Charles H Roney v. Minister of National Revenue, [1984] CTC 2701, 84 DTC 1431

Tremblay, TCJ:—This case was heard on June 22, 1983, at the city of Ottawa, Ontario.

1. The Point at Issue

The point at issue is whether the appellant is correct in deducting the amount of $73,238 for farming losses in the computation of his income for the 1975 taxation year. In the said year the appellant, the main shareholder of Universal Investigation Services Ltd, of Universal Alarm and of Universal Fire Security Services, earned a net income of over $220,000. Since 1968, the appellant made several purchases of farm properties and operated his farm as a beef cattle operation specializing in the Charolais and the Simmental breeds.

The respondent’s contention is that the appellant’s chief source of income for 1975 is neither farming nor a combination of farming and some other source of income. Therefore, $5,000 is the only amount that must be deducted as farming losses pursuant to section 31 of the Income Tax Act.

2. The Burden of Proof

2.01 The burden of proof is on the appellant to show that the respondent’s assessment is 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 assessment or reassessment are also deemed to be correct. In the present case, the assumed facts are described in the amended reply to notice of appeal as follows (however, the Court indicates in brackets the facts that were admitted or not by counsel for the appellant):

2. In assessing the Appellant, the Minister of National Revenue made the following assumptions of fact, inter alia:

(a) the Appellant was at all material times the President of Universal Investigation Service Ltd (“Universal”); (admitted by the appellant)

(b) the Appellant started Universal and built it up himself; (admitted)

(c) the Appellant’s chief source of income at all material times was that derived as an employee of Universal; (not admitted)

(d) the Appellant made several purchases of farm properties, in each of his 1968, 1970, 1972 and 1973 taxation years; (admitted)

(e) the Appellant and his wife maintain a personal residence on the farm property purchased in his 1970 taxation year; (admitted)

(f) the Appellant operated his farm since its inception in 1968 as a beef cattle operation specializing in the Charolais and Simmental breeds; (admitted)

(g) the Appellant employed a manager to oversee the farming operations who lived on one of the farm properties (admitted)

(h) the farming business operated by the Appellant had not earned a profit prior to and including the Appellant’s 1975 taxation year; (not admitted)

(i) the Appellant’s inventory of cattle reached a peak of 83 at the end of his 1973

taxation year, but was reduced to 44 at the end of his 1976 taxation year; (admitted)

(j) the Appellant maintains horses on his farm for his personal use; (not admitted)

(k) the Appellant’s farming operations constituted a sideline business; (not admitted)

2A. He further states that: (all the facts from paragraphs (a) to (g) are admitted)

(a) during the 1972 to 1980 taxation years, the Appellant reported the following net employment earnings, other income apart from farm losses, gross farm revenue and farm losses:

(b) the financial statements for the farm were as set out in Annexes “A” to “H” hereto;

(c) Universal Investigation Service Ltd (“Universal”) was established in 1946 and is one of Ottawa’s largest and most experienced security services;

(d) Universal presently provides the following services:

(1) Security Guards

(2) Radio-Equipped Patrol Cars

(3) Surveillance Work

(4) Shoplifting Protection

(5) Theft, Fraud and Criminal Investigation

(6) Character Reports

(7) Commercial Investigations

(8) Polygraph (Lie Detector) Examinations

(9) Pre-Trial Investigations

(e) Universal Alarm currently provides underwriter approved “AA” central station and local alarm services for:

(1) Burglary

(2) Fire

(3) Sprinklers

(4) Heating and Refrigeration

(5) Pressure

as well as:

(6) Guard Response

(7) Watchman Tours

(8) Surveillance Cameras

(9) Closed Circuit Television, all with 24-hour maintenance and a multiplex computer alarm service;

(f) Universal, Universal Alarms and Universal Fire Security Services from the Universal Group of Companies and all have their offices at 44 Byward Market, Ottawa, Ontario;

(g) in the alternative, and notwithstanding the Respondent’s assumptions, the Appellant

had no reasonable expectation of a profit from his farm operation.

3. The Facts

3.01 Admissions

As indicated above (para 2.02), counsel for the appellant made many admissions. Counsel for the respondent also made some admissions of fact described in the amended notice of appeal. Therefore, the “Statement of Facts” of the said amended reply notice of appeal reads as follows with indication of admissions by the Respondent:

A. Statement of Facts

1. The Appellant, pursuant to his intention to carry on a cattle breeding business on a full time basis, purchased farm properties in each of his 1968, 1970, 1972 and 1973 taxation years totalling some seven hundred acres.

