No. 263 dated March 23rd, 1949, . . . all of which are under the same hand and of substantially the same effect.

In the Brown case, it was introduced in evidence at page 170 (D.T.C. 1110) a ruling made on July 7, 1945 in the estate of one Anton Esphetter: the Minister of National Revenue "had ruled that crop, produce and livestock on hand at the date of death was, for income tax accounting purposes, a capital asset in the hands of the beneficiary.”

The "Esphetter rule" was applied in the Brown case as it appears in paragraph 8 of the joint statement filed by the parties at page 171 (D.T.C. 1110):

8. Following which acceptance and approval the Respondent paid to Jean Brown the sum of $8,234.08, which was the amount of the downward revision of the Income and Excess Profits Taxes payable by Sarah Brown in respect of the years 1945 and 1946 as determined by the Respondent after changing the result of certain sales of her cattle in those years from income to capital receipts.

In the Speers Corporation case (para. 4.02(7)) heard in 1957, Mr. Fabio Monet, Chairman of the Tax Appeal Board as he then was, explains at page 219 (D.T.C. 584) the general purpose of Directive No. 263:

The general purpose of Directive No. 263, as I read it, is to allow farmers and breeders of animals to maintain a permanent herd, to increase it under certain conditions and to be able to reduce it below its original count without being called upon to pay tax on the proceeds of the sales through which such reduction was effected. Except for the somewhat arbitrary method of computing the animals composing, increasing or reducing the basic herd, it seems to me that this directive was inspired by the general principles of law applying to this field of activity, which principles have been enunciated by this Board in Saunders v. M.N.R., 10 Tax A.B.C. 280 and are to the effect that if in the one hand the sale of the fruits of the herd produces income subject to tax, on the other hand the sale of, or part of, the basic herd produces a receipt of a capital nature.

In 1964, Mr. R.S.W. Fordham, Assistant Chairman of the Tax Appeal Board as he then was, gave a decision in the Chambers case (para. 4.02(8)), dealing with the question of a taxpayer who had disposed of a dairy herd. The question before the Board was whether part of a disposition could be considered as capital account. Mr. Fordham made an interesting comment at pages 242-43 (D.T.C. 624) concerning the directives:

At some time in 1960, the appellant made formal application to the respondent for the establishment of a “Basic Herd" of cattle, pursuant to a directive issued in or about the early nineteen-fifties. This directive has not the force of law, of course, but has proved to contain a convenient and workable way of assessing receipts from livestock sales for income tax purposes. There is much to commend it.

The learned Assistant Chairman arrived at the conclusion that a part of the dispersal sale should be treated as capital receipts.

4.03.5 As underlined above, it is only since 1972 that the concept of basic herd has been used in the Act. It is in section 29 which reads as follows:

29. (1) Where a taxpayer has a basic herd of a class of animals and disposes of an animal of that class in the course of carrying on a farming business in a taxation year, if the taxpayer so elects in his return of income under this Part for the year the following rules apply:

(a) there shall be deducted in computing his basic herd of that class at the end of the year such number as is designated by him in his election, not exceeding the least of

(i) the number of animals of that class so disposed of by him in that year,

(ii) /io of his basic herd of that class on December 31, 1971, and

(iii) his basic herd of that class of animal at the end of the immediately preceding taxation year; and

(b) there shall be deducted in computing his income from the farming business for the taxation year the product obtained when

(i) the number determined under paragraph (a) in respect of his basic herd of that class for the year

is multiplied by

(ii) the quotient obtained when the fair market value on December 31, 1971 of his animals of that class on that day is divided by the number of his animals of that class on that day.

(2) Where a taxpayer carries on a farming business in a taxation year and his basic herd of any class at the end of the immediately preceding year, minus the deduction, if any, required by paragraph (1)(a) to be made in computing his basic herd of that class at the end of the year, exceeds the number of animals of that class owned by him at the end of the year,

(a) there shall be deducted in computing his basic herd of that class at the end of the year the number of animals comprising the excess, and

(b) there shall be deducted in computing his income from the farming business for the taxation year the product obtained when

(i) the number of animals comprising the excess

is multiplied by

(ii) the quotient obtained when the fair market value on December 31, 1971 of his animals of that class on that day is divided by the number of his animals of that class on that day.

