Josef Mairleitner v. Minister of National Revenue, [1984] CTC 2472, 84 DTC 1426

Tremblay, TCJ:—This case was heard on June 9, 1983 at the city of London, Ontario.

1. The Point at Issue

The point at issue is whether the appellant is correct in not including in his income the amounts of $10,610.81, $21,883.69 and $36,904.78 for the 1977, 1978 and 1979 taxation years, and in deducting business farm losses.

The respondent reassessed the appellant on a net worth basis. The net increase during the said year was $73,500 and the declared income in the appellant’s return was $25,000. Moreover, the respondent considers that there was no reasonable expectation of profit in the appellant’s farming activities; that’s why he disallowed the farming losses in the amount of $27,500 during the said years.

The appellant’s contention is that he devoted all of his time and attention to his farming activities (raising and training of horses), and hence he was a full- time farmer.

Moreover, according to him the net worth assessment failed to take into account the actual cash on hand and significant assets he owned at the beginning of the period, namely at the end of the 1976 taxation year.

2. The Burden of Proof

2.01 The burden is on the appellant to show that the respondent’s assessments are incorrect. This burden of proof results particularly from several judicial decisions, including the judgment delivered by the Supreme Court of Canada in Johnston v MNR, [1948] CTC 195; 3 DTC 1182.

2.02 In the same judgment, the Court decided that the assumed facts on which the respondent based his assessments or reassessments are also deemed to be correct. In the present case, the assumed facts are described in the reply to notice of appeal as follows:

12. In so reassessing the Appellant for the 1977, 1978 and 1979 taxation years, the Respondent made the following assumptions:

(a) the Appellant incurred expenses in the taxation years 1977 to 1979 inclusive in excess of income from sources reported by him;

(b) the Appellant’s net worth increased during the 1977, 1978 and 1979 taxation years by the following amounts: $18,208.10, $9,792.35, and $45,675.03 respectively;

(c) the Appellant had personal expenditures in the 1977, 1978 and 1979 taxation years in the following amounts: $15,237.05, $14,631.25 and $17,204.92 respectively;

(d) the Appellant’s apparent income in the 1977, 1978 and 1979 taxation years was reduced in those years by adjustments of $22,834.34, $2,540.00 and $25,975.17 respectively;

(e) the Appellant gained income from a business or businesses in the 1977, 1978 and 1979 taxation years in the amount of $10,610.81, $21,883.59 and $36,904.78, respectively;

(f) the Appellant, during the 1977 through 1979 taxation years bred and raced

horses, in respect of which operations no reasonable expectation of profit existed.

3. The Facts

3.01 In his testimony the Appellant, 50 years of age, testified that:

(a) he was born in 1933 in Austria and was brought up on a farm where his father raised horses;

(b) in 1957, he immigrated to Canada with $2,000 in his pocket;

(c) from 1957 to 1969, he worked on a farm in Ontario to feed horses; he then earned $400 per month;

(d) in 1961, he got married; his wife inherited $15,000; he bought a farm in Granby, Quebec; the next year his wife bought the farm next door; they also rented a third farm located a few miles from the others; they invested $22,000 ($15,000 from his wife and $7,000 from his own); they had two horses and milking cows; they carried on the business of dairy, beef farming and raising and breeding horses;

(e) in 1970, the two farms were sold for $35,000; the family (the appellant, his wife and three boys born from the marriage, they were 16, 14 and 13 years old in 1983) moved to Ontario; they lived eight months on a farm where the appellant worked; he became partner with a Charly Watson who owned six farms; the appellant made a down payment of $30,000;

(f) the family also lived another 8 months at Rockwood, located three miles northwest of Guelph; he then bought four horses for $12,000; those horses raced in the prairies: Saskatoon, Calgary, Regina and Edmonton; the racing expenses were greater than any of the income or any of the purses.

3.02 In the latter part of 1972 or early part of 1973, the appellant purchased a one-half interest in a variety store and gas bar for $2,500. It was named J & C Variety Store. In fact, altogether he invested $7,000 including the improvements. The appellant’s partner in the business was his cousin, Mrs Weyerman. She was primarily responsible for the day-to-day business up to the time of sale in 1979. The appellant did not devote a significant amount of time to the business, although he assisted his partner from time to time when he was able to. He went there about one hour for the opening in the morning and 30 minutes at the closing, 10 o’clock at night. For the years involved, the net profits were $18,795 in 1977, $29,258 in 1978 and $26,135 in 1979. The appellant’s share was 50 per cent of those. It’s obvious that in the computation of the net profit capital cost allowance was taken into account. The appellant’s portion of the gain on sale in 1979 was $24,861.17.