2. In order to efficiently operate a cattle breeding business the Appellant engaged the services of a farm manager, who lived on the farm, and a herdsman but also devoted his own time and attention thereto on a daily basis as well as attending various seminars and shows.

3. The Appellant committed capital of $486,223 for land, buildings and equipment, being $127,956 for land, $322,984 for buildings, $33,847 for machinery and equipment, and $1,436 for a well and purchased cattle for $55,151, which cattle had a market value of approximately $141,400, with the full expectation that his cattle breeding business would generate substantial profits.

4. The Appellant intended to dispose of his interest in Universal Investigation Service Ltd and to devote his full time to the cattle raising business once he had built it up to a sufficient financial stature. The Appellant did not consider cattle raising as a sideline business and he fully expected, when first assembling the land in 1968 and subsequent years, that his income from that source would be very substantial indeed and that it would be his sole occupation in future years.

3.02 The first witness for the appellant, Mr Thomas Beveridge, testified in chief examination that:

(a) he is a member of the Chartered Accountants Association and a member of the firm of accountants, Thorne, Riddell & Co;

(b) for the period in question, they prepared the annual statement with the books maintained by the appellant’s wife concerning the Tighclach Farms (SN p 6);

(c) in 1977, he had many discussions with the respondent’s employee and even wrote a letter to the assessor, Mr Barabash to attempt to allay the Department’s concerns that there was no reasonable expectation of profit; he then referred to catalogues showing the market value of cattle was considerably in excess of the appellant’s cost;

(d) this position, not having been accepted by the respondent, then the appellant hired the services of a Mr Baird, a professional agriculturist, who was involved in an operation called Dwyer Hill Farms and previously with Hy- Cross Beef Breeders (SN p 8);

(e) based on this report: “It meant essentially, if selling had been done on a timely basis, there would have been profits”. (SN p 11 and 12);

(f) if in 1975, the inventory had been adjusted to its fair market value there would have been “a nominal loss, and if the same thing had been done in 1974 there would have been approximately $100,000 profit”; the cost value was indeed $55,000 and the fair market value was $141,000 (SN p 13 and 14).

3.03 In cross-examination, Mr Beveridge testified that:

(a) his accounting firm had other clients who were engaged in the same type of operation as the appellant; the clients were making profits; indeed, this involved importing so-called exotic cattle from Europe; however, the most important difference was in the timing;

(b) the nominal loss in 1975 was based on the appellant’s market value figures and on the Baird’s report figures (Exhibit A-l, SN p 15 and 16); in 1974, the correction is that the income would have increased by $90,000 and then the profit would have been around $45,000. For that, however, the condition was that the entire herd be sold in 1974 rather than 1975. Hence, there would not be anything to sell in 1975.

3.04 In his direct examination, Mr Douglas Baird, the second witness for the appellant testified that:

(a) he is a farmer and graduated in 1950 from the Faculty of Agriculture, University of British Columbia;

(b) he then worked for the federal Department of Agriculture in the Livestock Division in Saskatchewan and Ontario; he eventually moved to Ottawa “to head up the Livestock Division” (SN p 19);

(c) in 1970, he left the government service to go into the breeding and importing of cattle from Europe, the Simmental and Charolais breeds; he maintained the business up until he sold it in 1976 or 1977; it was a “buoyant cattle market” and “a buoyant economy”; indeed the cattle from Europe was commanding a high price in Canada and in the United States; it was a great opportunity for a rapid increase in capital improvements (SN p 19);

(d) they were imported through a very severe and lengthy quarantine program; therefore, it was hard to get them: “You were a year after you had bought them or almost a year before you saw your animals arrive in Canada. The US has no such program and their cattle industry is about ten times that of Canada, so there was a terrific demand”; some people made very big money (SN p 19 and 20);

(e) when his services were engaged by Thorne Riddell in 1977, he went to the appellant’s farm, and in his hands he had the accounting and breeding records from 1969 purchases through 1975; it was a good and an adequate farm: “The raising of beef cattle is something that can be in very posh surroundings or it can be in very simple and his were simple and adequate” (SN p 21); the appellant had four farms;

(f) the original purchases from 1969 were very well-priced:

A. And the biggest fault I could see was the fact that the breeding efficiency of the animals was not commensurate with what you would need to say that you had a first class breeding operation. By breeding efficiency, I mean the calving interval.

