Charles Juravinski v. Minister of National Revenue, [1986] 1 CTC 2429, 86 DTC 1274

Brulé, T.C.J.:—The appellant appeals from reassessments of income tax for the 1977, 1979 and 1980 taxation years. The Minister applied section 31 of the Income Tax Act to limit to $5,000 per year the deduction of farm losses from income from other sources. It was the appellant's contention that section 31 did not apply to restrict deductibility of farm losses because his chief source of income during those years was a combination of his farming business and his interest in a racetrack business known as Flamboro Downs Holdings Limited.

Issue

The issue is whether the appellant was correct in the computation of his income for the taxation years 1977, 1979 and 1980 in deducting farming losses of $41,730, $49,034 and $281,972 respectively. The appellant contends he was then a full-time farmer within the meaning of the Income Tax Act. He was involved in a racehorse operation and claimed he had a right to the full deductions as herein set out.

The respondent contended that the appellant was a full-time businessman and should be limited to the deductions afforded by section 31 of the Income Tax Act.

Facts

At all material times in this appeal the appellant was an officer and ultimately the president of Flamboro Downs Holdings Limited, a corporation which carries on the operation of a racetrack in the Greater Hamilton area.

In 1971 the appellant was asked to participate in the establishment of the racetrack. He had been a successful businessman and before agreeing to become active in the project, he researched the business for about six months. The track took four years to build and was opened in 1975.

The Minister in his reply to notice of appeal correctly expressed the situation when he set out on page 2, paragraph 3:

In establishing Flamboro, the Appellant determined that successful, privately- owned racetracks were usually operated by individuals who were involved in horse racing. In order to improve the viability of Flamboro, the Appellant became involved in the horse racing business. As a result of this involvement the Appellant improved his knowledge of the horse racing business and became acquainted with various persons who raced horses.

In addition to this and commencing in 1976 the appellant decided to become personally involved in the racing and breeding of horses. At first he was modestly successful, then lost his original investment. He then sought and received advice, and hired a Mr. John Gray Hayes to assist him in getting into the business in a proper manner. Together with his son, Dr. Robert John Hayes, the elder Mr. Hayes operated John Hayes Stables Ltd. They aided the appellant and eventually Dr. Hayes became the appellant’s mentor. At first it was said by Dr. Hayes that the appellant was unsophisticated, although he had considerable knowledge of horses. The appellant took an active role in the business including working at the stables and "hands-on” jogging and attending upon the horses. He was continuously in touch with Dr. Hayes and while suggestions were made to him as to the horses, the appellant made all the decisions.

Appellant’s Position

The appellant through his accountant introduced evidence of the activities involved. An election had been made to report on a cash basis, but the profit in the business is also projected on an accrual basis. This is shown in the three schedules introduced as Exhibit A-1 (attached as Schedules A, B and C).

These schedules it was pointed out confirm the tests set out in Moldowan v. The Queen, [1977] C.T.C. 310; 77 D.T.C. 5213. In that case Mr. Justice Dickson, as he then was, placed emphasis on the words "source of income”. He said at 313 (D.T.C. 5215):

Although originally disputed, it is now accepted that in order to have a “source of income” the taxpayer must have a profit or a reasonable expectation of profit. Source of income, thus, is an equivalent term to business . . .

On the same page he said:

There is a vast case literature on what reasonable expectation of profit means and it is by no means entirely consistent. In my view, whether a taxpayer has a reasonable expectation of profit is an objective determination to be made from all of the facts. The following criteria should be considered: the profit and loss experience in past years, the taxpayer’s training, the taxpayer’s intended course of action, the capability of the venture as capitalized to show a profit after charging capital cost allowance. The list is not intended to be exhaustive. The factors will differ with the nature and extent of the undertaking . . .

Counsel for the appellant pointed out that there had been a profit in 1978 and on an accrual basis there is a substantial overall profit. As to training, while the appellant had limited experience as a boy on a farm it was really his experience with the racetrack which assisted him. Dr. Hayes in evidence said that the appellant was in a unique and fortunate position, and that being in the racetrack business would help him to succeed personally. The schedules clearly demonstrate it was said, the appellant’s course of action, and this was emphasized by the testimony both of the appellant and Dr. Hayes. The capability of the venture as capitalized is also shown by the schedules.

Counsel for the appellant then went on to refer to a further paragraph from Mr. Justice Dickson’s judgment in Moldowan (supra) beginning at the bottom of page 314 (D.T.C. 5215) as follows:

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.

