William M Kerr, Gail Ann Forbes v. Minister of National Revenue, [1984] CTC 2071, 84 DTC 1094

Christie, CJTC:—By agreement these appeals were heard together on common evidence. During the relevant period, the appellants were engaged in a joint farming venture and they each deducted one-half of the losses incurred with respect to it from their income. What is in question are the deductions claimed by them for farming losses incurred in their 1977 and 1978 taxation years. The appellants claimed the full amount of these losses but, by notices of assessment which were mailed on December 4, 1980 (Forbes) and December 16, 1980 (Kerr), the respondent confined the deductions to restricted farming losses. The appellants objected by notices which are all dated February 9, 1981, and by notifications dated December 8, 1981, the Minister confirmed the reasssess- ments. These notices of confirmation precipitated the appeals.

“Loss from farming cases” are not infrequent and often difficult to resolve. They involve a consideration of subsection 31(1) of the Income Tax Act (“the Act”) which provides that, 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, his allowable deductions for farming losses in that year are restricted to a total of $5,000. “Farming” is broadly defined by subsection 248(1) of the Act in these terms: “‘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.”

These are common situations which may arise on appeals related to subsection 31(1):

1. The full amount of farming losses is claimed and the respondent is contesting this claim as well as an alternative claim for restricted losses. The first issue to be determined is whether the appellant’s farming undertaking was a business during the taxation period in dispute. This in turn raises the question whether the appellant has established, by a preponderance of evidence, the existence of profit or a reasonable expectation of profit. If the answer is no, that ends the matter and the appeal must be dismissed. In W Moldowan v The Queen, [1977] CTC 310; 77 DTC 5213, Mr Justice Dickson, in delivering the judgment of the Supreme Court of Canada, said that the Act envisages three classes of farmers, the third of which is persons who carry on some farming activities “as a hobby”, They are also sometimes referred to as “gentlemen farmers”. The farming activities of persons in this third class do not constitute a business and, for that reason, they are not entitled to any deductions for farming losses.

The existence of a reasonable expectation of profit is not to be determined by the presence of subjective hopes or aspirations, no matter how genuine or deep- felt they may be. The issue is to be decided by objective testing. In Moldowan this is said at 5215:

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: The Queen v Matthews (1974), 28 DTC 6193. One would not expect a farmer who purchased a productive going operation to suffer the same start-up losses as the man who begins a tree farm on raw land.

If the answer is that the appellant’s farming undertaking was a business during the taxation period in dispute, the sequential question is whether he or she comes within the ambit of the first class of farmers which Mr Justice Dickson said is envisaged by the Act; that is, a taxpayer for whom farming may reasonably be expected to provide the bulk of income or the centre of work routine. Such a taxpayer, who looks to farming for his livelihood, is entitled to deduct the full amount of his expenses to the extent that, as provided by paragraph 18(l)(a) of the Act, they are incurred for the purpose of gaining or producing income from his farming business.

Where, as is the situation with respect to these appeals and many others, the appellant’s source of income is a combination of substantial income from both farming and other unrelated employment, this must be considered in deciding whether the appellant is in the first class: Is the unrelated employment, to use the language employed in Moldowan, “subsidiary” or “auxiliary” to farming? If it is found that the appellant’s “major preoccupation” was farming during the taxation years under review resulting in an affirmative answer to the question posed, the appellant is in the first class and is entitled to full deductions.

Dickson, J made these observations in relation to resolving the issue of “subsidiary” or “auxiliary”:

(1) The test is both relative and objective.

(2) A quantum measurement, ie, a comparison of income from farming with income from unrelated employment, is relevant but not alone decisive.

(3) What were the appellant’s:

(a) reasonable expectation of income from farming and unrelated employment, and

(b) ordinary mode and habit of work.

These he said may be tested by considering, inter alia, the:

(i) time spent on farming and unrelated employment,

(ii) capital committed, and

(iii) profitability, both actual and potential.