Q. Yes?

A. You see, I think you must keep in mind when you are in the beef business, that it takes three years before you begin to realize anything. You get an animal, you import — well, it is four years really on import animals — it takes a year to import it, you breed it when you get it here and it is another year before it has a calf and another year before you have a merchandizable product.

Q. And was Mr Roney, then, in part of this start-up procedure?

A. Yes, I would say it was very much a development procedure that he was in.

(g) there was a change in 1975; there was a “severe drop in the cattle market, particularly for breeding animals, exotic animals’’; the cause, indeed, was the lower commercial cattle prices in the United States mainly; his own company went “from a profit of over $125,000 down to a loss of $25,000 between ’74 and ’75”. (SN p 22 and 23);

(h) for the end of the report concerning the appellant’s operation, he took the actual figures that his own company Hy-Cross Beef Breeders “received from their sales throughout two years” and then applied these or extrapolated them to Mr Roney’s full-blood operation”. (SN p 23);

Just looking at this first page, you can see that the purchased animal that would have cost him approximately $4,000 to come into Canada, he could have sold for $20,000 the day it got off the train, and using that $20,000 value and the average value of calves sold out of our herd during those years, and projecting that from 1973 through to 1978, you come up with a value of $78,000 for that animal and its offspring during that period.

Then the offspring, some of the older offspring would be producing offspring by that time and the total there came to $37,500. So, over the matter of 1972 through 1978 that $4,000 investment would have realized a gross of $115,500.

Q. Yes?

A. So that is what I base my conclusion upon. (SN p 23 and 24).

3.05 In cross-examination, Mr Baird testified that:

(a) the boom in the importing of exotic cattle began in 1965 for the Charolais cattle and in 1967 for the Simmental cattle; they peaked in the early seventies (SN p 24);

(b) one of the reasons why in 1975 the market went down was that the “semen was shipped into the United States in volume, so at that time they were starting to develop their own nucleus — fullblood animals”; so actually instead of importing the cattle they were importing the semen for them (SN p 25);

(c) it is in the nature of cattle markets that it runs in cycles, up and down;

(d) he sold the control of his interest in the breeding business in 1976 partially because of what had happened to the market and partially because he had had heart surgery (SN p 25 and 26);

(e) in the computation, the $4,000 investment would have realized a gross of $115,500 (para 3.04(h)), however, it was not taken into account all the expenses in keeping, the cattle, the expenses for quarantining the cattle, etc. (SN p 26 and 27);

(f) pursuant to Exhibit A-1, the appellant had a total of 9 pure Simmental, 25 Charolais and 16 Herefords;

(g) on his own farm, the full-blood situation started from the first import of five animals and ended up with about 45: In the percentage animals, which are those bred from purebred semen and commercial cows, we had about 400 at one time”. (SN p 30);

(h) in his peak year, the profit in 1974 was $135,000.

3.06 The appellant in his direct evidence testified that:

(a) he is an executive and he bought his first piece of land in 1968 in the township of Huntley, Ontario, which is now South Carleton; it was 100 acres; in 1970, he bought a second 100-acre piece of land located one mile and one half from the first one; he moved to live on it;

(b) the farm manager was living on the first property; he required a herdsman and accommodation for him, so he bought a third property of 400 acres, containing a house and outbuildings; it was located across the road from the second one;

(c) he then moved the herdsman onto property number one and the manager onto property number three;

(d) in 1973, he purchased a fourth farm for pasturing purposes; there was only one building on it and a barn; the area was 11 acres; he filed nine photographs of the farm number one (Exhibit A-2), eleven photographs of the farm number two (Exhibit A-3), thirteen photographs of the farm number three (Exhibit A-4), two photographs of the farm number four (Exhibit A-5) and one photograph showing cattle in the lounging barns (SN p 35 to 38);

(f) his information was then he could possibly make $150,000 to $250,000 a year in such an operation; people were making that kind of money; his intent was not that the farming business be a sort of sideline: “I operated it as a business as I do my other business” (SN p 39);

(g) it was difficult to obtain a permit to get cattle into Canada; there were limited number of import permits issued every year: 15 to 20 permits out of 300 to 400 applications (SN p 39 and 40);

(h) in 1974, he submitted a project proposal to the Department of Agriculture requesting permits to import Simmental cattle (Exhibit A-7);

(i) in 1971, he had also submitted a project proposal to the same Department requesting permits to import Hereford and Charolais (Exhibit A-8); he did not get the permit;