(3) For the purposes of this section,

(a) a taxpayer's “basic herd" of any class of animals at a particular time means such number of the animals of that class that the taxpayer had on hand at the end of his 1971 taxation year as were, for the purpose of assessing his tax under this Part for that year, accepted by the Minister, as a consequence of an application made by the taxpayer, to be capital properties and not to be stock- in-trade, minus the numbers, if any, required by virtue of this section to be deducted in computing his basic herd of that class at the end of taxation years of the taxpayer ending before the particular time; [Emphasis is mine.]

According to counsel for the appellant the wording of subsection 29(3) is clear that the basic herd is capital property and not stock-in-trade. He contends that this confirms that the general principles issued in sections 38 to 55 of the Act must apply in the sale of a basic herd. Therefore, it is normal that the V-Day value of the basic herd be deducted in the computation of the capital gain. However, the appellant being subject to section 29 may also claim the deduction of the value of basic herd. Counsel for the appellant freely admits that this constitutes an anomaly in the Act. This anomaly, however, does not change the permanent part of the livestock herd and particularly the basic herd portion from capital to income nature.

4.03.6 Referring to the Report of the Joint Committee of the Canadian Bar Association and the Canadian Institute of Chartered Accountants to the Ministers of Finance and National Revenue in 1976, counsel for the appellant says that the combination of those concepts does create a number of problems both for the Minister and for the taxpayer. Headings in the Report read as follows: "Basic herd and change in residence”, subsection 28(4) of the Act; “Basic herd and amounts receivable”, subsection 70(2) of the Act; “Basic herd and rights or things transferred to beneficiaries’, subsection 70(3) of the Act; "Farm partnerships", subsection 96(3) and clause 53(1)(e)(i)(B), "Tax equity of a partnership”, paragraph 26(12)(g) of the Rules.

4.03.7 Counsel for the appellant also referred to the McCubbin case (para. 4.02(9)). Mr. Cardin, Chairman of the Tax Review Board as he then was, said at page 2115 (D.T.C. 1115) concerning the lack of clarity in the Act relative to basic herds:

There is, as was pointed out by counsel, a lack of clarity in the sections of the Income Tax Act relative to basic herds. The Department of Justice, in order to arrive at a practical interpretation of the pertinent sections, issued certain Interpretation Bulletins referred to by counsel, which by Departmental policy or practice, seeks to avoid possible anomalies in applying those sections of the Act which are unclear. As commendable as this practice may be, such directives on policy should not become a quasi-permanent substitute for a clarifying amendment passed by Parliament.

However, this did not prevent him considering the basic herd of the deceased appellant as capital property, referring to paragraph 29(3)(a) of the ACt.

4.03.8 In conclusion, counsel for the appellant at pages 82-85 of the transcript suggests:

So the anomalies or I suppose if the basic herd is treated as a capital property and if it is not and the difficulty seems to relate to the inclusion in the Act of Section 29. Nevertheless, Section 29 is there. I suggest to you it has not changed the nature of the basic herd.

I would suggest to Your Honour that even though Revenue Canada takes the position . . . in their bulletin . . . that all livestock sales are to be included in income, but that is not the law. Revenue Canada does not have the power to convert capital into income any more than I have the power to convert clay into gold and I would say adequate time has now been provided. It’s now some 14 years after tax reform. It’s ten years since the submission was put in by a very well regarded and authoritative committee as to the necessity for change and it’s six years from the time that the McCubbin case was decided.

I think at this stage I would submit it’s clear that the basic herd is a capital property and the fact that there is an anomaly created by production provided by Section 29 it is not an anomaly that's been taken advantage of by choice of the taxpayer. He is required in fact to make the deduction under Section 29 and that there are no grounds for taxing the proceeds of the gain on the disposition of a basic herd as income.

B. Respondent's submission

4.03.9 The respondent's contention is that the entire proceeds from the sale of basic herd is brought into income less the prescribed deduction allowed under section 29 which is basically the fair market value of the basic herd on December 31, 1971, called V-Day.

The respondent does not accept the appellant's position to treat the proceeds of sale as capital after deducting the V-Day [value] pursuant to section 39 of the Act and then from the taxable gain to deduct a second time the V-Day value, the one provided by subsection 29(2).

According to counsel for the respondent, there is in fact a triple deduction because when the deduction provided in subsection 29(2) of the Act is made in full against the taxable capital gain, “it works twice as much" (TS, p. 87). Therefore, counsel for the respondent concludes that the result of the appellant's position is that there would never be a taxable gain on the sale of a basic herd, unless the proceeds from the sale of the herd were three times its fair market value on December 31, 1971. Counsel submitted that this is an absurdity (see para. 3.05(b), Schedule 1).

