Paul J. Taillefer v. Minister of National Revenue, [1987] 2 CTC 2137, 87 DTC 418

Rip, T.C.J.:

Assessments

Paul J. Taillefer, the appellant, appeals against taxes assessed by the Minister of National Revenue, Taxation, the respondent, in respect of his 1981 and 1982 taxation years.* [1] In filing his income tax returns for 1981 and 1982 Mr. Taillefer deducted losses incurred in farming in the amounts of $11,450.20 and $7,113.06 respectively from his income. The respondent disallowed the deduction of the losses on the basis that Mr. Taillefer was not carrying on the business of farming in 1981 and 1982 with a reasonable expectation of profit and the expenses so incurred were personal or living expenses.

Facts

Mr. Taillefer was born to farming parents in 1938 and lived on the family farm in La Broquerie, Manitoba until 1966 when he moved to Winnipeg to work at the Canada Packers abattoir. In 1966 the appellant also purchased 160 acres of land from his father for $4,000; the land was vacant, containing no building. He acquired the land with the intention of starting a farm sometime later. He spent weekends on the land and from 1966 to 1978 cleared 50 acres for cultivation.

Mrs. Taillefer had worked as a teacher but has worked at home since their child was born two years ago.

In 1979 Swift Company Ltd. closed its abattoir in St. Boniface without notice, according to Mr. Taillefer. Rumours were rampant Canada Packers would close its abattoir as well since it had older facilities than Swift Company Ltd. Mr. Taillefer then started to “seriously” work the land, expecting to be laid off. In 1981 he built a house on the property although he maintained his residence in Winnipeg. In the meantime Canada Packers announced it would close its abattoir at the beginning of 1988; lay offs have started.

Mr. Taillefer testified he expanded beekeeping activities, which he started several years earlier, into a business in 1979, using his brother's garage for storage. His brother's property was next to his land. His brother's neighbours were not happy with this activity and so the appellant built a structure measuring 22 feet by 60 feet; the building included the "house" previously referred to as well as areas to extract the honey and for storage. During 1978 to 1983 Mr. Taillefer purchased beekeeping equipment to support one hundred hives as well as an extractor and a storage tank. Other buildings he built included two grain sheds, a garage and a road. The appellant estimates that by 1983 he had from 15 to 20 hives, about the same he had earlier.

He ceased carrying on beekeeping sometime in 1983 because of an allergy and in 1986 sold some honey left in storage for a low price to a co-operative; he contemplates selling additional honey in storage in 1987.

In 1980 Mr. Taillefer purchased three standardbred horses, one of which died; he also had a one-half interest in a horse in which he acquired a full interest in 1981. In 1981 and 1982 he had two horses; a colt was born in 1983. By 1984 the appellant owned four horses and he started training the colt for stakes races. While he received a lot of advice, Mr. Taillefer was not a trainer and relied on a trainer named Gentzer, on whose farm the horses were boarded. Mr. Gentzer's farm was about 12 minutes from Mr. Taillefer's residence. In 1982 Mr. Taillefer trained the horses "under the eyes" of Mr. Gentzer who finished the training. The horses were also boarded at As- siniboia Downs, a racetrack in Winnipeg, where they were available for stakes races. At the time of trial the appellant was awaiting the birth of two colts. The horses were being raised for sale and for racing. One of the horses he acquired in 1982 was sold in 1985. He believes he has a good chance to win a stakes race soon.

Mr. Taillefer purchased ten cows to begin a feeder operation in 1985. He started this operation because of the rumours respecting the Canada Packers abattoir closing were getting stronger and were more disturbing to him. He stated he was not financially capable of starting a cattle operation until 1985; he fenced the pasture area in 1985.

No major crop was grown on the cultivated portion of the farm land until 1985. Because of chemicals in the earth Mr. Taillefer was only able to grow some corn; in 1985 alfalfa and crops for forage were planted. About one- third of the farm was rented out during 1982, 1983, 1984 and 1985. In the future Mr. Taillefer anticipates an annual crop of 200 bales of alfalfa, each bale weighing 1,500 pounds.

In 1982 and 1983 Mr. Taillefer cleared 10 more acres of land for cultivation.