The reasons for judgment in Moldowan do not purport to include a definitive list of what may be relevant in determining whether a taxpayer was within the first class at the relevant time, nor does any other judicial pronouncement of which I am aware. In P E Graham v The Queen, [1983] CTC 370; 83 DTC 5399, a judgment of the Federal Court — Trial Division, these things are also specifically mentioned: gross income, net income and cash flow. Nevertheless the extent to which these various things can be taken into consideration in respect of a particular appeal will necessarily depend upon the evidence adduced at the hearing of the appeal.

If the conclusion is that the appellant is not in the first class, he or she will automatically fall within the second class of farmers characterized by Mr Justice Dickson because there has already been a finding that the appellant’s farming operation is a business. When this occurs the appeal should be allowed to the extent of permitting restricted losses. The second class constitutes (77 DTC at 5216): “the taxpayer who does not look to farming, or to farming and some subordinate source of income, for his livelihood but carried on farming as a sideline business.”

2. The full amount of farming losses is claimed, but the position of the respondent is that the appellant is only entitled to restricted losses. This is what obtains in respect of the appeals under consideration. As related in the opening paragraph of these reasons for judgment, this transpired leading up to these appeals. After full losses were claimed the respondent, on reassessment, only allowed restricted losses to which the appellants served notices of objection. The respondent then confirmed his reassessments. In the face of this, the only issue on these appeals is whether the appellants are in the first class. If the appellants are found to be in the first class, the appeals must be allowed. If not, the appeals shall be dismissed. This is because conduct by the respondent of the kind just described is tantamount to an express acceptance or admission in the proceed- ings that the farming venture conducted by the appellants was a business at the relevant time. Nothing, however, is to be attributed to the Minister of National Revenue on appeals to this Court involving deductions under subsection 31(1) of the Act by the mere fact that, in taxation years other than those under review in a particular appeal, full or restricted farming losses have been claimed by the appellant and allowed to pass unchallenged. Having regard to the immense volume of returns filed with the Minister of National Revenue pursuant to section 150 of the Act, it is notorious that each return is not and, as a practical matter, cannot be the subject of special investigation or audit.

3. Restricted deductions are claimed by the appellant, but no deductions are allowed by the respondent. For reasons already given, the only issue to be determined is whether the appellant’s farming undertaking was a business at the relevant time. If it is found to have been a business at that time, the appeal shall be allowed. Otherwise the appeal must be dismissed.

Finally, by way of general observation, it is noted that, if a person who gets involved in farming cannot initially be regarded as being engaged in a business, that can mutate by reason of changed circumstances. A taxpayer could change from hobby farmer to businessman farmer and directly into a position of being able to lawfully claim deductions for the full amount of his farming losses. On the other hand, he might only move into a position of being able to claim restricted deductions and then, possibly, later on, to full deductions. These shifts in the position of a taxpayer vis-a-vis farming losses will depend on changed relevant facts. The various movements in the direction of favouring deductions are, of course, reversible by reason of changed circumstances.

Now for the facts on which these appeals are founded. After some 21 years as a member of the RCM Police, Kerr retired in 1971 and took employment as a chief investigator into fraud with the Unemployment Insurance Commission (“UIC”). Forbes was also employed by the UIC as an investigator. While this employment was acknowledged to be secure, Kerr said it “did not reflect a life style we wished to pursue”. In the result, early in 1973, while continuing to be employed by the UIC, the appellants purchased a five acre property located on 8th Avenue, in Langley, British Columbia, with the resolute intention of becoming full-time farmers. There is no evidence that either Forbes or Kerr had any background in farming. In cross-examination Kerr said he was not raised on a farm. His father was in the logging business although he alluded to the fact that his grandparents were ranchers and farmers in the Kamloops area of British Columbia. Nothing was said about the circumstances under which Forbes was raised. In any event the appellants proceeded to develop the five acres for farming purposes with the expenditure of their labour and funds within the limits of the circumstances imposed upon them by their employment with UIC and their financial means. Kerr, and presumably Forbes, were required to commute to work in Vancouver when they took up residence in Langley. This would involve a round trip of some 120 or more kilometres. A barn was built on the property, fences erected and equipment, including a tractor, was purchased. During the first year the appellants bought four or five cattle, fed them over the winter and sold them at auction in 1974. In the latter part of 1975, eight cattle were purchased and chickens and ducks were added later. In the spring of 1976 one-half of these animals were sold at auction and the balance butchered and the meat sold. Subsequently in that year the appellants bought “30 plus cows and fed lot them over the winter”.