3.03 In late 1972, he bought a house at Newbury, Ontario. He lived there two years and rented it after. He paid $10,000 for it and spent $1,000 for improvements. In 1977, he sold it for $28,900. Pursuant to Schedule IV which is part of the statement and adjustment of the comparative net worth, (Exhibit A-5), on which is based the reassessment, it appears that the gain was $16,890.34. ($28,900 less $12,009.66: $10,000 cost and $2,009.66 legal fees and commissions). The net deposit was $23,821.77 ($28,900 less $3,068.57 mortgage and $2,009.66 commission and fees).

3.04 In late 1975, he bought a farm located three miles north of Glenco. He purchased it for $64,500 and gave $20,000 in cash. He then had 4 or 5 horses. He also purchased machinery and tractors. In 1981, he sold that farm for $69,000.

3.05 From 1972 to 1976, he raced his horses in Canada and the United States. In 1976, with twelve other Canadians, for discriminating reasons, he was suspended in the United States. He then stopped racing until the summer of 1980. During all the time the horses were racing, the purses never covered the expenses.

3.06 During all that period from 1972 to 1976, the appellant in the process of carefully purchasing, breeding and training his horses, had gradually been able to acquire a number of horses which had a great deal of potential of becoming outstanding racing horses. The appellant, in the past, has also owned and trained many horses which have become winners.

3.07 In order to further his business, the appellant has devoted an extensive period of time to researching the genealogical backgrounds of the various horses which he planned to use for breeding purposes. The appellant has implemented this research information and has produced, through breeding, racing horses with superior abilities. This was especially true from the fall of 1976 to 1980, when the appellant had retired from the racing circuits with the intention of breeding his horses. He engaged in that breeding. However, due to ignorance of a veterinary surgeon, he gave a non-appropriate medication to the mare. It was called Anadol. They were hormones which were good for racing purposes but not for breeding purposes. The result was that this steroid prevented the appellant’s mares from giving foals for the years 1977 to 1979. The appellant indicated that it was the experience of the racing community, that the horses that had had the steroid had to get the steroid out of their system and that took a two to three year period to happen. It seems that this was the real cause of the problem.

In the 1977 to 1979 period, the appellant had 10 to 15 horses. In late 1979, Tar Queen (a very good racing mare which was injured and that no one else than the appellant was interested in purchasing) had her first colt; she has had two other colts since then. In 1982, $50,000 was offered for a two-year old horse, a descendant of Tar Queen.

3.08 Since 1972, the appellant has never been employed.

3.09 The appellant has rarely used a bank for his farming business. He has purchased and sold farms and farming assets throughout the years and has generally carried on business in cash, which he has retained in his home in a safe, or on his person. He opened a bank account especially to pay mortgages.

He had no accounting system. He had no documentation to substantiate the transactions and the amounts received.

3.10 The appellant filed as Exhibit A-6, a document signed by Mr William Bustard to the effect that he paid to the appellant $1,500 for a gold watch. The appellant said he had received it from his father.

3.11 The second witness for the appellant was Mr Donald Green, chartered accountant, who in April 1979 became the appellant’s accountant to prepare the financial statements using the information from the net worth assessment prepared by the respondent and the income tax returns. The appellant had no accounting system. Mr Green filed as Exhibit A-7 a statement of revenue and expenses for the years 1977 to 1982.

It appears from this document the following gross income and the net income or losses:

(Loss)

Gross Income			Net Income
1977	$ 1,300.00		($ 4,461.04)
1978		nil	($12,218.50)
1979	$ 585.20		($14,476.69)
1980	$	839.20	($ 9,862.19)
1981	$16,799.80		$ 1,027.09
1982	$38,000.00		$ 3,710.09

In the computation on his net income for the years 1981 and 1982, he took into account the purchase of horses for $6,650 and $24,500 respectively. The gross income came from one or more of the following items: horses, sheep, beans, oil lease, oats. No salary was paid during these years except for $100 in 1979.

3.12 Mr Green also filed as Exhibit A-8 the statement of “Sources and Uses of Cash”. It was worked back from 1979 to 1977. Pursuant to that document, it appears that at the beginning of the year 1977, the appellant had in cash $ 11,308.

Mr Green admitted in cross-examination by working back from 1979 to 1977, he made the assumption that the excess of expenses paid for in those years over apparent sources of income, was from prior savings.

3.13 Pursuant to Exhibit A-5 which is the basis of the reassessments, the respondent contends that at the beginning of the period, ie January 1, 1977, the cash of the appellant was $2,500 plus a total of $156.62 in two bank accounts. From the same document, the living and personal expenditures for the family amounted to $15,237 in 1977, $14,631 in 1978 and $17,204.92 in 1979.

3.14 For the years under appeal, the appellant claimed the following losses in respect of breeding activities: $3,005.52 in 1977, $10,261 in 1978 and $14,476.69 in 1979.

4. Law — Cases at Law — Analysis

4.01 Law

The main provisions of the Income Tax Act involved in the instant case are 3, 9, 18(l)(a) and (h), 31(1), 152(7) and the definition of “personal and living expenses” in 248(1). They shall be quoted in the Analysis if required.

