James Leakos v. Minister of National Revenue, [1986] 1 CTC 2245, 86 DTC 1190

Taylor, T.C.l.:—This is an appeal heard in Saskatoon, Saskatchewan on December 9 and 10, 1985, against income tax assessments for the years 1977, 1978, 1979 and 1980 wherein the Minister of National Revenue disallowed, “full farming losses"' claimed, but did allow "restricted farming losses” for all years in issue. The notice of appeal detailed the appellant’s position as follows:

— The Appellant is resident on a farm located near the City of Saskatoon, in the province of Saskatchewan.

— The Appellant is a medical physician, who specializes in the practice of ear, nose and throat medicine. Prior to 1976 the Appellant devoted the majority of his time to his medical practice averaging up to 100 hours of medical work per week. During this period he maintained operating privileges and actively carried on his medical practice at all three of Saskatoon’s hospitals, he served as the Chief of Ear, Nose and Throat at the City Hospital and the St. Paul’s Hospital both located in the City of Saskatoon, he sat on various medical committees and also served as an Associate Professor of Surgery at the College of Medicine at the University of Saskatchewan. During this time period, the Appellant maintained subscriptions to many medical journals and spent many of his late evenings reading such journals in order to remain current in his areas of expertise.

— The Appellant became involved in the thoroughbred racing industry in 1964 with his early participation being limited to the training and racing of horses. The Appellant’s medical background led him to believe that the only way to succeed in the thoroughbred horse racing business was to develop good genetic bloodlines though the process of breeding thoroughbred horses.

— In 1976, the Appellant decided that he would commit a major portion of his energies to the business of breeding thoroughbred horses. He resigned his position as Chief of Ear, Nose and Throat at City Hospital, he gave up his operating and practicing privileges at the University Hospital, he resigned his teaching position at the College of Medicine at the University of Saskatchewan and reigned from most of the medical committees he had previously sat on. Further, since 1976, the Appellant has not renewed the majority of his medical journals as his reading is now devoted to the study of breeding and bloodlines of horses through various books and journals.

— The Appellant has spent, on average approximately 40 to 50 hours per week in respect of his medical practice and between 40 to 50 hours per week in respect of his thoroughbred breeding business. He has been actively involved in the maintenance of the farmland and the caring of the horses performing such functions as foaling his own horses, halter breaking weanlings, grooming or handling the horses’ feet, and feeding the horses twice daily. With the assistance of his children, the Appellant uses his farmland to grow sufficient feed for his horses, and in the 1982 crop year, 7,000 bales were grown for purposes of feed. In addition, the Appellant performs the normal maintenance functions related to the farming operation such as construction and repairing of fences, the repair of equipment, maintaining the land and reseeding and fertilizing the land with manure from the barns and the corrals. The Appellant's time commitments in respect of his thoroughbred horse-breeding business have severely reduced his personal holiday time and in the last five years, the Appellant has not taken a holiday.

— The Appellant’s gross revenue from the thoroughbred horse business has increased since 1976 from $12,493.00 to $62,642.00 in 1982. Though the Appellant's medical income has also increased in this time period, this can be attributed to the addition of a salaried associate who generates net revenue for the Appellant, operating medical and administrative efficiencies permitting more work to be performed in a shorter period of time and at less cost and increased revenue from the provincial medical plan.

— Since 1976, the Appellant has invested substantial sums of money into his thoroughbred horse business.

— In the Appellant’s opinion, his extensive investment of money and time in his thoroughbred racing operation will create a profitable operation. The nature of the thoroughbred horse racing industry is such that results from breeding will take at least four years from the time of the acquisition of the mare prior to obtaining any returns and the payback period of the total investment can take much longer until such time as the bloodline has been proved and the offsprings have either been sold or the horses have been put out to stud. Although the Appellant has as yet not generated net income for tax purposes, his breeding operation is viewed as one of the most successful operations in western Canada. His medical background and genetic training have been of great assistance to him in the breeding process and the success ratio of his horses in such a short period of time is unparalleled in western Canada. Marrobrich, a horse bred and raised by the Appellant and the winner of the 1982 Saskatchewan Derby provides evidence of the success the Appellant has had with his breeding program.

