Ross M. Johnston v. Minister of National Revenue, [1987] 2 CTC 2374, 87 DTC 632

Sarchuck, T.C.J. [Orally]: —Mr. Ross Johnston appeals from assessments of income tax for the 1979 to 1982 taxation years inclusive.

The respondent on assessment proceeded on the basis that subsection 31(1) of the Income Tax Act applied to restrict the deduction of losses from a mixed farming operation carried on by Mr. Johnston.

In this appeal the respondent admits that Johnston was carrying on a farming business which has a reasonable expectation of profit. The respon- dent, however, maintains that the appellant is not entitled to deduct full farming losses because he is in the words of Dickson, J., as he then was, in Moldowan v. The Queen, [1977] C.T.C. 310 at 315; 77 D.T.C. 5213 at 5216:

. . . a taxpayer who does not look to farming, or to farming or some subordinate source of income, for his livelihood but carried on farming as a sideline business.

In Moldowan v. The Queen Mr. Justice Dickson stated that the Act envisaged three classes of farmers. The third class or hobby farmer is not relevant to this appeal. According to Dickson, J. the first class of farmers consists of those taxpayers for whom farming may reasonably be expected to provide the bulk of income or the centre of their work routine. Such taxpayers who look to farming for their livelihood are entitled to deduct the full amount of their farm losses. The appellant says that he falls into this class.

Mr. Johnston grew up on a two-section, mixed farm in Saskatchewan, and worked there until he was 22 years of age. He then left and at some point of time obtained his journeyman's papers as a pipe fitter. He moved to Alberta in 1968 and worked there at his trade until his return to Saskatchewan in 1976. In that year, utilizing some funds inherited by his wife and the proceeds from the sale of his home in Calgary, Alberta, as well as some moneys borrowed from Niagara Finance, he purchased and equipped a one-quarter section of land in Balgonie, Saskatchewan, some 20 miles east of Regina. He described this land as fair in quality. It had been cultivated but rather poorly in the immediately preceding years. According to Mr. Johnston some 150 acres were workable while the rest was reserved for the construction of buildings and so forth. There were no buildings on the side of any nature and between 1976 and 1979 he engaged in a modest construction programme. He hired builders to build a home which was completed in 1977. He built a barn which was completed in 1978 and a shop in 1979. The Court was told that by 1979 he had corrals in place, the farm was fenced as needed, some 2,000 trees had been planted; a water well had been dug and they had brought in power. He also told the Court that in 1979 he seeded 17 acres of grass and some 133 acres in cash crops.

The year after he purchased the farm he acquired a tractor, a disker, harrows, a cultivator and several years later he bought an old swather. He first seeded a crop in 1977. In addition he brought with him five or six head of cattle from Alberta. His intentions as best as one could gather from his evidence were, and I quote: "We were hoping we could live off the farm.”

It appears that the main thrust of his intended operation was to be in cattle. He stated that he hoped in due course to develop a herd of Registered Polled Herefords with the eventual objective of selling the product for breeding purposes, a rather specialized activity. In 1979 he acquired four Registered Herefords and also purchased a registered bull. I note at this point that the Court heard little evidence as to Mr. Johnston's training or qualifications in the field of raising and breeding purebreds at the level he contemplated. In any event, the Hereford plan failed, and the appellant continued with crossbred cattle, raising them for sale as beef cattle.

During all of the years in question Mr. Johnston maintained outside employment in the plumbing business, first with Wholesale Plumbing and Heating in Regina and then with Phoenix Contractors, with whom on occasion he was required to work on projects outside of Saskatchewan, and then with Amalgamated Plumbing and Heating. In 1982 he formed his own business, R. J. Plumbing and Heating.

During the relevant taxation years the appellant's gross income from farming and his net losses were, and I round off the figures for the sake of convenience:

Gross Farm

	Income	Net Loss
1979	$ 7,700	$ 9,680
1980	$ 3,350	$11,460
1981	$ 4,740	$14,900
1982	$ 6,590	$17,440

It was further established in cross-examination that the farm losses continued into the succeeding years. They amounted to $6,730 in 1983, a year in which I note that a portion of his herd was sold off. The losses in 1984 were $10,500 and in 1985 $10,690.

During the same years his income from employment, including U.I.C. payments and some profit from his own business in 1982, amounted to $13,500, $19,100, $20,700 and $13,600 in the taxation years respectively.

The evidence also discloses greater activity in R. J. Plumbing in the years 1983, 1984 and 1985:

The Court was told that in 1985 R.J. Plumbing employed one other person as well as the appellant.

The appellant attributed the farm losses incurred in the taxation years in question to low grain prices, lack of rain, high expenses and particularly in the latter years increased costs due to high interest rates. He said, and I paraphrase, that there was not much that he could have done to change these circumstances. He tried to go into the cattle business but everything went wrong. There was no rain, he had to buy feed. He said he did not want to lose the farm, but if he did not go to work he would have done so, and that is what he did not want to do. He said, "I would not spend any time off the farm if I didn't have to financially.”

The determination of a taxpayer's chief source of income is both a relative and objective test. The Supreme Court of Canada in Moldowan outlined certain criteria which should logically be considered. Emphasizing that none alone are a determinative, I see as appropriate for a proper consideration of the issue in this case the following.

