Raymond Huckle v. Minister of National Revenue, [1985] 1 CTC 2122, 85 DTC 136

Tremblay, TCJ [TRANSLATION]:—This case was heard on April 9, 1984 at Montréal, Quebec.

1. Issue

According to the notice of appeal and the reply to the notice of appeal, the issue to be determined is whether the appellant, a foreman at Celanese Canada Inc, was correct in claiming in the computation of his income for 1978, 1979 and 1980 farm losses of $2,025, $2,489 and $2,500, respectively. The appellant maintained that he had been carrying on a horse-breeding operation since 1978, that he devoted 45 hours a week to it, and that in the normal course of events, he should have made a profit in a short time.

The respondent argued that the farming activity did not constitute a business within the meaning of the Act, and that the amounts claimed constituted “personal or living expenses”.

2. Burden of Proof

In assessing the appellant for the 1978 to 1980 taxation years, the respondent relied, inter alia, on the following presumptions of fact:

(a) during the 1978 to 1980 taxation years, the appellant was employed as a foreman at Celanese Canada Inc;

(b) on September 29, 1976, the appellant bought four acres of land with a building on it, which he converted into a stable, using second-hand construction materials he already had on hand;

(c) for farm equipment, the appellant had an old tractor and an old truck; (d) in 1978, the appellant bought a stallion and two fillies;

(e) in 1979, the appellant sold one filly for $404.59, and boarded one horse for $420;

(f) in his income tax returns for the 1978 to 1980 taxation years, the appellant reported the following farm income and claimed the following farm losses:

3. Facts

3.01 The appellant was the only witness to be called. At the start of the hearing, he admitted paragraphs (a), (b), (e) and (f) of the above allegations in paragraph 2 of the respondent’s reply to the notice of appeal (para 2.2). He also admitted paragraph (c), pointing out, however, that the tractor was second-hand but in good condition.

3.02 In his direct examination and cross-examination, the appellant testified that:

(a) since 1970, he has been a foreman at Celanese Canada Inc;

(b) In 1943, at the age of 10, he began working at a nearby race track, grooming, washing and stabling horses; this enabled him to observe and note how that type of training was done;

From 1962 to September 1978, he rented out horses for riding. He had first leased stalls in an equestrian centre. Later, in September 1976, he bought four acres of land for $6,000;

In September 1978, he decided to do away with the unprofitable riding stable, and took up the breeding of race horses. In 1981, his activities turned to trotters for harness racing. He is about to complete a quarter-mile track on his farm, on which he will train horses;

(c) From 1978 to 1980, the appellant was a member of the Canadian Stand- ardbred Horse Society, an association to which persons breeding thoroughbreds must belong;

The appellant was also a member of the Canadian Trotting Association and Sodec, the branch of the Régie des loteries et courses du Québec which assists breeders of thoroughbreds. He thus received $30 a month for one year;

(d) Under Exhibit A-1, the appellant filed a series of documents relating to:

(a) the inventory of the horses owned by him from 1978 to 1981 (Appendix A);

(b) the break-even point of his farming activities (Appendix B);

(c) comparative income for the three years in question (Appendix C);

(d) the pedigrees of the two stallions that he owned (Appendices E and F);

(e) accounting principles;

(e) From 1978 to 1981, the appellant owned from three to seven horses. When he had seven horses, he had to devote about forty-five hours a week to them, in addition to his paying job at Celanese Canada Inc. He therefore had to give up some horses. In 1984, he had only three, and devoted an average of twenty-five hours a week to them. According to the cost method, the value of the year-end inventory of horses was: $1,500 (1978), $3,500 (1979), $4,500 (1980) and $5,500 (1981);

(f) The stallions, Gemini, Almahurst and Liberty Flag, have top pedigrees. Some of their ancestors won as much as $200,000 and $800,000. The semen of Bret Hanover, the sire of Liberty Flag, cost $30,000;

The three fillies (from 2 to 3 years) that the appellant now owns are the offspring of the two stallions Almahurst and Liberty Flag;

(g) According to the financial statement of farm income and losses filed as Appendix C to Exhibit A-l, account was taen of the inventories at the start and the end of the years concerned in order to arrive at the following net book losses:

(h) The break-even point is shown in Appendix B to Exhibit A-1:

(i) For 1981 and 1982, the gross income and tax losses were as follows:

(j) The appellant’s purpose in having a farm is to establish a business that will provide him with a livelihood when he retires in 1988 at age 55. He says that he is a very active person by nature, who has loved horses since childhood, and that his business will be a success.