— The Appellant has achieved the above only by providing constant attention to the management and operation of his thoroughbred horse business and his total work effort is a combination of his professional practice and farming. The Appellant says that the foregoing is consistent only with the Appellant being engaged as a farmer in the business of farming whereby the Appellant’s chief source of income for the years 1977, 1978, 1979 and 1980 constitutes farming or a combination of farming and some other source of income within the meaning and use of these words in Section 31(1) of the Income Tax Act (Canada).

In response, the Minister put forward:

— at all material times the Appellant carried on a business of horse racing and horse breeding as a sideline business,

— the Appellant’s aggregate net professional income was $768,805 for the years under appeal, whereas his aggregate net farming losses were $209,382 for the same period, and,

— the Appellant's chief source of income was neither farming nor a combination of farming and some other source of income for the 1977, 1978, 1979 and 1980 taxation years.

I should first comment on the portion of the quotations from the notice of appeal (supra) which recites:

In 1976, the Appellant decided that he would commit a major portion of his energies to the business of breeding thoroughbred horses. He resigned his position as Chief of Ear, Nose and Throat at City Hospital, he gave up his operating and practicing privileges at the University Hospital, he resigned his teaching position at the College of Medicine at the University of Saskatchewan and resigned from most of the medical committees he had previously sat on. Further, since 1976, the Appellant has not renewed the majority of his medical journals as his reading is now devoted to the study of breeding and bloodlines of horses through various books and journals.

Some part of the testimony and evidence provided on behalf of the appellant dealt with this aspect of his affairs — and it was asserted that the phrase from Moldowan v. The Queen, [1977] C.T.C. 310; 77 D.T.C. 5213 to be found at 315 (D.T.C. 5216):

. . . 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.

might be of value to the appellant’s case. In my view that position cannot be sustained. While Dr. Leakos undoubtedly realigned his time, effort and resources starting in about 1976, what he actually accomplished was a restructuring of his medical practice routine so that his continuing practice would interfere as little as possible with his ongoing farming operation. He did not “re-orient” his entire life in a fashion to give unquestioned prominence to the farming activity when compared with the medical practice. In simple terms, by 1976 something had to give, and he did eliminate the less productive, more time-consuming aspects of his medical practice, but he did not reduce or eliminate the thrust, impact, or overall productivity of that practice. He did not change direction, so as to forsake, or embark on a program to forsake, the medical practice in favour of the farming operation. It should also be noted that Dr. Leakos was aided in maintaining his level of medical practice income during the more recent years, by beneficial changes in fee schedules and income support arrangements arising out of the medical plan in place in the Province of Saskatchewan, and by the addition to his practice of another qualified surgical specialist. In deciding that the “change of direction” argument does not aid this taxpayer I am conscious of the fact that reference was made to that proposition in The Queen v. Paul E. Graham, [1985] 1 C.T.C. 380; 85 D.T.C. 5256 but as I read the context of that case, such a “change in direction” for Graham, arrived in 1968, and did not serve to affect the critical decision regarding “chief source” in the years therein under appeal which commenced in 1977. At this juncture it would also be useful to note the following quotation from 383 (D.T.C. 5259) of Graham (supra):

. . . It seems to me, therefore, that one of the issues with which the Court must deal in this appeal is whether or not it is possible, in the rather unusual circumstances of this case, for a person to have employment in two full-time occupations at the same time, the existence of one of which would not, per se lead to the conclusion that he fell within the restrictions imposed by section 31(1) of the Income Tax Act limiting his claim for the deductibility of his farming losses to $5,000.