4.02 Cases at Law

The following cases at law were referred to by both counsel:

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

2. Leslie v MNR, [1982] CTC 2233; 82 DTC 1216;

3. Klie v MNR, [1981] CTC 154; 81 DTC 5061.

4.03. Analysis

4.03.1 The crux of the matter concerns two points: (a) the cash at the beginning of the period and (b) whether the appellant’s farming operation had a reasonable expectation of profit.

A — The Cash at the Beginning of the Period

4.03.2 The cash at the beginning of the period, January 1, 1977, according to the respondent is $2,656.62 and according to the appellant is $11,308 (para 3.12).

The evidence is to the effect that since 1972, the appellant has never been employed. Pursuant to the evidence the only important amount he received was in 1970 when he sold the two farms in Québec for $35,000. He then moved to Ontario where he disbursed $30,000 to become partner in a farm with one Charly Watson.

The evidence does not state that if later he sold this partnership or for what amount (para 3.01(e)). The Court knows, however, that probably in late 1971, he again disbursed $12,000 to buy four horses (para 3.01(b)) and in late 1972 or early part of 1973, he spent $7,000 to buy interest in a variety store and to make improvements in the buildings (para 3.02). The Court also knows that in 1972 he paid $10,000 to purchase a house at Newbury (para 3.03). In late 1975, he bought a farm and gave disbursement of $20,000. All those amounts totalled $79,000 ($30,000 + $12,000 + $7,000 + $10,000 + $20,000). However, no evidence of income during the years from 1970 to the end of 1976 was adduced. On the contrary, the appellant said that the purses never covered the expenses for the travellings and feed of the horses. He probably made income from the variety stores from 1972 to 1977. Moreover, they were six persons in the family. Certainly, they also had expenses. The profit on the sale of the properties occurred in 1976 pursuant to the evidence.

The Court is convinced that the appellant had other income from 1971 to the end of 1976, but the Court has no knowledge of that. Maybe the appellant forgot some evidence, or on certain aspects was neither interested in revealing it, nor in revealing the contents of the safe he had at home.

Nevertheless, the Court cannot see with the evidence adduced why another amount would be added at the beginning of the period. The Court is even surprised that he then had $2,500. The assumption of the accountant that the amount of $11,300 came from prior 1977 is a “pious” assumption not in conformity with the evidence (para 3.12).

4.03.3 It is true, however, that the appellant sold a gold watch and a chain in 1978 for $1,500. Even if this cannot affect the cash at the beginning this, however, affects the revenue for that year, and it must be taken in consideration accordingly.

B — Reasonable Expectation of Profit

4.03.4 Concerning the reasonable expectation for the years involved, it was explained that the main problem concerning the lack of profits was Anadol a non-appropriate medication for breeding horses. It was the experience of the racing community indeed that it takes two to three years to let the steroid out of the system of a horse that had taken Anadol for racing (para 3.07).

With such a fact, it is understandable that objectively it was not possible to financially succeed during the 1977 to 1979 period. Can it be said that objectively in that period there was no reasonable expectation of profit? It seems not at first glance. However, it is important to check at least with the main case at base concerning farming operation. I mean the Moldowan case.

In this case Mr Justice Dickson said:

In my opinion, the Income Tax Act as a whole envisages three classes of farmers:

(1) 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 free of the limitation of s 13(1) in those years in which he sustains a farming loss.

(2) 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. Such a taxpayer is entitled to the deductions spelled out in s 13(1) in respect of farming losses.

(3) the taxpayer who does not look to farming, or to farming and some subordinate source of income, for his livelihood and who carried on some farming activities as a hobby. The losses sustained by such a taxpayer on his non-business farming are not deductible in any amount.

The reference in s 13(1) to a taxpayer whose source of income is a combination of farming and some other source of income is a reference to class (1). It contemplates a man whose major preoccupation is farming, but it recognizes that such a man may have other pecuniary interests as well, such as income from investments, or income from a sideline employment or business.

It appears from this definition and from the evidence that the centre of the work routine of the appellant during the 1977 to 1979 period was his farming operation. For his sideline business J C Variety Store indeed, he devoted only 1/2 hours each day (para 3.02). He had 10 to 15 horses on the farm (para 3.07). He was not paid and received no salary or wages except $100 in 1979 (para 3.10 in fine). He had no employment elsewhere (para 3.08). All this confirms his testimony that he spent the major part of his time on the farm. Moreover, the Court must take into account that in 1981 and 1982 he really made some profits. Therefore, the conclusion is that the appellant must be considered in class I and the losses must be taken into account in the computation of the income. The quantum of the losses not being disputed, the whole amounts are allowed.

5. Conclusion

The appeal is allowed in part and the matter referred back to the respondent for reassessment in accordance with the above reasons for judgment.

Appeal allowed in part.