4.03.10 Counsel for the respondent does not dispute the case at law referred to by counsel for the appellant prior to 1972. Since 1972, indeed sections 28 and 29 of the Act set up a special scheme for taxing farmers and also section 31, which is not involved in this case. Subsection 28(1) reads as follows:

28. (1) For the purpose of computing the income of a taxpayer for a taxation year from a farming or fishing business, the income from the business for that year may, if the taxpayer so elects, be computed in accordance with a method (in this section referred to as the "cash method") whereby the income therefrom for that year shall be deemed to be an amount equal to the aggregate of

(a) all amounts that

(i) were received in the year, or are deemed by this Act to have been

received in the year, in the course of carrying on the business, and

(ii) were in payment of or on account of an amount that would, if the income from the business were not computed in accordance with the cash method, be included in computing income therefrom for that or any other year, and

(b) such amount, if any, as may be specified by the taxpayer in respect of the business in his return of income under this Part for the year, not exceeding the fair market value at the end of the year of livestock (other than animals included in his basic herd within the meaning assigned by section 29) owned by him at that time in connection with the business

minus the aggregate of

(c) all amounts that

(i) were paid in the year, or are deemed by this Act to have been paid in the year, in the course of carrying on the business, and

(ii) were in payment of or on account of an amount that would, if the income from the business were not computed in accordance with the cash method, be deductible in computing income therefrom for that or any other year, and

(d) the amount, if any, specified by the taxpayer in respect of the business in accordance with paragraph (b) in his return of income under this Part filed for the immediatley preceding taxation year;

and minus any deductions for the year permitted by paragraphs 20(1)(a) and (b).

Counsel for the respondent explained that pursuant to paragraph 28(1)(b), a farmer must include in his income for a taxation year the fair market value of his livestock (other than the animals of the basic herd) and must subtract the fair market value of his livestock for the immediately preceding taxation year. He then concludes that the livestock purchased during the year is deducted pursuant to paragraph 28(1)(d).

Similarly, he said, the farmer, in purchasing livestock, is entitled to deduct the full cost of the livestock but at the same time when he sells it, he must show it all as income. He underlined that if one compares section 28 of the now Act and section 85F of the former Act which is the predecessor of section 28 of the Act, he can see that it does not base special provision for livestock. The paragraphs 28(1)(b) and 28(1)(d) are not in section 85F. This latter provision indeed reads as follows:

85F. (1) For the purpose of computing the income of a taxpayer for a taxation year from a business of the following description, namely:

(a) farming, or

(b) a profession,

the income from the business for that taxation year may, if the taxpayer so elects, be computed in accordance with a method (hereinafter in this section referred to as the "cash" method) whereby the income therefrom for that year shall be deemed to be an amount equal to

(c) the aggregate of all amounts that

(i) were received in the year, or are deemed by this Act to have been

received in the year, in the course of carrying on the business, and

(ii) were in payment of or on account of an amount that would, if the income from the business were not computed in accordance with the cash method, be included in computing income therefrom for that or any other year,

minus

(d) the aggregate of all amounts that

(i) were paid in the year, or are deemed by this Act to have been paid in the year, in the course of carrying on the business, and

(ii) were in payment of or on account of an amount that would, if the income from the business were not computed in accordance with the cash method, be deductible in computing income therefrom for that or any other year;

and minus any deduction for the year permitted by paragraph (a) of subsection (1) of section 11.

4.03.11 After underlying [sic] that subsection 29(1) is optional, and subsection 29(2) is a required deduction, counsel for the respondent points out that subsection 29(3) starts with "For the purposes of this section” and, therefore, the definition of “basic herd" applies only for section 29 of the Act, not to anywhere else in the Act. It is not written "For the purposes of this Act".

Section 29 is part of Subdivision b of Part 1 of the Act entitled "Income or loss from a business or property".

Therefore, counsel argues that, despite what is said in subsection 29(3) of the Act, the animals (basic herd) are "capital properties and not . . . stock- in-trade”, the appellant cannot apply the general principles of Subdivision c of Part 1 of the Act entitled “Taxable Capital Gains and Allowable Capital Losses", sections 38 to 55. In Subdivision c there is no reference to basic herd. He said:

. . . if the parliament had intended basic herds to be taxed as capital property, the section wouldn't be put in the part on income from business or property. It would be put on [sic] the part on taxable capital gains. [TS, pp. 98-99]

4.03.12 Counsel for the respondent pointed out that the appellant for ten years, when it was purchasing cattle for its dairy herd, deducted the expense. It did not treat them as capital assets and it was accepted by the respondent. Counsel says that the appellant now cannot suggest that the basic herd be taxed as capital property.