The appellant testified that during the years under appeal he worked approximately 30 hours a week on the farm. His shift at Canada Packers was from three o'clock in the afternoon to eleven o'clock at night. He therefore had the mornings free for the farm and spent approximately four to five hours per day cleaning and generally improving the farm. He spent seven to eight hours on Saturdays doing a “big cleaning”, doing what he could not do during the week. He spent two hours on Sunday running the horses. Of his four weeks vacation from his employer, Mr. Taillefer would take one week off, the other three weeks would be devoted to the farm.

Mrs. Taillefer helped clean the stables in 1982 and 1983.

In 1981 one of the horses won modest prize money; no other prize money has been won.

Mr. Taillefer's income during the years 1978 to 1985, and its sources, are set out in Schedule I of these reasons.

Issue

The issue in the present appeal is whether the appellant is entitled to deduct all of his farm expenses or, as he submits in the alternative, whether he is entitled to deduct his farm losses only to the extent of $5,000, or whether he is not entitled to deduct any farm losses in computing his income for each of 1981 and 1982.

Law

Section 31 of the Income Tax Act ("Act") limits the amount of losses from farming which a farmer whose chief source of income is neither farming nor a combination of farming and some other source of income may apply to reduce his income from other sources.

Section 31 reads as follows:

31(1) Where a taxpayer's chief source of income for a taxation year is neither farming nor a combination of farming and some other source of income, for the purposes of sections 3 and 111 his loss, if any, for the year from all farming businesses carried on by him shall be deemed to be the aggregate of

(a) the lesser of

(i) the amount by which the aggregate of his losses for the year, determined without reference to this section and before making any deduction under section 37 or 37.1, from all farming businesses carried on by him exceeds the aggregate of his incomes for the year, so determined from all such businesses, and

(ii) $2,500 plus the lesser of

(A) /2 of the amount by which the amount determined under subparagraph (i) exceeds $2,500, and

(b) $2,500, and

(b) the amount, if any, by which

(i) the amount that would be determined under subparagraph (a)(i) if it were read as though the words "and before making any deduction under section 37 or 37.1" were deleted,

exceeds

(ii) the amount determined under subparagraph (a)(i);

and for the purposes of this Act the amount, if any, by which the amount determined under subparagraph (a)(i) exceeds the amount determined under subparagraph (a)(ii) is the taxpayer's "restricted farm loss" for the year.

Classes of Farmers

The Supreme Court of Canada considered this "awkwardly worded and intractable” provision (then subsection 13(1)) together with the whole of the Income Tax Act in William Moldowan v. The Queen, [1977] C.T.C. 310; 77 D.T.C. 5213. Mr. Justice Dickson, as he then was, described, at page 315 (D.T.C. 5216), three classes of farmers envisaged by the Act;

(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) in those years in which he sustains a farming loss.

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

(3) the taxpayer who does not look to farming, or to farming and some subordinate source of income, for his livelihood and who carried on some farming activities as a hobby. The losses sustained by such a taxpayer on his non-business farming are not deductible in any amount.

Reasonable Expectation of Profit

The important ingredient distinguishing one class of farmer from another is the source of his income. If the chief source is farming or farming combined with something else, then the taxpayer is a class (1) farmer, if farming is only a secondary source of income the taxpayer is a class (2) farmer; if farming is not a source of income, the taxpayer is a class (3) farmer.

The Supreme Court of Canada confirmed that because subsection 13(1) comes into play only when a taxpayer's farming activities have incurred a loss for a taxation year, one must place emphasis on the words "source of income" to determine the meaning of the subsection. The Court acknowledged that “in order to have a 'source of income’ the taxpayer must have a profit or a reasonable expectation of profit" (Moldowan, op cit, page 313; D.T.C. 5215).

One must look first at the taxpayer's farm activities to find whether he has a reasonable expectation of profit from farming and thus carries on the business of farming. Both class (1) and class (2) farmers carry on the business of farming.

To determine whether a taxpayer has a reasonable expectation of profit is an objective determination to be based on all the surrounding facts. Mr. Justice Dickson suggested the following criteria as a guideline, but stated that the list is not exhaustive and factors would differ with the nature and extent of the undertaking: profit and loss experience in past years, the taxpayer's training, the taxpayer's intended course of action, and the capability of the venture as capitalized to show a profit after deducting capital cost allowance (Modowan, op cit, page 314 D.T.C. 5215). One of these criteria may predominate over the others and weight to be given to any criterion will depend on all the circumstances of an individual case: Hadley v. The Queen, [1985] 1 C.T.C. 62 at 68; 85 D.T.C. 5058 at 5063.