In support of these tests set out in the preceding quotation it was argued that the time spent in the horse-racing business was ever on the increase during the taxation years in question. This was borne out by the appellant’s evidence, corroborated by Dr. Hayes and demonstrated by Exhibit A-1. The exhibit also showed that the appellant had over $1 million invested in his horse-racing business. As to profitability (actual and potential) there was pointed out to the Court that this was clearly shown on Schedule A of Exhibit A-1, and in addition there were large potential stud fees from a syndicated horse as well as purse prizes and sales of horses.

The case of The Queen v. Paul E. Graham, [1985] 1 C.T.C. 380; 85 D.T.C. 5256 was cited to illustrate a similar situation to the present case. There the appellant embarked in the farming business gradually while retaining a full time employment. Here this is comparable with the added feature that the appellant was not restricted as to working hours at the racetrack and, even while there, was free to consult and deal with his horses and their activities. This was pointed out by the appellant and by Dr. Hayes.

Counsel for the appellant also made reference to other cases in support of his argument, and without going into the details of each they were:

Harold S. Hadley v. The Queen, [1985] 1 C.T.C. 62; 85 D.T.C. 5058,

Jean-Marie Auffrey v. M.N.R., [1984] C.T.C. 3002; 84 D.T.C. 1808,

Melvin Astroff v. M.N.R., [1984] C.T.C. 2788; 84 D.T.C. 1689,

Charles R. McCambridge v. M.N.R., [1981] C.T.C. 2314; 81 D.T.C. 251.

Respondent's Position

The respondent has conceded that the appellant had a “reasonable expectation of profit" in allowing, by reassessment, the restricted farm losses provided for in subsection 31(1) of the Income Tax Act. His argument was that the appellant’s chief source of income for the taxation years in question was neither farming nor a combination of farming and some other source of income.

Following the principle set out by Mr. Justice Dickson in the Moldowan case (supra), and in particular as quoted from page 314 (D.T.C. 5215) respecting a taxpayer's chief source of income, counsel put to the Court that the appellant had not met the tests.

As to the time spent by the appellant in the business it was set out that a major change took place only in 1980 when he changed roles from president and general manager to president and chief executive officer. Prior to this corporate reorganization the time spent in his horse-racing business was minimal and largely confined to consultation with the Hayes. The result was that the time spent by the appellant in the business during the years in question did not meet the test suggested in Moldowan.

With respect to the capital committed, the obligations of the appellant to Flamboro Downs were very large in comparison to the money he spent in the horse-racing business, even though the amounts were large in each case.

The profitability, counsel said, has not been demonstrated, and further, one need only look at the losses being claimed to verify this.

Cases cited by the appellant were reviewed and the respondent stated that these could be distinguished from the present case, referring to the actions of the appellant as set out above with those presented in the cases advanced by the appellant’s counsel.

The argument was that each case must be examined on its own particular facts to determine if the tests as io “chief source" of income have been met. There has to be a fundamental change in direction and the Minister maintained that this did not take place until after the period under appeal.

Analysis

Once it is determined that a taxpayer has a reasonable expectation of profit from farming and thus is carrying on a farming business, and such was conceded by the Minister here, it is necessary to determine whether farming, either alone or in combination with another source of income, constitutes the taxpayer’s chief source of income. The Minister alleged that in this case it did not, as set out above.

The word “combination" in subsection 31(1) does not require any connection by way of physical relationship or integration or interconnection between farming and the activity which provides another source of income. In this case there was, however, a relationship between the racetrack business of the appellant and his horse-racing business.

In the Moldowan case (supra) Mr. Justice Dickson indicated in the paragraph quoted above by counsel for the appellant that the word “combination" does not mean the simple addition of two sources of income but rather is the taxpayer's expectation of income and his work habit which may be tested by considering the time spent, the capital committed by the taxpayer and the profitability, both actual and potential.

In the present case, the taxpayer was farming and such provided a source of income. Was it, however, his chief source of income determined by the tests? While he was commencing to spend more time in his horse-racing business as well as investing more capital the profitability was lacking. He had elected to report on the cash basis and from schedule A of Exhibit A-1 money was lost on both bases in 1977 and in 1979. While this was also the situation in 1980, by then the appellant had invested large sums of capital, the evidence indicated that he devoted more time to his horses and the potential profit for the future was great. This latter indication is shown in that in 1980 on the accrual basis the loss was under $20,000 while in 1981 the profit was some $280,000.

I believe that on the application of the tests set out in the Moldowan case, by 1980 the appellant with his time spent, his capital committed and his potential profit, had a chief source of income as set out in the jurisprudence cited. Before this time he did not.

The result then is that the appeal is dismissed for the 1977 and 1979 years and allowed for the 1980 year. Because this represents substantial success by the appellant, he is allowed his costs on a party and party basis.

Appeal allowed in part.