Examining that particular point did not seem to impede the decision of the learned Justices to uphold the judgment of the lower Court that the main preoccupation of Mr. Graham “is farming but he has income from a sideline employment.” In this matter, I am proceeding I believe, along the same lines of examination

Referring then to the testimony and evidence, only that which would be of value in making such a determination will be considered. It is agreed that Dr. Leakos was in the “business of farming" (see W. H. Warden v. M.N.R., [1981] C.T.C. 2379; 81 D.T.C. 322) for purposes of this appeal, by virtue of the fact that the Minister has accorded to Dr. Leakos the “restricted farm loss?" That should not be regarded as any form of “concession” in this appeal, but rather as a clear recognition by the Minister of the enormous investment of time and resources, plus the dedication and determination of Dr. Leakos in developing and running his operation of breeding, training, racing and selling horses. (See S. Gorjup v. M.N.R., [1985] 2 C.T.C. 2194; 85 D.T.C. 530 and L. M. Zichy v. M.N.R., [1985] 2 C.T.C. 2340; 85 D.T.C. 639). As portrayed by witnesses on his behalf, and as modestly acknowledged by Dr. Leakos, he is the premier breeder in the Province of Saskatchewan, and one of the most highly regarded and respected in the Canadian West. During the last couple of years (from 1983 on) he has received both recognition and awards to demonstrate this, as well as that he has competed admirably in some very prestigious races. The “bloodlines” which he has developed and maintains are among the best, and his contribution to breeding and racing of horses in the West, and for that matter in all of Canada, should not be minimized. In addition, I would certainly accept that Dr. Leakos has made a great contribution to a better comprehension of the horse-raising and racing industry and probably has assisted materially in improving the prospects for future growth and stablility in that industry. That thought did give me some pause, in view of the decision in Hall v. M.N.R., [1985] 2 C.T.C. 2314; 85 D.T.C. 624 favourable to that appellant — but it should be remembered that Mr. Hall was seeking and received from the Court, only that which had already been accorded to Dr. Leakos by the Minister — recognition of his status and entitlement to the “restricted farm loss.” The issue brought to the bar by the Minister's assessment is whether “farming” as a business (which it is) was the “chief source of income” for Dr. Leakos during the years in issue, or whether his medical practice occupied that place in his business affairs. In deciding that question the current leading case must be that of Graham (supra). The similarity between that case and the current situation was highlighted by counsel for the appellant, particularly that Dr. Leakos had also brought forward as witnesses, independent third parties who attested to his interest and activity in the farming venture, just as had Mr. Graham.

In cross-examination of Dr. Leakos, counsel for the Minister had introduced certain documents Exhibit R-1, R-2, R-3 and R-4, prepared by Revenue Canada which gave details of the appellant’s income for a period which encompassed that under review. I have extracted therefrom certain information which I believe to be relevant to a determination of this appeal:

Exhibit R-1

		DOCTOR LEAKOS
	REPORTED SOURCES OF INCOME
	Net		Gross	Gross
	Professional	Net farming	Professional	Farming
Year	Income	Income (loss)	Income	Income
1977	164,128.00	(44,235.00)	333,184.00	12,608.00
1978	161,967.00	(29,600.00)	345,910.00	15,138.00
1979	212,300.00	(47,728.00)	401,394.00	7,603.00
1980	230,410.00	(87,819.00)	471,805.00	14,148,00
1981	243,267.00	(30,729.00)	467 ,264.00	27,185.00
1982	209,613.00	(54,422.00)	448,797.00	62,642.00
1983	352,781.00	(77,599.00)	494,919.00	54,625.00
1984	359,568.00	(59,746.00)	521,402.00	88,858.00

Exhibit R-2

DOCTOR LEAKOS

FARM LOSS AS A % OF NET INCOME

Total

reported

Income

(includes % Farm Net interest Farm Losses/ Professional dividends, Losses Total Year Income etc.) Income Reported

1977 164,128.00 169,284.00 41,135.00 24.2% 1978 161,967.00 150,797.00 29,600.00 19.6% 1979 212,300.00 234,139.00 47,728.00 20.4% 1980 230,410.00 244,802.00 87,819.00 35.9% 1981 243,267.00 241,392.00 30,729.00 12.7% 1982 209,613.00 206,375.00 54,422.00 26.4% 1983 352,781.00 363,022.00 77,599.00 21.4% 1984 359,568.00 366,139.00 59,746.00 16.3%