Section 39 says that capital gains dispositions are those dispositions that are not subject to income. The beginning of section 39 indeed reads as follows:

39. (1) For the purposes of this Act,

(a) a taxpayer's capital gain for a taxation year from the disposition of any property is his gain for the year determined under this subdivision (to the extent of the amount thereof that would not, if section 3 were read without reference to the expression "other than a taxable capital gain from the disposition of a property" in paragraph (a) thereof and without reference to paragraph

(b) thereof, be included in computing his income for the year or any other taxation year) from the disposition of any property of the taxpayer other than

(i) eligible capital property, [Emphasis is mine.]

4.03.13 Counsel for the respondent suggested that if the Court found that section 29 is ambiguous, it can look at the legislative context and the history of the legislation so referring to a decision of the High Court of Justice of Ontario, Babineau et al v. Babineau et al. (para. 4.02(19)). Mr. Justice Grange had to interpret section 19 of the Motorized Snow Vehicles Act, 1974 (Ont.),

c. 113. The point was whether a guest on a farm is a licensee in the sense of the said section which reads as follows:

19. An occupier of land owes no duty of care toward a person who is driving or riding on a motorized snow vehicle or being towed by a motorized snow vehicle upon the land and who is a trespasser or licensee except the duty to not create a danger with the deliberate intent of doing harm or damage to the trespasser or licensee or do a wilful act with reckless disregard of the presence of the trespasser or licensee.

As the section was not clear, the learned Judge said at page 548:

In the interpretation of a statute there seems to be little question but that a Court may now delve more deeply into the making of that statute than it could before. The traditional view as expressed in Maxwell on the Interpretation of Statutes, 12th ed. (1969), p. 50, is "the modern rule is clear: the Parliamentary history of legislation is not a permissible aid in construing a statute".

After referring to many cases, he added at pages 548-49:

These cases are, of course, constitutional and as I have said there may be special considerations in a constitutional case. It may be, however, that political statements or reports are in some circumstances admissible in any kind of case. In R v. Vasil, March 2, 1981 (since reported 58 C.C.C. (2d) 97, 35 N.R. 451), Lamer J. for the Supreme Court of Canada in considering the interpretation of s. 212(c) of the Criminal Code, not only refers to Sir John Thompson's comments in Hansard of April 12, 1892, but also quotes excerpts from the Report of the Royal Commissioners leading to the adoption of the English Draft Code of 1878. Moreover the reference appears to be made to assist in the interpretation of the statute, not merely to determine the evil the statute sought to remedy. In England the House of Lords in Black-Clawson Int'l Ltd. v. Papierwerke Waldhof-Aschaffenburg A.G., [1975] A.C. 591, while affirming that the reports of a parliamentary committee can be looked at to identify the mischief sought to be remedied, reaffirmed by a judicial margin of three to two that a report could not be looked to for assistance in the interpretation of the statute. In Canada it may be that the view of Laskin C.J.C. expressed at p. 389 S.C.R., p. 468 D.L.R. of the Anti-Inflation Reference, supra, that "no general principle or admissibility or inadmissibility can or ought to be propounded . . . and that the questions of resort to extrinsic evidence and what kind of extrinsic evidence may be admitted must depend on the constitutional issues on which it is sought to adduce such evidence”, applies to all cases of statutory interpretation regardless of the subject-matter of the issue.

Perhaps a safe test for a trial Judge is that referred to in R. v. Stevenson and McLean, 57 C.C.C. (2d) 526,19 C.R. (3d) 74, released December 30, 1980, where the Court of Appeal (at pp. 530-1), observing the dicta of Lord Reid in Warner v. Metropolitan Police Com'r, [1969] 2 A.C. 256 at p. 279, suggested that parliamentary proceedings might be examined where the examination "would almost certainly settle the matter immediately one way or the other". To determine whether the test was met one would, of necessity, have to look at the proceedings.

In the instant case concerning the legislative context of sections 28 and 29 of the Act, counsel for the respondent referred first to the Summary of 1971 Tax Reform Legislation by the Honourable E.J. Benson, Minister of Finance. At pages 51-52 under heading "Farmers and Fishermen", it reads as follows:

Because the legislation makes capital gains part of the tax base, the need for the basic herd and straight-line depreciation is substantially reduced. Accordingly the new legislation provides that these two provisions will be phased out.