The testimony then reverted back to 1975 at which time the appellants purchased 33 acres of farmland in the Fort Langley area. It was intended that this property would be a source of feed for the animals kept on the five acres. The latter came to be regarded by the appellants as a feed-lot. The 33 acres, however, suffered from an over-abundance of water. It was intended to drain the land, but this was not undertaken because anticipated financing from a “Farm Board” was not to be forthcoming for at least two years and, in addition, it was the opinion of an expert who was consulted by Kerr that the property was not viable for farming and, in particular, for pasturing cattle “due to its wetness”. The property was placed on the market and sold within four or five months. Application was then made to a provincial Board which was concerned with the leasing of land for a lease of 35 acres which was also located in the Fort Langley area. This property was not afflicted by the problems related to the 33 acres. The appellants, however, had competitors who also wished to lease the 35 acres and it went to a competitor who operated a dairy farm on adjacent property.

In 1977 some important decisions were made and steps taken. The appellants decided to engage in that aspect of farming which is concerned with the breeding of thoroughbred race horses and to engage in horse racing. Forbes said that the latter is concomitant with the former. The breeding, raising, selling and racing of thoroughbred horses has, on more than one occasion, been recognized in decisions by members of the predecessor of this Court as being an undertaking involving high risk. I refer, by way of example, to Shiewitz v MNR, [1979] CTC 2291; 79 DTC 340, and Hall v MNR, [1983] CTC 2003; 83 DTC 8. The nature of the risk involved was implicitly acknowledged by the appellants in the course of their testimony. There was evidence about brood mares aborting without apparent reason, with consequent meaningful and unanticipated loss. Kerr spoke of paying a large sum for a race horse which, as matters developed, was woefully deficient in one of the most — if not the most — desirable characteristics in an animal of that kind, namely, speed. I mention this because it can be relevant in determining potential profitability as a test in respect of the appellants’ reasonable expectation of income from farming on the one hand and unrelated employment on the other. The reason given by Kerr for entering into this facet of farming was the expectation that supportive government subsidies would be paid. Such subsidies were in fact subsequently payable. In 1977 the appellants also agreed that Kerr would resign from his employment with the UIC and become engaged in selling real estate. Kerr said that the conception motivating this move was that once he had established himself as a real estate salesman to the point where “common expenses” could be met Forbes would also resign from her employment with UIC and also engage in the selling of real estate. This new occupation would allow more time to work on the farm as it would be practised relatively close by. Kerr resigned about mid-1977 and in a year’s time was quite well established as a real estate salesman. His earnings were equivalent to his income as a UIC investigator when allowance was made for the diminution in his expenses by reason of ceasing to commute to Vancouver. He concentrated on the sale of small farms and acreages.

The first thoroughbred brood mare was purchased in 1977 and then a year later two more brood mares were bought and the appellants became engaged in racing horses. Between 1978 and 1980 there were transactions involving the purchase and sale of six different horses. At the date of the hearing of the appeal the appellants had five horses in their inventory plus a share in a stallion imported from Kentucky. The five were said to consist of two extremely good bloodline brood mares, a young stallion who it is hoped will commence racing next April, a two-year-old filly which will also start racing, and a weanling filly. It was stressed in evidence that, in purchasing horses, the appellants placed emphasis on quality, not quantity. The last brood mare was purchased in 1980 at a cost of $25,000.

