Minister of National Revenue, Respondent., [1988] 1 CTC 2407, 88 DTC 1289, [1988] 1 CTC 2407

Brulé, T.C.J.: —Mr. William G. Howes is appealing from reassessments of tax with respect to the 1980 and 1981 taxation years. The respondent having conceded that the appellant's farming operations had a reasonable expectation of profit, the issue is whether the Minister was correct in assessing that the appellant’s chief source of income in the said years was neither farming nor a combination of farming and some other source of income within the meaning of subsection 31(1) of the Income Tax Act (the Act) and therefore subject to the restricted farm losses described therein.

The full amounts of farm losses claimed as deductible by the appellant in this appeal are of the order of $38,809.43 and $15,181.65, for the taxation years 1980 and 1981 respectively.

At the hearing the appellant was the only witness called. He testified that he is a trained mining engineer presently working as the president of a private mining corporation in West Vancouver, British Columbia. He admitted having no farming experience prior to his purchase of an apple orchard farm (hereafter "the farm") located near the town of Picton, Ontario, in the spring of 1977.

At the time of its purchase, the farm consisted of a farm house residence, a tenant house, a cold storage, a barn, approximately 78 acres and approximately 1,500 apple trees. The purchase price was $145,000.

The appellant told the Court, that he first visited the farm in the fall of 1976 during the course of a trip to Kingston, Ontario. Both he and his then wife were instantly taken by the idea of operating their own fruit growing business. Later in the fall of 1976, they spent up to two weeks working in the farm's orchard “tapping the owner's knowledge". The appellant also took short courses at the University of Guelph in order to give himself a further background prior to taking over the farm.

When asked whether he had made any plans to operate the farm, the appellant answered that his plan at the time he bought the farm was firstly to phase out the "standard" trees, which had been planted in the farm’s orchard in 1932, and replace them with more productive and efficient "semistandard" and "dwarf" trees. Aside from the fact that they are easier to prune and pick, it was explained that smaller types of trees, and "dwarf" trees in particular, come into production four to five years after being planted, that they are fully productive by the time they are 10 years old and that they decline after 20 years. By contrast the "standard" trees take from 10 to 12 years to come into production and they normally last no more than 30 years.

The other plan of the appellant was to do his own retailing by opening a roadside fruit outlet. The appellant said that he knew important investment in time and money would be necessary to realize his plans. At first all he could hope for was to break even. After a few years, once the two parts of his plan would be implemented, he was projecting net profits of approximately $100,000 a year. Pressed by counsel for the Minister for clarification as to when and how he would turn a net profit before taxes of $100,000 a year, the appellant stated that he was prepared to spend another $600,000 to expand, but gave no further specifics as to his timetable except that initially it was believed that five years would be sufficient to implement his plans, but that later on this projection was revised to around ten years.

From the time the farm was purchased in the spring of 1977 to August 1977, the appellant kept working as an investment executive in Toronto. While his regular work week in Toronto did not change after he bought the farm, he commuted every weekend to put in 20 to 25 hours of work on the farm. Some time in 1977, the appellant's then wife started to live on the farm where she still lives today.

In August 1977, the appellant lost his job in Toronto and moved to the farm for the next five months. This period on the farm came to an end when he accepted an offer to return to work in Toronto as a manager for another investment company. This new job was described by the appellant as "flexible" and provided for much needed revenues to keep up the farm. Once again, he said that he arranged to make the three-hour trip to and from the farm every weekend. Also around the time the appellant moved back to Toronto, his son came to work on the farm as a full-time manager of operations.