Livestock farmers will be able to establish a basic herd as at December 31, 1971, but no additions may be made to the basic herd after that date. The accrued gain on a basic herd as at December 31, 1971 will be a tax-free capital gain, as under the present law. When livestock is sold after December 31, 1971 a farmer may consider the sale as being out of the basic herd or the other herd, subject to special rules, but the legislation requires that the sale reduce the basic herd when the total livestock on hand is less than the remaining total of the basic herd. The proceeds in excess of the value of the basic herd on Valuation Day will be treated as part of farming income and will be eligible for general averaging or the income-averaging annuity.

4.03.14 Moreover counsel for the respondent quoted the well-known decision of Mr. Justice de Grandpré in Harel v. The Deputy Minister of Revenue of the Province of Quebec (para. 4.02(17)). Mr. Justice de Grandpré said that a Court, in some circumstances may take into account the administrative interpretation. It "has real weight” and becomes an “important factor".

The counsel then quoted two administrative interpretations. The first one is Interpretation Bulletins, No. IT-427, “Livestock of Farmers", paragraph 1:

1. The Department's position is that proceeds from all sales of livestock by a taxpayer in the business of farming, including those animals in a basic herd, are considered to be income. A farmer who has a basic herd, is permitted a formula deduction on both an optional and a mandatory basis under section 29 of the Income Tax Act in the year of disposition of any livestock.

The second one he referred to is a pamphlet of Revenue Canada entitled Basic Herds—Tax Reform and You. We can read on page 1 under the heading "General":

In the past, livestock farmers could, in certain circumstances, treat part or all of their herds as capital assets. Where they were eligible and elected to do so, they could treat the cost of acquiring or increasing a basic herd as a non-deductible capital expenditure. When they disposed of their herd, or reduced it below the basic herd level, they could treat part of the proceeds from livestock sales as a non- taxable capital realization. The part so treated was determined by multiplying the number of animals by which the basic herd was reduced by the average selling price of all animals sold in the year.

Under the amended Income Tax Act, provisions have been made for phasing out basic herds that have been approved by the Department as of the end of the 1971 taxation year.

Under these provisions, basic herds may not be established or increased as a result of transactions occurring after the end of the 1971 taxation year.

And under the heading “Phasing Out Basic Herds" at page 2:

Generally stated, beginning in 1972, all livestock purchases must be charged against income. The new provisions will not tax any increase in value of a basic herd which occurs before January 1, 1972, but it will tax any increase and allow any decrease in value which occurs after the end of 1971, in the year in which the increase or decrease in value is realized.

One of the main legal arguments of counsel for the respondent is to not allow more than one deduction of the V-Day value of the basic herd which is based on subsection 4(4) of the Act. It reads as follows:

4. (4) Unless a contrary intention is evident, no provision of this Part shall be read or construed to require the inclusion or to permit the deduction, in computing the income of a taxpayer for a taxation year or his income or loss for a taxation year from a particular source or from sources in a particular place, of any amounts to the extent that that amount has been included or deducted, as the case may be, in computing such income or loss under, in accordance with or by virtue of any other provision of this Part.

When this subsection refers to “this Part", this means Part 1 of the Act, i.e. sections 1 to 180. This includes sections 28 and 29 and all sections concerning the computation of taxable capital gains and allowable capital losses, i.e. sections 38 to 55.

Counsel for the respondent contends that despite a basic herd being considered as a capital property pursuant to subsection 29(3), the deduction of the V-Day value of the basic herd cannot be taken twice pursuant to subsection 4(4).

4.03.15 Concerning the Armstrong case (para. 4.02(5)) referred to by counsel for the appellant (para. 4.03(2)), counsel for the respondent contends that it cannot apply because Mr. Justice Rouleau found that the appellant purchased the horse as a hobby. Sections 28 and 29 would not apply, because the appellant, Mr. Armstrong, was not in business. Then there is no dispute that, when someone disposes of a hobby asset, it is a capital gain.

C. Appellant's reply

4.03.16 With respect to the place and meaning of sections 28 and 29 and the relationship between them, counsel for the appellant contends that paragraph 28(1)(b), which permits to include certain amounts in the income of the farmer with respect to livestock, is not related to section 29.

Indeed on January 1972, the new Act did include neither paragraph 28(1)(b) nor paragraph 28(1)(d). Those provisions were enacted only in 1973 but retroactively to January 1972.