Where the farming activities have never shown a profit the Court must decide whether the undertaking is susceptible of profit, if the losses were reasonable in view of the income produced and whether the taxpayer did what would be necessary to show a profit. A profit in a future year from activities identical to those undertaken in the years under appeal is relevant in determining its profitability.

Also relevant in determining whether a taxpayer has a reasonable expectation of profit is the activity itself: a farmer who purchases a productive going operation will in all likelihood achieve profit before a man who begins a business of growing trees on raw land: The Queen v. Matthews, [1974] C.T.C. 230; 74 D.T.C. 6193, cited in Moldowan, op cit, at page 314 (D.T.C. 5215). A profit may never be achieved where the undertaking is not suitable to a particular area, or the undertaking is on an insufficient level of operations, or the taxpayer is without competence to carry on the undertaking.

The dedication the taxpayer has to making the farm profitable must also be considered. His physical labour in working the farm is almost always put into evidence and is important: The Queen v. Graham, [1985] 1 C.T.C. 380; 85 D.T.C. 5256 F.C.A.; [1983] C.T.C. 370; 83 D.T.C. 5399 F.C.T.D. The potential for profitability frequently depends on the amount of capital the taxpayer has invested, and if the amount of capital invested cannot reasonably yield any profit, the taxpayer has no reasonable expectation of profit. The farm must have sufficient capitalization from which one may reasonably expect a profit. Where the taxpayer does not have money available to invest and must borrow, the interest rate on the money borrowed is an additional factor to consider whether there is a reasonable expectation of profit.

A taxpayer who has farmed profitably over the years will ordinarily retain farming as a source of income even if he subsequently suffers losses; however a taxpayer starting out to farm must consider the economic conditions and forecasts at the time he enters that activity.

The fact a taxpayer enjoys farming does not turn what is a farm business where he can reasonably expect to earn a profit into a hobby. Also, a farming business ought not to be distinguished from any other business, and simply because the taxpayer may or may not reside on the farm property, does not perform physical labour, or hires people to work the farm should not affect the business nature of the farm. For example, see Hadley v. The Queen, op cit.

When determining if a taxpayer has a “reasonable expectation of profit” one must place some emphasis on the word “reasonable”. “Reasonable” is defined by the Shorter Oxford English Dictionary on Historical Principles as:

.. .4. Not going beyond the limit assigned by reason; not extravagant or excessive; moderate. . .

The term “reasonable expectation of profit" in the french language is "espoir raisonnable de tirer un profit”. The word "raisonnable" is the equivalent of the word "reasonable". "Raisonnable" is defined by Le Petit Robert as:

. . .v. Naturel, normal . . . Qui consent des conditions honnêtes et modérées (commerçant, homme d’affaires, etc.), opposé à exigeant . . .3. Qui correspond à la mesure normale . . . prix raisonnable.

The expectation of profit, therefore, is not a mere hopeful or wishful expectation; it is what a person having a basic knowledge of the undertaking would normally expect having regard to the various factors involved in the undertaking. If the undertaking is susceptible to the vagaries of weather (e.g. drought), disease, economics (e.g. fluctuating prices and costs) or other adversities beyond the taxpayer's control, that potential adversity must be taken into account in appreciating the meaning of “reasonable”. Many of the adversities, beyond the control of the taxpayer, may be expected and are normal risks of farming but others are unusual and exceptional occurrences; the taxpayer ought to allow for the former in determining his expectation of profit. The term “reasonable expectation" is not analogous to "expectation under ideal conditions".

If a taxpayer starts his farming operations with a reasonable expectation of profit but incurs losses year after year the expectation of profit, for whatever reason, at a given time may cease to be reasonable and the taxpayer has to consider cutting his losses to minimize the continuing erosion of his personal net worth: Hadley v. The Queen, op cit, at page 68 (D.T.C. 5063).