During his first year of operation, 1977, the appellant claimed, despite a harvest of some 10,000 bushels of apples, a net farm loss of $18,997.21. For the next six years, in fact, paragraphs 2 and 6 of the notice of appeal show that no profits were made:

Counsel for the Minister was able to cast considerable doubt on the accuracy of these figures during cross-examination. Referring to the appel- lant's various sources of income and expenses itemized in Schedule A and Schedule B, and filed as part of the reply to the notice of appeal, counsel pointed out, that one of the reasons why the appellant finally showed a profit of $9,289.23 in 1984 was not so much a matter of better returns on sales as it was due to a government grant of $25,521.52 entered in Schedule A as "Labour Rebate”. Similarly, the appellant admitted that the $10,000 marked in Schedule B “Packing Charges" for the years 1980 and 1981 had already been deducted from the proceeds of the sales and that accordingly his farm losses for those years should read $48,809.43 and $25,181.65 respectively.

One other fact that was left largely unexplained is that even though the appellant's son owned and operated the greatest portion of another piece of land, not contiguous to the farm, (hereafter "the new orchard”) acquired in 1981 as an extension of the farm, the appellant was writing off the expenses of both the farm and the new orchard against his income. The appellant's answer with regard to how his son was remunerated for his work on the farm was that he ceased to do the accounting for the farm in 1982 and that he believed that his son's remuneration came essentially from the operation of the fruit outlet his son had built by the side of Highway 33 on the site of the new orchard.

While the appellant's farming activities were recording losses during his first years of operation, his income from other sources was estimated to be well over $100,000 a year. For instance, according to the appellant’s tax returns for the 1980 and 1981 taxation years, the appellant reported the following amounts:

Regarding the appellant's capital commitment to the farm, the following figures submitted by the appellant, notably at paragraph 3 of the notice of appeal, were also contested by counsel for the Minister:

Between 1977 and 1980

Purchase of farm:

Even if the above expenses are consistent with the operation of a fruit farm, I agree with the contention of counsel for the Minister that there was no evidence adduced to confirm that it was effectively the appellant who personally incurred many of those expenses. In the case of the new orchard, it was in fact admitted by the appellant that he purchased only 75 acres out of the 200 acres of land of the new orchard. His son purchased the remaining 125 acres and has since been managing the new orchard and its fruit outlet in addition to the farm. In the case of the sprinkler system, again the appellant said that his son installed it and maintained it, but he could not confirm whether or not it was he or his son who paid for it.

Aside from the original 1,500 standard trees planted on the farm by previous owners in 1932, the appellant also stated that approximately 3,000 new trees were planted and started producing in 1982. As a result of a damaging frost in the early 1980s, all the standard trees were eventually cut down and replaced by "semi-standard" and "dwarf" trees. It was acknowledged that part of the cost of replacing the appellant's trees was absorbed by the payment of $6,497.75 in crop insurance in 1981 and government subsidies of $1,348.89 toward the cost of trees and $25,521.52 toward labour in 1984.

When the appellant and his son bought the new orchard in 1981, the appellant explained that the new orchard was a non-productive piece of land. To make it productive his son planted some 5,000 rootstock whips which he had been collecting between 1978 and 1980. The total cost incurred to purchase rootstock and two-year old trees was $10,117.06.

At the hearing the appellant made the point that although he was still interested in farming and that he hoped that fruit farming would stay in the family, he was now divorced from his wife and that in 1984 his son had bought most of his interest in the farm. He was also now living in western Canada.

In assessing the appellant's tax liability for the 1978 and 1979 taxation years, the Minister refused the appellant's claim to deduce the full amount of his farm losses for those years. The objections filed by the appellant against those assessments were eventually abandoned. In respect to 1982 and 1983 taxation years, the appellant claimed and was granted restricted farm losses. For the taxation years 1980 and 1981, at issue in this appeal, the appellant's claim for the full deduction of his farm losses was rejected by the Minister on the basis that pursuant to subsection 31(1) of the Act the appellant's chief source of income was neither farming nor a combination of farming and some other source of income.