Act, Case Law and Analysis

4.01 Act

The main provisions of the Income Tax Act are subsection 31(1) and the definitions of “farming” and “personal or living expenses”, both contained in section 248. They read as follows:

SEC 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 deductions 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,

SEC 248

“Farming” — “farming” includes tillage of the soil, livestock raising or exhibiting, maintaining of horses for racing, raising of poultry, fur farming, dairy farming, fruit growing and the keeping of bees, but does not include an office or employment under a person engaged in the business of farming;

“Personal or living expenses” — “personal or living expenses” includes

(a) the expenses of properties maintained by any person for the use or benefit of the taxpayer or any person connected with the taxpayer by blood relationship, marriage or adoption, and not maintained in connection with a business carried on for profit or with reasonable expectation of profit,

4.02 Case law

The parties referred the Court to the following cases:

1. William Moldowan v The Queen, [1977] CTC 310; 77 DTC 5213;

2. Norman G Hall and Stirling C Lane v MNR, [1983] CTC 2003; 83 DTC 9;

3. Terrence S Gray v MNR, [1978] CTC 3101; 78 DTC 1814.

4.03 Analysis

4.03.1 The question to be determined is whether there is a “reasonable expectation of profit” in the operation of the appellant’s farming business, as set out in the definition of “personal or living expenses” quoted above. If there is no such reasonable expectation, the farm losses must be considered to be “personal or living expenses”, and therefore cannot be deducted under paragraph 18(1)(h).

However, if such a reasonable expectation of profit does exist, the appellant is entitled to deduct a maximum tax loss of $5,000 a year, under subsection 31(1). The appellant does not consider himself a full-time farmer who is entitled to deduct his total farm losses. He admitted that his chief source of income “is neither farming nor a combination of farming and some other source of income” as provided in subsection 31(1). Rather, he considers himself a gentleman farmer, to whom the deduction under subsection 31(1) is applicable.

The respondent, on the other hand, was of the view that subsection 31(1) did not apply to the appellant, and considered his farming activities a hobby, denying him the deduction for the full loss.

4.03.2 The appellant submitted that with reference to the three years in question, the evidence showed that the break-even point had been reached. He contended that the book loss was $2,515 (para 3.02(h)), for an average annual loss of $838 ($2,515 — 3) or $16 a week.

The appellant argued that it was the book loss, and not the loss for tax purposes, that should be considered in determining whether there was a reasonable expectation of profit.

He based his opinion on the concept of “operating cycle” according to general accounting principles. Referring to the study Accounting Principles: A Canadian Viewpoint by R M Skinner, FCA, p 243, he quoted:

The operating cycle is the average time intervening between the acquisition of materials or services and the final cash realization from their sale.

The appellant had started breeding trotters for harness racing in 1978. The operating cycle was from three to five years. At the end of 1981, however, he changed the nature of his activities (para 3.02(b) in fine), limiting them to harness racing. He sold a part of his livestock in 1982, keeping only three two-to- three-year-old fillies, which were the offspring of ancestors with excellent pedigrees (para 3.02(f)).

4.03.3 In the Moldowan case, decided by the Supreme Court, it was said that whether a taxpayer had a reasonable expectation of profit was an objective determination to be made from all the facts. The following criteria were suggested: the 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 charging capital cost allowance. The Court said that the list was not intended to be exhaustive.

The past losses (there were no profits) are given in paragraphs 3.02(g), (h)f and (i). The appellant’s argument as to the break-even point (para 4.03.2) is far from being without foundation.

The appellant’s experience in training horses was not questioned (para 3.02(b)).

The taxpayer’s intended course of action seemed to be well demonstrated by his activities. From 1962 to 1978, he began by renting out horses for riding. In 1976, he bought a small four-acre property. From 1978 to 1981, he bred race horses. In 1982, he limited his activities to racing his three pedigree fillies in harness races. The capitalized investment, even though it was not the most substantial, was nonetheless sufficient in the circumstances. The appellant proceeded in the usual way.

4.03.4 Can it be said that there was a reasonable expectation of profit?

As has been pointed out many times, the word “reasonable” modifies the word “expectation” and not “profit”.

The Court is of the opinion that the preponderance of the evidence favours the appellant’s argument, and that for the years in question when the appellant was starting up, there was a reasonable expectation of profit.

5. Conclusion

The appeal is allowed and the matter is referred back to the respondent for reconsideration and reassessment.

Appeal allowed.