(j) he invested $486,223 on the four farms:

(k) the second property, bought for $45,000 in 1970 was worth between $65,000 to $70,000 in 1975 (SN p 42);

(l) he was assisted by his wife who kept the farm books and the breeding plans and records (SN p 42);

(m) he spent Wednesday of every week on the properties checking fences and discussing the health of the cattle in general with the farm manager; he devoted around 12 to 15 hours a week to the farm operation; moreover, he went to the cattle sales and attended various seminars in the west mostly in Calgary;

(n) in starting to assemble the farming operation, his intention was in view of retirement:

A. I started my business career as a seventeen-year-old and by 1969 I had had several years of office and administrative work and I was planning towards having an operation that would give me a better than average income on my retirement, which I had planned for about now.

As a matter of fact that plan is starting to take place. I am disposing of some of my holdings. I have to slow down my present endeavours. (SN p 43, line 17 to 24);

(o) he was a member of the Canadian Charolais Association; in 1977, he received a letter dated June 15 from the said Association giving sales summaries that were published in the Banner covering sales from 1970 to 1976 (Exhibit A-9); there were good prices;

(p) at an auction sale in 1974, two purebred heifers were sold for $107,000; it was a top because purebred bulls were sold for $40,000 (Exhibit A-10);

(q) he was also a member of the Simmental Association; in the bulletin of December 1974 received by the appellant (Exhibit A-l 1), the pure-blood bulls averaged $15,608.00 at auction sales;

(r) in 1975, he was still partially in his start-up phase of the cattle business; he did not have enough “merchandise” to sell until 1975; in late 1974 and 1975, the prices tumbled drastically; in 1976 and 1977, he sold off all of the herd and rented the farm land for pasture to his neighbours.

3.07 In cross-examination, the appellant testified that:

(a) the total investment on December 31, 1978 was worth $486,000; on December 31, 1975 it was worth $382,000;

(b) the portion of the buildings worth $322,000 about 40 per cent was used as personal residence;

(c) he owned the shares of “Universal Investigation Services, Universal Alarms”; during the construction of the Rideau Centre, he (his companies) provided the security men;

(d) upon retirement, he was going to make his farming operation his sole activity;

(e) he was planning to retire in 1983; he started to dispose of his investigation company and alarm company;

(f) it was from 1973 to 1977, he devoted 12 to 15 hours a week; he spent the rest of his working week in the daytime which was about 32 hours, going in and taking care of Universal Alarms and Universal Investigation;

(g) on the farms, the largest size of herd was, at its peak point, approximately 80;

(h) he owned 50 per cent interest in Universal Alarms and 100 per cent interest in Universal Investigation;

(i) in 1975, in most cases, speaking about himself, he was an executive, but often also said he was a farmer; on his 1975 income tax return he declared his occupation of an executive;

(j) in the early seventies, he was an active member of the Hunt Club; until the end of 1976 or 1977, he owned 3 or 4 horses which were kept on the farm; he enjoyed riding;

(k) in 1975, he had two boys who were living on the farm.

4. Law — Cases at Law — Analysis

4.01 Law

The main provisions of the Income Tax Act involved in the instant case are 31(1) and the definition of “farming” at 248(1). They read as follows:

31. Loss from farming where chief source of income not farming:

(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 business carried on by him shall be deemed to be the aggregate of:

(a) the lesser of

(1) the amount by which the aggregate of his losses for the year, determined without reference to this section and before making any deductions in respect of expenditures described in section 37, from all farming businesses carried on by him exceeds the aggregate of his income 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 deductions in respect of expenditures described in section 37” were deleted,

exceeds

(ii) the amount determined under subparagraph (a)(i);

and for the purposes of this Act the amount, if any, by which the amount determined under subparagraph (a)(i) exceeds the amount determined under subparagraph (a)(ii) is the taxpayer’ “restricted farm loss” for the year”.

248(1) . . .In this Act,

“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;

4. Cases at Law

The cases at law to which the parties referred are:

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

2. Helen Kasper v The Queen, [1982] CTC 178; 82 DTC 6148;

3. Harry Arnold Brown v The Queen, [1980] CTC 413; 80 DTC 6341;

4. Charles R McCambridge v MNR, [1981] CTC 2314; 81 DTC 251;

5. Casimir Van Straubenzee v MNR, [1981] CTC 2692; 81 DTC 552.

4.03 Analysis

4.03.1 It is not in dispute that the appellant’s operation of breeding exotic cattle is farming.

Moreover, the respondent, in considering the appellant’s operation as a sideline business and therefore in allowing a limited loss of $5,000, has admitted in fact that there is a reasonable expectation of profit in the business of farming.