Chief Source

Once the Court finds that a taxpayer carries on the business of farming does not always end the conflict between the taxpayer and the fisc. The Court may then be asked to find whether the taxpayer is a class (1) or class

(2) farmer, that is, whether or not farming, or a combination of farming and some other source of income, is the taxpayer's chief source of income. If so, the taxpayer is a class (1) farmer. In describing the three classes of farmers envisaged by the Act Mr. Justice Dixon stated that a class (1) farmer looks to farming for his livelihood. One may apply quantitative tests, among others, to determine whether farming may reasonably be expected to provide the bulk of income to a taxpayer. To determine whether farming may reasonably be the centre of the taxpayer's work routine requires subjective tests bearing in mind the work routine must be directed to earning one's livelihood. Keeping oneself busy is not the work routine of a class (1) farmer unless he may reasonably be expected to earn his livelihood from that work.

In his reasons for judgment in Moldowan v. The Queen, [1975] C.T.C. 323; 75 D.T.C. 5216 Mr. Justice Ryan of the Federal Court of Appeal considered the possibility that a source may be a source of income in a particular year although it did not yield a profit in that year and therefore to determine the chief source for a year it appears pertinent:

. . .to look at each of the taxpayer's sources from the point of view of capacity for present or future profit or for both when one is seeking to determine his chief source of income in that year. The relative importance of sources as sources of income would seem to me to be in most part a function of their capacity to produce gain. In my opinion an appropriate path to a resolution of this difficult problem is to give significant attention to the taxpayer's ongoing income-earning activities in a practical and businesslike way in this way to determine which of the taxpayer's sources of income, in the ordinary run of his affairs, but taking account of his plans and his activities in implementation of his plans,* is the chief source of his income in the sense of its usual or its foreseeable profitability or of both. In seeking an answer, gross income, net income, capital investment, cash flow, personal involvement, and other factors may be relevant considerations. (page 333; D.T.C. 5219)

*See, for example, Wi/fley v. The Queen, [1974] C.T.C. 510; 74 D.T.C. 6422.

Mr. Justice Dickson stated in Moldowan, op cit, at page 314 (D.T.C. 5215-16) that:

Whether a source of income is a taxpayer's “chief source" of income is both a relative and objective test. It is decidedly not a pure quantum measurement. A man who has farmed all of his life does not cease to have his chief source of income from farming because he unexpectedly wins a lottery. The distinguishing features of “chief source" are the taxpayer's reasonable expectation of income from his various revenue sources and his ordinary mode and habit of work. These may be tested by considering, inter alia, in relation to a source of income, the time spent, the capital committed, the profitability both actual and potential. A change in the taxpayer's mode and habit of work or reasonable expectations may signify a change in the chief source, but that is a question of fact in the circumstances.

In determining if a taxpayer's chief source of income is from farming the Court must consider whether it follows from the facts that notwithstanding the taxpayer's other income sources farming can reasonably be expected to be a major force in the taxpayer's income-earning process or to have priority over other income-earning activities that require his energies. The taxpayer's commitment of capital or personal energy to the farm must be such that a knowledgeable person would reasonably expect the farm to provide a livelihood. In short, to find farming to be the chief source of a taxpayer's income the Court must determine the relevant importance of farming to the taxpayer's other sources of income: The Queen v. Graham, op cit, at page 388 (D.T.C. 5263) (F.C.A.).

Combination of Farming and Some Other Source

In many cases under section 31 the taxpayer usually acknowledges farming alone is not his chief source of income but claims his chief source of income is from a combination of farming and some other source of income. It is usually, but not always, from this other source of income that he is seeking to deduct his farming losses.

There need not be any connection between farming and the "other source of income" for a taxpayer's chief source of income to be a combination of the two sources; however, the meaning of “combination” in section 31 does not mean the simple addition of any two sources of income for any taxpayer (Moldowan, op cit, page 314; D.T.C. 5216).

In the Federal Court of Appeal Mr. Justice Ryan was of the view that:

Just as in the case of determining whether farming alone is the chief source, so in the case of determining whether farming combined with another source is the chief source, a practical judgment must be made, and in my opinion the judgment is to be made by way of analogy to the process appropriate to determining whether farming alone is the chief source. In making this assessment, the comparative importance of the combination must be assessed as if the decision were being taken by a reasonable and informed observer. The question to be decided is one of fact: Was the combination the taxpayer's chief source? The answer is to be sought in a context which, depending on the facts of the particular case, may embrace the past and predictions about the future as well as the present, (page 334; 5219-20 D.T.C.)