Exhibit R-3

DOCTOR LEAKOS

HORSE PURSES WON TO HORSE FARM EXPENSES

% of Farm

Income

Farm Farm to Farm Year Income Expenses Expenses

1977 12,608.00 56,843.00 22.2% 1978 15,138.00 44,738.00 33.8% 1979 7 ,603.00 55,331.00 13.7% 1980 14,148.00 101,967.00 13.8% 1981 27,185.00 57,729.00 47.1% 1982 62,642.00 117,064.00 53.5% 1983 54,625.00 132,224.00 41.3% 1984 88,858.00 148,604.00 59.8%

Exhibit R-4

JAMES LEAKOS

ADJUSTING FARM LOSSES FOR INVENTORY USING MR. LEAKOS'S OWN ASSUMED VALUES

Dealing with Exhibit R-4 first, it was counsel’s line of questioning of Dr. Leakos, that the average “farm income" of $13,903 shown thereon (even when calculated on an “inventory accrual" basis) was very minor compared with his medical practice income. It was quickly noted by counsel for the appellant that since such “inventory" figures were only estimated from information provided by Dr. Leakos to Revenue Canada, they could vary greatly from year to year and it could not be said in real terms that Dr. Leakos had a “profit" or a “loss" based on such calculation, and that the results at the end of 1980 or 1984 might be entirely different. The Court would also add that inventory of stock is not the only factor to be considered in such a reconstructed accrual method of arriving at a profit. One should not forget accounts receivable, accounts payable, bank loans, particulars of capital assets, drawings, etc. — all, and more, needed to complete such a process. There would also be the additional impact of income taxes on any “profits” which might be shown by the “accrual” method. While the presentation of this Exhibit is appreciated by the Court, it does not support directly or incontrovertibly the Minister’s position.

It seems to me unacceptable for a taxpayer to calculate and report a “farming loss”, on a “cash basis” which has the result of a reduction of income taxes otherwise payable, and then somehow recalculate a “farming profit” on an incomplete form of “accrual basis” for purposes of escaping the provisions of section 31 of the Act. Those “recalculated profits” must inevitably show up in later financial statements — if indeed they are real, and taking advantage of current losses by reducing taxes on later profits is the basis for the inclusion of paragraph 111 (1 )(c) in the Act. To change from one form of farm reporting (cash) to another form (accrual) is only permitted under the Act in certain circumstances and I fail to see a basis for its specific utilization to dilute the reported figures for either party, although such information (inventory, etc.) may have some general probative value to the Court.

Turning then to the information above from Exhibit R-3, this does show that while Dr. Leakos' gross farm income has increased over the years, so too have the gross farm expenses. It might be agreed that the “gap” is narrowing, but unless there is a dramatic change in one, or the other, or both, the trend towards “profit” is exceedingly slow if discernible at all. The prospect of “profit” rivalling that of the medical practice is almost inconceivable. It certainly could not be said that the four years since 1980 have supported Dr. Leakos' alleged optimism at December 31, 1980, that the losses would reduce dramatically and consistently — they have not doneso.

With regard to Exhibit R-2, counsel for the Minister proposed for Dr. Leakos' consideration, that he had not devoted a large part of his professional income to investment in the farm — at least to the degree represented by losses. I am not certain how to take that proposition by the Minister. I doubt that the Minister means that Dr. Leakos should lose more money, and therefore somehow qualify for the “full farming loss” claimed. Obviously this analysis (Exhibit R-2) does not take into account possible investments in fixed assets — land, buildings, machinery, etc. One point brought out in this line of questioning was that Dr. Leakos did avail himself of certain “tax shelters”, such as MURBS, films, oil and gas investments, etc. I did not find that conduct on the part of Dr. Leakos to be particularly diabolical. While interesting, I do not see that the information revealed by Exhibit R-3, is particularly supportive of the Minister's case.