Analysis

In William Moldowan v. The Queen, [1977] C.T.C. 310; 77 D.T.C. 5213, the Supreme Court of Canada attempted to give meaning to this rather ambiguous subsection 31(1) and established some guidelines to be followed by the Courts in determining the status of an appellant in relation to allowability of farm losses. These guidelines provide very useful categories into which the Courts may "slot" an appellant to determine his eligibility. Problems arise, however, where an appellant has characteristics which place him in the gray area between two of these categories.

Because the numerous cases involving this matter are almost completely fact oriented, it is often difficult to determine why one appeal is allowed but a similar case is dismissed. Slight differences in fact situations, can mean the difference between full deductibility of losses versus no deductibility. For this reason it is necessary to avoid purely factual comparisons between cases and to concentrate instead on the general statements regarding factors which should be considered and the weight to be accorded to them in light of the other factors present in that case.

The Moldowan decision (supra) provided us with a two-tiered test for determining categorization of losses:

(1) Does the taxpayer have a reasonable expectation of profit?

(2) Is farming the taxpayer's chief source of income?

Here the former, or reasonable expectation of profit, is conceded but the latter part of the test must be determined.

When it is found that a taxpayer has a reasonable expectation of profit, it must be determined whether he falls within Class (1) or Class (2) of farmers as set out in Moldowan (supra) at page 315 (D.T.C. 5316):

(1) a taxpayer, for whom farming may reasonably be expected to provide the bulk of income or the centre of work routine. Such a taxpayer, who looks to farming for his livelihood, is free of the limitation of subsection 13(1) [now subsection 31(1)] in those years in which he sustains a farming loss.

(2) the taxpayer who does not look to farming, or to farming and some subordinate source of income for his livelihood but carried on farming as a sideline business such a taxpayer is entitled to the deductions spelled out in subsection 13(1) [now subsection 31(1)] in respect of farming losses.

In considering whether or not farming is a taxpayer's “chief source" of income, Dickson, J., (as he then was) in Moldowan (supra) tells us that the test is both relative and objective, the distinguishing features being the taxpayer's reasonable expectation of income from his various revenue sources and his ordinary mode and habit of work.

The criteria for such a test were said to include, inter alia, in relation to a source of income:

(a) the time spent;

(b) the capital committed;

(c) the profitability both actual and potential.

Subsection 31(1) ,which is substantially the same as that considered in the Moldowan case (supra), reads in part

Where a taxpayer's chief source of income for a taxation year is neither farming nor a combination of farming and some other source of income . . .

In Moldowan (supra) the Supreme Court attempted to clarify what is meant by the word “combination” as found in subsection 31(1). It was the Court's view that it was not necessary that there be a "connection" by way of physical relationship, integration or inter-connection between the sources of income. Dickson, J., as he then was, went on to state, however, that it did not mean the mere addition of two sources, as that would permit all taxpayers to deduct full farming losses. Rather, he felt it contemplates a taxpayer whose major preoccupation is farming but who may have other pecuniary interests as well. While a quantum measurement of farming income is relevant to the matter, it is not alone decisive. The test again is both relative and objective using the same criteria as those indicative of farming as a chief source.

One case referred to the Court by the solicitor for the appellant was that of The Queen v. Paul E. Graham, [1985] 1 C.T.C. 380; 85 D.T.C. 5256, a decision of the Federal Court of Appeal.

This case, as in so many, asks the Court to decide whether it is reasonable to consider farming to be part of a combination forming a chief source of income when in fact the farm has generated only losses.

In Graham (supra) an extreme example of the Court allowing a claim when there were only losses where the taxpayer was employed full-time off his farm but nevertheless it was found that he was entitled to deduct his full farming losses. The taxpayer was what one might term a "workoholic", sleeping only five hours per day and in fact carrying two full-time jobs. The trial judge concluded that the farm was capable of providing a reasonable standard of living but the taxpayer was not satisfied with that and sought to increase his holdings. His outside employment was therefore utilized to supplement his standard of living and to achieve his ultimate objective of farming as his sole source of income. Among those factors considered by the trial judge were:

(i) the plaintiff had always desired to return to farming and geared his employment to the ultimate achievement of that objective. He went through a change in occupational direction;

(ii) he invested all his available capital in farming;

(iii) gross farming revenue exceeded employment income (the utility of this comparison has been questioned by some Courts);

(iv) the farming operation was started from scratch; (the Court referred to Mr. Justice Dickson’s comments re deduction of start-up costs Moldowan);

(v) a substantial cash flow was used to offset substantial start-up expenses for machinery, equipment and acquisition of land;

(vi) his personal involvement was very high. Obviously he was dedicated to farming; and

(vii) he chose to maintain his current employment as a source of financing rather than begin farming on borrowed capital.

The trial judge found that the cumulative effect of all these circumstances was that the plaintiff's main preoccupation was farming with income from a sideline employment and this was upheld later by the Federal Court of Appeal.

In the present case, it is difficult to find in the appellant a change in occupational direction during the years at issue. Indeed the evidence adduced suggests that except for the five-month period when he was inbetween jobs, the appellant's involvement on the farm since 1977 has been confined to weekends and holiday leave. In the years the appellant owned the farm, his main residence was Toronto where he also worked as a senior executive earning in 1980 and 1981 well over $100,000 a year — which was his target for the farm after five to ten years of constant re-investment.

Even assuming a 100 per cent harvest every year, I share the concerns of counsel for the Minister vis-a-vis the appellant's planning and recording of the farm's performance over the years. The evidence in that respect clearly shows that even allowing for some discrepancy, the appellant would need more than regular weekend expeditions and new approaches, to turn in five to ten years a 1,500 standard tree farm into his chief source of income. Whether we look to his previous record as an apple grower, or to the time and capital committed to making farming the centre of his work routine, I find no comparison between the appellant's case and the case of the taxpayer in Graham (supra), wherein the cumulative effect of all the circumstances indicated that the only reason the taxpayer maintained his current employment was to provide the required cash flow to offset the start-up costs of his farming operation. In the present case, the cumulative effect of all the circumstances does not support the same conclusion. In my view, while it is not disputed that the appellant's farming operation constituted a business during the years at issue, the evidence does not satisfy me that this should be viewed as anything other than a subsidiary business, which because of its nature, could perhaps be combined with his main preoccupation of being a senior investment executive.

The primary consideration in all the cases appears to centre on the involvement of the taxpayer in the farming operation. This involvement can be evidenced by commitment of time, capital, resources, etc. coupled with a knowledge of what is taking place. Obviously the more involved an individual is in the operations the easier it is to conclude that he fits within the Moldowan test of: "ordinary mode and habit of work".

Many cases have concluded that where from the very commencement of farm operations a considerable loss has occurred every year, the farming operations could not be considered a source of income combining with other sources to form a chief source of income. This was so in the case of Joseph Shiewitz v. M.N.R., [1979] C.T.C. 2291; 79 D.T.C. 340. There a series of unlucky occurrences coupled with losses and no expectation of a profit, and no management plan led the Court to say that the farming operation was not a chief source of income.

In the case of Robert T. Gordon v. The Queen, [1986] 2 C.T.C. 280; 86 D.T.C. 6426 (F.C.T.D.), the taxpayer, who continued to work in the construction industry after he purchased a farm, claimed large farm losses in his 1979 to 1982 taxation years. The Court rejected his claim as it was found that the taxpayer's involvement into farming was not his main concern. The words of Madam Justice Reed at page 285 (D.T.C. 6430) of that judgment, seems to me to have immediate application to the present case:

. . . There was obviously a change in the plaintiff's mode and habit of work from pre-farm days to post-farm days. But, this is not one of those cases in which a taxpayer has retained his employment income in order to acquire the capital to build up a farm. I can find no crystallized intention in this case on the part of the taxpayer to change his chief source of income from employment to farming.”

For the foregoing reasons this appeal is dismissed.

Appeal dismissed.