Forbes estimated the time spent on daily chores directly related to the care of the animals just referred to; ie, feeding, cleaning stalls, etc, to be: “probably during the winter — probably about four hours a day.” She did not agree with the suggestion by counsel for the respondent that the time involved would be considerably less in the summer. This disagreement was based on the ground that during the summer season young foals must be cared for.

In September 1978 Forbes resigned from her employment with the UIC and obtained a licence to sell real estate. She had previously held such a licence in 1970, but discontinued in this vocation after about six months. The licence was allowed to lapse. The testimony of both appellants was that Forbes was primarily preoccupied with farming and not real estate for the balance of 1978. Forbes testified that six months elapsed after she was licenced in September of 1978 before she received income from selling real estate. She concentrated on the sale of residential housing.

The five acre farm on 8th Avenue was sold at the end of 1978 and a “5 plus acres” parcel was purchased in its stead. It was also located in Langley. The construction which was undertaken on this land was designed to meet the requirements of a “horse farm”. Some of the land was cleared. It was completely fenced with wooden fencing and a barn was built. Kerr made application for and obtained what he described as “farm taxes”, which is understood to mean that he obtained a lower rate of taxation with respect to the land than would otherwise have applied. Entitlement to pay taxes of that nature involved an inspection by provincial authorities, tentative approval by them and final approval after a year when they were satisfied that he had done those things to the property which would qualify it for the lower rate of taxation. The same thing occurred in respect of a subsequent purchase of lands by the appellants which will be referred to in a moment. Kerr attached considerable importance to this and for that reason I observe that I do not regard it as meaningful. There was no evidence that the considerations applicable to determining the question whether “farm taxes” may be allowed in respect of real estate in Langley are the same as those which apply in determining the issues before this Court on these appeals. Even in the highly unlikely event that such an identity of considerations could be established, I would regard myself as being compelled to reject as authoritative guidance, the determinations made by the provincial assessors. To do otherwise would be to substitute their judgment for what I am required by law to decide.

In 1979 the second farm was sold and nine acres purchased in the nearby municipality of Surrey. In addition to the nine acres, there was access as required to some adjacent pasture. This pasture land was not leased. The arrangement regarding it was described by Kerr as ‘‘a loose sort of neighbour thing”. The general surroundings were described as a “horse farming area”. A “complete brood mare operation” was established on the nine acres. Again comprehensive wooden fencing was constructed together with a large barn and sheds.