Firstly, a comparison of income from farming with income from unrelated employment. I note immediately that a quantum comparison of these two items is never by itself conclusive of the issue. There are trends, however, in this case which must not be overlooked. Aside from the obvious fact that the operation has never shown a profit in the ten years of its existence, the figures appear to indicate that there is little likelihood of any change in the foreseeable future. On the other hand, in more recent years the gross revenues of the plumbing business have risen dramatically, and I think it is fair to infer that more impetus is being put into that business than had been before, and that perhaps establishes a trend.

Secondly, one must consider the taxpayer's intended course of action. This is an area which gives me great cause for concern, in part, because of the manner in which the evidence was adduced or perhaps it might be better to say was not adduced. I do not know what experience the appellant had in specialized cattle breeding, nor was there any evidence that his farm was properly set up to carry on the operation that he envisioned. In other cases one hears of the training taken by a farmer entering this kind of business. One hears that a farmer is taking courses, is learning breeding techniques, is investigating artificial insemination procedures and so on. Evidence is very often elicited from other witnesses, experts in their field, or sometimes agronomists with whom the farmer consults, to establish that a particular taxpayer is a knowledgeable and skilled person and that he is taking the right approach, as well as to establish that his operation falls within generally accepted standards. There may have been such evidence, but it was not presented to the Court.

If one is to accept the losses which were incurred in those years as start-up costs, one would expect to hear some evidence of an organized, well- considered programme for the earning of profit from the farm operation in the future. There should be some evidence that these initial outlays and losses were acceptable in light of these plans. How large a herd is needed to be commercially viable on the land which the taxpayer has purchased? How long would that take? How much capital is needed? How much will it cost until he reaches that stage? I heard no such evidence.

Another factor is the capital investment. The appellant seems to have made a reasonable capital investment. I do not believe that his borrowing of additional funds from Niagara Finance was a major source of his financial difficulties, but this aspect too is difficult to determine since the evidence adduced on this issue was sketchy and quite inconclusive.

The Court is required to consider the personal involvement, that is, the time spent on farming and other employment by an appellant in this situation. I am prepared to accept that Mr. Johnston spent as much time as he could on the farm. In view of the assistance he received from his family — he had one son who was 17 in 1979 — Mr. Johnston's absences due to his employment were not critical to the farm operation.

There is no question that when needed he was there. He was always there at calving time, at seeding time, at harvest time and other key times. In his mind, no doubt, the farm was the centre of his work routine. However on the evidence before me I cannot confidently reach the same conclusion.

In my view, straight economics dictated his major preoccupation. In his case it was the maintenance of an income-producing employment. Everything else was secondary by virtue of necessity. It is difficult to view the income from the plumbing business as subordinate to or auxiliary to the farming operation in circumstances such as these where the farm operation owes its continued existence to the other sources of income.

Lastly, one must consider the profitability of the operation, both actual and projected. I have to some extent dealt with this issue. What is most remarkable about this appeal is that there appears to have been no financial projection made at any time. One would expect that any individual who has decided to go into business would have made at least some financial analysis; determined the capital required; of the length of time before the operation generated a positive cash flow; would have considered such matters as the increased cost of feed as the size of the herd increased and the many, many other financial matters which normally are considered. It was not necessary to sit down and do a formal accounting analysis, but certainly one would have expected some simple analysis to have been made. This was, at least on the evidence before me, apparently not even contemplated. Even if such projections had not been done initially, one is entitled to expect that at some point of time a businessman would sit down with a pencil and make some financial projections based on the history of the operation in the first three or four years and at that point in time ask himself, "When am I going to see some profit and how is that going to come about?” This was not done.

In the context of the subject of profitability I noted that many of the expenses incurred in each and every one of the years up to 1985 are ongoing expenses and it is unlikely that they could be classified as start-up ‘costs. Again in the context of profitability, I note that the Farm Credit Corporation would not lend the appellant any money at the time he purchased the farm, principally, as I understood Mr. Johnston, because the farm was too small. I think one is entitled to draw the inference that this fact casts some doubt on the commercial viability of that small a farm operation.

I note finally that in the relevant years the farm losses incurred did not include any claim for capital cost allowances and obviously had this item been included the losses would have been much greater. I note this factor because in Moldowan v. The Queen, Dickson, J., when he enumerated the criteria to determine whether or not there existed a reasonable expectation of profit said, and I quote:

. . . the profit and loss experienced in past years, the taxpayer's training, the taxpayer's intended course of action and . . .

I emphasize:

. . . the capability of the venture as capitalized to show a profit after charging capital cost allowance.

So in my view it is proper to look at the losses incurred and consider the effect on those losses had capital cost allowances been claimed.

On balance, I am of the view that Mr. Johnston has failed to demonstrate that he is a taxpayer for whom farming may be reasonably expected to provide the bulk of his income or that in the relevant years he could look to farming for his livelihood.

There is nothing that I can see, taking account of his plans and his activities in the implementation of his plans, to satisfy me that the farm operation is the chief source of income either in the sense of its usual or its foreseeable profitability. Accordingly, Mr. Johnston is not entitled to full farm losses in respect of his 1979 to 1982 taxation years, and the Minister was correct in confirming the deductions as set out in subsection 31(1) of the Income Tax Act.

Appeal dismissed.