According to counsel for the appellant, those two provisions were not related to section 29. Pursuant to the 1973 House of Commons debate indeed, the purpose of adding paragraphs 28(1)(b) and 28(1)(d) with respect to livestock was to allow the spreading of the losses over a period longer than the five-year carry-over period that was available at that time.

The relevant portion of the debate from the House of Commons reads as follows on page 117 of the Transcript:

For farmers and ranchers reporting their income on a cash basis the early years of establishing the new herd can result in heavy start-up expenses and a substantial loss. In many cases the losses are not within the five-year period allowed with a carry forward of losses under the existing Act. The proposed amendment will permit a farmer or rancher to carry his livestock with this inventory at any amount up to fair market value. This will overcome the problem of unusual losses in early years and will allow the start-up expenses to be taken into account in the later profit.

Moreover, Mr. McNair pointed out that this passage referred to "inventory" which is not defined in the Act. He suggested that the reason the word "livestock" alone was used, rather than “livestock inventory", was because of the difficulty with the fact that the livestock would not ordinarily be considered to be included in the inventory of the cash basis system of a farmer, "who would, in fact, have no inventory whatever" (TS, p. 118).

I think it is notable however, if my argument is correct, that the reference left out the word inventory for a particular reason, because of a particular shortfall of the Act. There is a definition made between this livestock that could be added to income, which I suggest to Your Honour are inventory in the normal sense we would refer to inventory and the animals that are in the basic herd. These animals cannot be added to income under 28(1)(b) of the Act and the purpose of excluding that is to, I believe, to take into account only those animals that are relevant to the computation of income, the animals that would normally be treated as inventory. Those in excess of the animals in the basic herd [TS, pp. 118-19].

Moreover paragraphs 28(1)(b) and 28(1)(d) are an exception to the normal rate of cash-basis system that does take into account, accounts receivable, accounts payable, or inventory. Therefore, Mr. McNair suggests that "no conclusion should be drawn from that as to the nature of the basic herd or as to whether or not all livestock proceeds must be included in income" (TS, p. 121).

4.03.17 In response to the argument of Mr. Templeton that section 39 (part of Subdivision c of the Act concerning capital gains and capital losses) has no reference to basic herd and, therefore, it was not the intention of the parliament that “basic herd" fall under this section, Mr. McNair answered that section 39 has neither reference to land nor to marketable securities, and even so they are subject to capital gain and capital losses.

4.03.18 Concerning the intention of parliament to include all livestock sale proceeds in income referred to by the Honourable E.J. Benson (para. 4.03.13) and by Revenue Canada (para. 4.03.14), Mr. McNair refuted that they are "merely expressions of what the government intended to achieve through legislation. It’s not a guarantee that it did so . .. because it was silent as to the question of the treatment of the livestock other than providing a deduction in Section 29” (TS, pp. 122-23).

Concerning the deduction provided in the latter section, Mr. McNair says it applies automatically because the section specifically required to make the deduction. It is a mandatory deduction.

D. Decision

4.03.19 The Court states that both counsels gave strong arguments.

The Court also states that despite the declared intention of the legislator, it is by far not obvious in section 29 of the Act that livestock sale proceeds must be included in the income. If I apply a strict interpretation of this charging section, the conclusion at first glance would be that it must not be included in the income as income but only as taxable capital gain. However, despite the lack of clarity, one thing is obvious to me: the deduction of the value of the basic herd cannot be deducted twice in the computation of the capital gain. In my opinion, subsection 4(4) quoted above (para. 4.03.14) has application in this case at bar.

Moreover, since 1972, the appellant, in the computation of its income, deducted all the purchase prices of livestock including those used for the renewal of the basic herd. Then it did not treat them as capital asset and this was accepted by the respondent. Applying the theory of estoppel by representation, the appellant cannot now contend that the basic herd be taxed as a Capital property.

For those reasons, I must maintain the reassessments for 1979 and 1980 hoping, however, that the legislator, one of these days, clarifies the wording of the provisions involved.

4.03.20 As no evidence was adduced and no submission given concerning the 1981 interest income (para. 3.01.1 above, notice of appeal paragraphs 4(f), 4(g)(iii), 4(h)(iii), 4(i)(iii)), therefore the reassessment for 1981 is maintained.

5. Conclusion

For these reasons, the appeal concerning the 1979, 1980 and 1981 taxation years is dismissed.

Appeal dismissed.