Turning now to the financial picture, a table (“the table”) was produced by counsel for the respondent pertaining to the years 1974 to 1980 inclusive. It depicts the income of each of the appellants during that period. In addition it includes gross farm income, net farm income and related figures such as capital cost allowances. It was examined by the appellants and, subject to one error, it was acknowledged to be accurate. The error was that the table shows Forbes as having an income from the sale of real estate in 1978 of $9,407.20, while in fact that amount was totally attributable to income from her employment in that year with the UIC. Kerr’s income as an employee of UIC during 1974, 1975 and 1976 was $16,127.07, $17,140.36 and $17,873.30 respectively. In 1977, the year in which he resigned as an employee of UIC, his income from the sale of real estate was $5,351.03 and his income from UIC was $8,315.77. In 1978 his employment income was exclusively related to real estate sales and there was a very sharp increase to $44,867. In 1979 and 1980 his income from selling real estate was $50,847.31 and $74,341 respectively. Forbes was described by Kerr as being more conversant than he with the books and accounting. Her evidence included facts relating to Kerr’s income from the sale of real estate beyond the 1980 termination year of the chart. This evidence was that in 1981, his income declined steeply to $38,000 and in 1982 plunged to $3,300. In cross-examination Kerr attributed this in part to the decline in the economy and the remainder to an increased allocation of his time to the farm. The chart shows the income of Forbes as an employee of the UIC during 1974, 1975, 1976, 1977 and 1978 to have been $12,826.08, $14,182.71, $16,275.84, $17,673.36 and $9,407.20 respectively. In 1979 she earned income from the sale of real estate in the amountof $10,809.63 and this increased significantly to $31,498 in 1980. No figures were given for 1981, but Forbes earned $11,900 in 1982. Forbes estimated that she currently devotes 85 per cent of her time to the farm and about 15 per cent to the sale of real estate. The figures given for income from real estate sales for both Kerr and Forbes are net. For example, Forbes incurred expenses of $2,495.82 to earn $10,809.63 in 1979, and expenses of $8,136 to earn $31,498 in 1980. Kerr incurred expenses of $20,450 to earn $74,341 in 1980. Forbes said her expenses were primarily automotive. Kerr made special mention of entertainment. Forbes testified that 1979 and 1980 were banner years for those engaged in the sale of real estate in the area in which she and Kerr functioned and went on to say that, while this source of income was high in those years, that did not reflect that a disproportionate amount of time was being spent on the sale of real estate. Kerr described 1980 as a “good real estate year”. The chart shows gross income from farming for the years from 1974 to 1980 to have been: “$2,734.75, $2,236.85, $7,180.79, $24,835.79, $26,326.12, $13,226.40 and $18,087” respectively. These figures include a factor for the personal use of the residence on the farms. For example, in 1974 it was $1,600 and in 1978, $4,800. These farming losses were incurred in each of the years 1974 to 1980: “$(2,778.50), $(26,735.02), $(15,139.12), $(12,549.12), $(20,453.22), $(28,410.23) and $(52,319)” respectively. The figures for farming losses in 1981 and 1982 were not given in evidence. On the other hand Forbes said that in 1981 gross income from the farm was $49,000 as compared to Kerr’s income of $38,000 from real estate sales, and in 1982 the combined income of Kerr ($3,300) and Forbes ($11,900) from the sale of real estate was less than the gross farm income which was $22,000. With respect to these losses I mention that while the appellants did not employ outside help to do the ordinary work of the farm, they found it necessary to pay trainers to train the horses at the race track. These expenses were considerable. Forbes said: “In some years they’ve (trainer’s expenses) been, I think as high as what, $17,000? I don’t know. $15,000 anyway.” The appellants intend to deal with this by commencing to train their horses themselves “very shortly”.

There was already testimony that after the farming operation was commenced in 1973 all of the appellants’ financial resources, except what was required for “basic necessities”, were committed to the farming operation. When Forbes was asked by Mr Mah why she secured a licence in 1978 to sell real estate instead of devoting her full time to farming, this exchange took place:

A. Because I — because I had no money in my bank account. Why else?

Q. Well, basically, you need the money to keep the farm going?

A. Exactly, exactly.

As for 1982 and 1983, Forbes said:

Our real estate income has decreased greatly in the last two years, primarily because our farm has taken up more and more of our time, and it looks like maybe — maybe this year or maybe next year, we actually will be able to live on the money we make from our farm. But that’s still maybe, which is the case in most farming operations.

Later she added:

This year is probably not going to be a good year. We didn’t make much money in real estate. We also are not going to have a good year on the farm, and in fact, we’ve had to remortgage our farm, just to keep things afloat.

The foregoing constitutes a detailed resumé of the evidence adduced at the hearing of these appeals.

The appellants stressed, and I accept it as a fact, that when they purchased the five acres in Langley back in 1973, it was their bona fide intention to become full-time farmers although, as indicated, there was no evidence that either of them had any significant background in farming. They expended time and wealth in pursuit of that goal and, in my view, they must have applied themselves assiduously to the acquisition of the requisite knowledge in that regard. Kerr concentrated with success on selling farms and small acreages. I expect that engaging successfully in selling farms must necessarily involve having a good working knowledge of farming. Forbes testified at some length regarding the breeding and racing of thoroughbreds. I have no difficulty in concluding that, during the early stages of the farming undertaking, the appellants were not persons within the first class. They were both employees of the UIC and this, combined with other factors such as the nature and scope of the operation plus the financial realities, rules them out of the first class at that time. While it is not impossible for a person to fall within the first class even if he has other employment which is usually regarded as “full-time” it would, in my view, require a truly unusual set of facts of the kind described in Graham v The Queen, (supra), to arrive at that result.