Mr. Justice Dickson described what section 31 contemplates and what one must consider in determining whether a combination of farming and some other source of income is a taxpayer's chief source of income. On page 315 (D.T.C. 5216) he wrote that section 31:

. . .contemplates a man whose major preoccupation is farming, but it recognizes that such a man may have other pecuniary interests as well, such as income from investments, or income from a sideline employment or business. The section provides that these subsidiary interests will not place the taxpayer in class (2) and thereby limit the deductibility of any loss which may be suffered to $5,000. While a quantum measurement of farming income is relevant, it is not alone decisive. The test is again both relative and objective, and one may employ the criteria indicative of “chief source” to distinguish whether or not the interest is auxiliary. A man who has farmed all of his life does not become disentitled to class (1) classification simply because he comes into an inheritance. 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.

Review of Facts

At the case at bar the years under appeal are 1981 and 1982. During those years the appellant kept bees for honey and owned horses for racing and resale. The evidence was that the beekeeping venture was not successful and he gave up that undertaking in 1983, only selling previous years' inventory in later years.

As far as the activities relating to the horses are concerned there is no evidence before me to indicate how many horses would be necessary for a viable operation either for racing or for resale, or for both racing and resale. It is obvious the number of horses owned by the appellant in the years under appeal and in subsequent years did not by themselves generate any profits. Many cases have commented on the risk involved in maintaining horses for racing*. [2] It was only in 1985, after the appellant added cattle to his farming activities, that the farm operations may have had a profit potential.

The appellant did not own any cattle in the years under appeal and the evidence does not even suggest the appellant was seriously considering in those years adding cattle to his farming activities. The appellant stated the pasture was not fenced until 1985 and did not start purchasing cattle until that year because he was not financially capable of doing so earlier. However the evidence shows him receiving interest income of over $10,000 a year from 1980, indicating he had sufficient capital to enter cattle farming before 1985. The profit potential of the appellant's farm only improved in 1985 when he started to raise cattle; this was not part of his farm operations in 1981 and 1982.

I do not doubt that Mr. Taillefer’s evidence of the time he devoted to his horses and to beekeeping. But time expended on farming activities is only one indicator of a taxpayer's intention to make farming a business. A person may spend much of his time in a pursuit that is not a business; the spending of the time at such labour does not turn what is not a business into a business if there is no reasonable expectation profit will accrue.

Decison

In my view Mr. Tai liefer was a class (3) farmer in the years under appeal.

The appeal is dismissed.

Appeal dismissed.

PAUL J. TAILLEFER

TABLE OF INCOME AND EXPENSES

TAXATION YEAR	1978	1979	1980	1981	1982	1983	1984	1985
Employment Income	$14,605.00	$18,369.40	$20,452.01	$23,144.09	$26,353.61	$22,251.61	$25,402.49	$28,069.38
Investment Income	$ 4,445.00	$ 7,571.28	$11,385.64	$18,068.76	$15,000.04	$14,105.38	$15,374.16	$17,014.29
Rental Income (gross)	—		—	—	1,000.00	1,000.00	1,000.00	1,000.00
Rental Expenses
— repairs and
maintenance					760.00	250.00	65.00
— land taxes	—	—	—	—	—	670.00	650.00	662.99
— insurance	—	—	—	—	—	145.00	—	—
seeding by tenant				—	—	—	—	839.95
— seeding by tenant	—	—	—
Income or Loss from
Rentals (net)			—	—	240.00	(65.00)	285.00	(502.94)
Rentals (net)	—	—						v.
Farming Income (gross)
— honey		0	489.44	507.10	200.00	0	230.85	0
— horses	0	0	0	35.00	0	0	0	850.00
— cattle	0	0	0	0	0	0	0	5,722.92
Farming Expenses		931.87	1,692.41	10,749.86	5,789.18	5,206.80	4,766.90	5,087.22
Capital Cost
Allowance		260.50	875.37	1,242.44	1,523.88	1,695.00	—	—
Farming Income or
Loss (net)	($263.00)	($1,192.37)	($2,078.34)	($11,450.20)	($7,113.06)	($6,901.80)	($4,536.05)	$1,485.22

It is noted that at trial Mr. Taillefer anticipated a net income for 1986 and 1987, before capital cost allowance, of $3,116.22 and $4,695.00 respectively.