Jean B Leroux v. Minister of National Revenue, [1985] 1 CTC 2007, 85 DTC 112

Cardin, TCJ [TRANSLATION]:—By a notice of assessment dated December 21, 1981, the Minister of National Revenue disallowed amounts of $1,235, $4,974.58 and $5,000 for the 1977, 1978 and 1979 taxation years respectively that had been claimed by the appellant Jean B Leroux as restricted farm losses pursuant to section 31 of the Income Tax Act, SC 1970-71-72, c 63, as amended.

The assessment was based on the Minister’s assumption that the appellant did not have a reasonable expectation of profit from his farming activities during the years in question and that these activities accordingly did not constitute a farming business. The Minister regarded these expenses as being of a personal or capital nature, neither of which was deductible.

Facts

During the years in question, the appellant practised the profession of dentistry in St-Bruno, Quebec, where he lived. His professional income was between $45,000 and $50,000 annually. Jean Leroux, the youngest of nine children, had been raised on his father’s farm and had worked on it for many years. On May 23, 1975 the appellant bought an abandoned farm at Napierville, thirty-five miles from St-Bruno. The farm cost $15,000 and included a house, a barn, a shed and 104 arpents of land, of which twenty-nine arpents were wooded, thirty were old grassland, thirty were bush and fifteen were wooded over, formerly arable land. The land and the buildings were in poor condition. In 1975 the appellant intended to operate the farm as a family business to be run by himself, his wife, his son Pierre who was sixteen in 1975 and Jean-Francois who was nine.

The Court has no reason to doubt the truthfulness of the testimony given by the appellant or by his son Pierre, who has since become a certified accountant. The appellant not only demonstrated a decided interest in farming, but also showed that he possessed agricultural know-how of a practical and technical nature.

Work on the farm in summer 1975 consisted mainly of clearing underbrush, removing rocks, cleaning ditches and repairing the barn and the shed. The house, which had not been modernized, was livable in summer and served as a shelter for the appellant and his family when they worked on the farm during the first three years it was in operation.

In 1976, the appellant had the soil analysed by the Quebec Department of Agriculture. In spring 1976, he planted wheat on twenty arpents, the only arable land at the time. The harvest was poor and in the following year the appellant planted buckwheat to get rid of the weeds that were invading his fields. However, the buckwheat developed aphids, and the crop had to be ploughed under (Exhibit A-1).

Wheat was planted in 1977, but enough buckwheat grew back to cause serious damage to the wheat crop, and earnings were substantially below market prices. In 1979 and the years following, seventy-five arpents were planted, but mainly in hay, oats and barley. Only a third of the 104 arpents had been drained, and planting the wheat on undrained land had resulted in poor yields. The appellant testified on several occasions that he planned to drain the remaining arpents in order to improve his wheat crop.

The appellant’s investment in land, including the cost of purchasing the land, was approximately $66,000 in property, plant and equipment. This amount includes the cost of soil preparation on land that had been abandoned, labour and planting, major repairs to the barn and the shed, the construction of a silo and the purchase of farm machinery and agricultural implements. The cost of operating assets on the farm did not include the amounts spent by the appellant to repair the house, which became the permanent residence of the appellant and his family beginning in 1979. Outlays to purchase horses, including a thoroughbred in 1976 and Percherons, or draft horses, which the appellant planned to raise, were made by the appellant himself and were not part of farm operating expenses.

The appellant and his son Pierre acknowledged that they used the thoroughbred for riding and jumping, but expenses related to the horses and the riding ring were not entered as farm operating expenses.

In response to a request by counsel for the respondent during the proof for information on the profitability of the appellant’s farm, Mr Pierre Leroux, CA, submitted the following table illustrating farm income and expenditures for 1977 to 1983 inclusive (Exhibits 1-1 and I-3):

JEAN LEROUX

These figures, which were not disputed by counsel for the respondent, show a gradual increase in farm income and a gradual decrease in operating expenses. Even counting depreciation and interest payments on money borrowed to operate the farm, which at the time were very high, there was a profit, albeit a very small one, in 1982 and 1983.