Finally, Exhibit R-1 provides certain statistical evidence which cannot easily be thrust aside. I have never been of the view that ""gross income” as such should play a great role in determining the question of chief source of income except in the most unusual circumstances (support for this view may be found in The Deputy Minister of Revenue of Québec v. Julius Lipson, [1979] C.T.C. 247 (Supreme Court of Canada)). In this case they are at least informative and certainly not in support of Dr. Leakos' case. The gross professional income shows a sustained high level, and a virtually uninterrupted upward incline. Whatever assistance, assistants, or efficiencies, Dr. Leakos might provide in his medical practice, the overall involvement and management a practice of this magnitude required of Dr. Leakos can hardly have been an inconsequential matter. But the real tale is told by the “net professional income" and “net farming losses" figures for the four years involved in this appeal, and the results and trends shown in the subsequent years. That leads to the recent case of J. Said v. M.N.R., [1986] 1 C.T.C. 2115; 86 D.T.C. 1009, in which an examination was made of the impact and interpretation of Graham (supra) in circumstances similar to those before the Court. I believe the following comments to be found therein are equally applicable to Dr. Leakos:

. . . Accordingly the “actual” results do not support a conclusion that the farm was his primary source of income. No clear indication has been given that by December 31, 1981 the “potential” results were of demonstrable or outstanding proportions attributable to the years under review. Between the years 1981 and 1984 it is possible that such a development occurred, but that is not before the Court. As I see it therefore, the question of weighing the relative merits of the appellant's “ordinary mode and habit of work” as it reflected his interest in and attachment to his employment or to farming need not come before this Court, as it did in Graham (supra), since Mr. Said has not succeeded in showing that farming was the main preoccupation, as contrasted with the auxiliary preoccupation, based on the simple expedience of profitability, either actual or potential. As noted in Mol- dowan (supra) at 315 (D.T.C. 5216) “.. . The test is again relative and objective, and one may employ the criterion indicative of 'chief source’ to distinguish whether or not the interest is auxiliary . . .”

It may be possible to conceive of a set of circumstances wherein a taxpayer would fail to establish the primacy of his farming venture (in a comparison with another source of income) from the first viewpoint “expectation of income from his various income sources”, and yet manage to overcome that built-in handicap and support his assertion on the second viewpoint “mode and habit of work” but I do not see in this appeal the prospect for such a turn of events. Indeed, I would suggest, it would be the extraordinary set of circumstances which could fit into that equation, as the judges saw in Graham (supra).

Before closing, I should like to note with appreciation the cases other than Moldowan (supra) and Graham (supra) referred to by counsel for the appellant — Hunter v. M.N.R., [1985] 1 C.T.C. 2440; 85 D.T.C. 404; Hadley v. The Queen, [1985] 1 C.T.C. 62; 85 D.T.C. 5058; Astroff v. M.N.R., [1984] C.T.C. 2788; 84 D.T.C. 1689. While I have reviewed these they do not for me provide direction which conflicts with my expressed view of Graham (supra). Hadley (supra) is under appeal but that in itself is no restriction of its applicability, since several other cases referenced by counsel for the respondent are also under appeal. Further it would appear to me that for the decision in Astroff (supra) the judge relied substantially on the factor of “profitability" as calculated by the inclusion of an estimated inventory figure. I have already noted my reluctance to rely on such evidence alone in making a decision on this point.

In the end analysis I am of the view that Dr. Leakos fits directly into the category of farmer for which the deductibility restriction of $5,000 per year remains an integral part of the Income Tax Act. A comment from page 2081 (D.T.C. 71) of the case of Dr. Noel A. Kerin v. M.N.R., [1985] 1 C.T.C. 2077; 85 D.T.C. 67 in a matter not totally dissimilar from Dr. Leakos may be instructive:

Where the Minister provides for the “restricted farm loss” in assessing a situation as in the instant appeal, and notes its accumulation for purposes of the carry forward provisions of the Income Tax Act (section 111), it would appear to me that the Minister has opened the door and shown the way to a taxpayer, in order that he demonstrate the kind of profit from the operation that it is alleged resides therein. In mathematical terms for the taxpayer, the prospect of using up the accumulated losses from the early years, against the real profits of the operation in later years, (thereby reducing or eliminating the tax impact), does provide a very real incentive to make the operation profitable — an incentive and a yardstick similar to that provided all other businessmen. The proposition of this taxpayer — immediate write off of a loss with little or no indication that profits will result in a reasonable period of time, is one which the Minister and other taxpayers are entitled to look at with a degree of reservation. . . .

The appeal is dismissed.