What must be decided therefore is whether, prior to their 1977 taxation year, the appellants had crossed the line into the first class and remained there during that year and the subsequent year. As mentioned at the outset, only 1977 and 1978 are involved in these appeals. It is, nevertheless, permissible to look beyond those years because what happened then may well shed objective light on the appellants’ true condition respecting their farming venture in the years under review. In Graham, (supra), the taxation years in question were 1977, 1978 and 1979. Mr Justice Cattanach received and considered post-1979 evidence. In that regard he said at 5403:

I fully appreciate that some of this evidence is subsequent to the taxation years in question but that evidence is properly admissible as illustrative and confirmatory of the plaintiffs course of conduct and intention in those antecedent years.

As disclosed by the evidence, at the beginning of 1977 both appellants were employees of the UIC. Kerr remained in that capacity until about the middle of that year when he resigned and became engaged in selling real estate. The UIC employment involved commuting a considerable distance. As exhibited in the information forwarded to this Court pursuant to subsection 170(2) of the Act, Kerr’s gross income in 1977 from the sale of real estate was $9,408.31 with claimed expenses in that regard of $4,057.28 resulting in a net of $5,351.03. The largest item of expense related to “1 of 2 autos — used 100% for business” and amounts to $2,831.22. The next largest item is $791.42 for “entertaining and promotion”. Forbes remained with the UIC throughout 1977. When what preceded 1977 and what followed 1978 is carefully considered, I believe one is driven to the conclusion that in these two years the appellants were not in the first class. While, as Dickson, J pointed out in Mo Ido wan a quantum measurement of farming income is not in itself decisive, it is nevertheless relevant. The figures prior to and including 1977 and 1978 in respect of employment either with UIC or in the sale of real estate when compared with the financial results from the farming operation draws away from the first class. This is also true of the 1979 and 1980 figures. While it is true that in 1981 Kerr’s income from the sale of real estate is eclipsed for the first time by gross farm income, and in 1982 gross farm income surpasses the income of both appellants from the sale of real estate, they still have not turned the financial corner in respect of their farming operations by 1983, which is over four years after the 1978 taxation year and a decade after the commencement of the farming venture. To this I add that the value of a comparison of gross farm income with net income from the sale of real estate may be regarded as questionable.

These appeals have been considered from the perspective of whether, even though the conclusion is that the appellants were not in the first class in 1977, could they be regarded as being there in 1978? While by September of 1978 Forbes had also resigned from her employment with the UIC and the appellants are moving in the direction of greater concentration of time and effort to their farming enterprise, I do not believe the circumstances had changed to a sufficient degree in 1978 to place them in the first class in that taxation year.

With respect to the appellants’ investing all of their available resources in the farming operations, it is I believe clear from the evidence that this was necessary to keep the enterprise from going under financially. While I am not suggesting that funding a farming operation with revenue derived from outside employment is something that per se excludes a taxpayer from the first class — especially when start-up costs are involved — it is something that can point away from the first class when that funding is relatively substantial and of long duration. I have already quoted from the evidence of Forbes concerning the recent necessity of remortgaging the farm to keep the farming operation afloat financially.

My conclusion is that the appellants are not entitled to full farming losses in respect of their 1977 and 1978 taxation years and that the respondent was correct in reassessing them to confine their deductions to the restricted farm losses prescribed by subsection 31(1) of the Act. Nothing in these reasons is to be construed as expressing an opinion regarding whether the appellants came within the first class after 1978. This is not before me on these appeals and the relevance of the post-1978 evidence and comments thereon is limited as previously indicated.

The appeals are dismissed.

Appeals dismissed.