Between 1977 and 1983, farm income amounted to $21,614. Pierre Leroux testified that if the land had been in good condition in 1976, the damage caused by the buckwheat had not occurred and the weather in 1978 and 1979 had been better for farming, income from the hay, straw and oat crops would normally have been far higher than it actually was. According to Carmen Derome, an agronomist who inspected the appellant’s farm (Exhibit A-2), the appellant could normally have expected to harvest a greater number of tons of hay, oats and barley per arpent. At regular market prices, he could have anticipated an income of $38,000 between 1977 and 1983.

The Minister’s assessment was based mainly on an audit of the appellant’s farming income and expenses from 1977 to 1981, carried out by Mr Dilihero, an auditor from the Department of National Revenue.

Mr Dilihero testified that he spent two hours at the farm in the course of his audit and that the supporting documents for the income and expenditure statements for 1977 to 1981 were available and in good order. In his opinion, the land was in poor condition and did not seem to have been the object of specific planning, and since 1977 improvements had been carried out only gradually. Mr Dilihero acknowledged, however, that he had not visited the entire farm, but had stayed near the buildings. He said that the appellant had told him that his main objective was to get the farm in a position to show a profit when he retired.

For the purposes of this case, it must be determined whether the appellant could have a reasonable expectation in 1977, 1978 and 1979 of making a profit from the operation of the farm. Accordingly, the facts and surrounding circumstances must be considered.

I doubt that a taxpayer who invests $66,000 in property, plant and equipment does so with no expectation of profit. The work done by the appellant and his family on a farm located in an area wholly given over to farming and not in a cottage district, and the kind of crops they raised, are not characteristic of a gentleman farmer operating a hobby farm.

During summers and weekends in 1977, 1978 and 1979 the appellant, his wife and their sons spent enough time working on the farm to ensure the effective operation of their family farming business. After hearing the evidence, it is clear that the appellant and his family had a reasonable expectation of making a profit from their farming operation.

However, in order to be successful in this case, the appellant must show that his reasonable expectation of profit from the farm was based on observation and an objective consideration of current and anticipated results from the farming operation.

The auditor stated that he had seen no sign of progress or planning on his visit to the farm in September 1981. Although this is not a case of land being brought under cultivation for the first time, the auditor does not seem to have taken into consideration that the appellant had been trying to turn abandoned land into arable land since 1976. Far more preparation is required to make an abandoned property cultivable than land newly acquired but in good condition. The appearance of land that has been continuously worked is not comparable to land that has only been worked for three years. When the auditor stated that the land seemed to be in poor condition, he did not take into account that in 1976 only some twenty arpents were arable, while in 1979, seventy-five arpents were under cultivation.

The auditor also did not take account of the fact that the cost of putting abandoned land back into cultivation and procuring the equipment needed for cultivation is much higher than the cost of continuing to work land already under cultivation. Soil analysis and the chemical fertilizers were additional operating expenses that had to be incurred in order to turn the farm into a going concern. The mediocre wheat crop, the planting of buckwheat followed by the return to hay, oats and barley cultivation in preference to poor wheat crops were, to my mind, part of the appellant’s plans to obtain the best possible crops at that particular time. The evidence showed that the appellant was also planning to drain the rest of his land, which would make the soil more fertile for a variety of crops. The purchase of the Percherons with the intention of raising them to meet a demand which the appellant had found in the United States and in Canada is a further example of the manner in which he planned the farm’s operations and had the potential of becoming a major source of income.

Although putting the appellant’s farm back into operation did result in losses in 1977, 1978 and 1979, the evidence as a whole and an objective observation of the facts allow the Court to find that the appellant had a reasonable expectation of profit from his farm and that he was carrying on a farming business in 1977, 1978 and 1979. The evidence did not show that the farming business constitutes or will soon constitute the chief source of the appellant’s income. It seems clear that for the appellant the farm is only an incidental business and a secondary source of income. It is, however, a farming business entitling the appellant to deduct the restricted farming losses provided for in subsection 31(1) of the Income Tax Act.

The appeal is therefore allowed and the whole referred back to the Minister for reconsideration and reassessment on the basis that the appellant had a reasonable expectation of profit in the 1977, 1978 and 1979 taxation years and that the restricted farm losses claimed for those years are deductible under subsection 31(1) of the Income Tax Act.

Appeal allowed.