However, in the assumptions of facts quoted above (2.02), the respondent in subparagraph (g) of paragraph 2A(g) contends: “‘ in the alternative, and notwithstanding the Respondent’s assumptions, the appellant had no reasonable expectation of profit from his farm operation”.

First, the prepondence of the evidence shows that the farming operation had a reasonable expectation of profit: the total investment (certainly over $200,000), the taxpayer’s intended course of action (purchase of 4 farms, hiring of farm manager and herdsman, etc). Why he did not succeed? It’s only because of the policy of the American farmers to import the semen of purebred cattle rather than import cattle. Until 1974, the American farmers purchased an important part of the Charolais cattle and Simmental cattle from the Canadian farms. Therefore, this policy caused a drop in 1975 on the Canadian market: 3.04(g), 3.05(c). It was a question of timing as Mr Beveridge 3.03(a) and Mr Baird (3.04) said. Even if in fact the appellant’s farming operation would not have had a reasonable expectation of profit and thence that it was only a hobby, then the Court would have not had the jurisdiction to amend the reassessement in disallowing the $5,000.

4.03.2 In consequence of the former paragraph, the only point in dispute is whether the appellant’s chief source of income for the 1975 taxation year is neither farming nor a combination of farming and some other source of income pursuant to subsection 31(1) quoted above.

4.03.3 Counsel for both parties have referred to the Moldowan, (supra), case, judgment given by Mr Justice Dickson of the Supreme Court of Canada, with which the four other judges concurred. Both counsel invoked the principles issued in this case to base their own thesis.

In the said case, the Court explained the meaning of “the chief source of income’’ of subsection 31(1):

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. A change in the taxpayer’s mode and habit of work or reasonable expectations may signify a change in the chief source, but that is a question of fact in the circumstances.

It is also important to quote the Moldowan, (supra), case, when Mr Justice Dickson explained how the Income Tax Act envisaged the three classes of farmers:

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. The section provides that these subsidiary interests will not place the taxpayer in class (2) and thereby limit the deductibility of any loss which may be suffered to $5,000. While a quantum measurement of farming income is relevant, it is not alone decisive. The test is again both relative and objective, and one may employ the criteria indicative of “chief source” to distinguish whether or not the interest is auxiliary. A man who has farmed all of his life does not become disentitled to class (1) classification simply because he comes into an inheritance. On the other hand, a man who changes occupational direction and commits his energies and capital to farming as a main expectation of income is not entitled to deduct the full impact of start-up costs.

4.03.4 What is the adduced evidence concerning the change of the occupational direction of the appellant in 1975 from executive of his companies to farming as main expectation of income?

The appellant, born in 1922, was 47 years old when he purchased his first farm in 1969. He said “I was planning towards having an operation that would give me a better than average income on my retirement which I had planned for about now”. He means in 1983 (para 3.06(n) and 3.07(e)). From 1972 to 1980, the actual income from net employment and dividends from his companies was roughly:

Despite the fact that the test for the chief source of income is not “a pure quantum measurement” according to the Supreme Court, one must state that the above income is impressive if one compares it with the farm losses for the same years going from $16,000 to $73,000, the latter figure being for 1975, the year under appeal.

Moreover, the evidence is to the effect that in the same year the appellant spent about 12 to 15 hours per week in the farming operation and 32 hours as executive of his companies (3.07(f)).

The Court cannot see that Mr Roney in 1975 was a taxpayer for whom farming may reasonably be expected to provide the bulk of income or the centre of work routine — or was a man whose major preoccupation is farming but has some income from a sideline employment or business. On the contrary, pursuant to the evidence his main occupation was still Universal Investigation and Universal Alarms.

The Court thinks that the appellant, in declaring in his 1975 income tax return he was “an executive”, well described his main function in that year. In substance the appellant meets the description number (2) of the Supreme Court, he carried on farming as sideline business. The appellant’s contention however, is that he was starting up and that he was changing course of his occupation, therefore, he is not disentitled to deduct the full impact of starting up costs, as the Supreme Court said in Moldowan.

Is it sufficient to set about a career change, before one actually makes the change? Is it sufficient that the appellant decided in 1968 that he would change his chief orientation in 1983 to allow farming losses in 1975 as starting up costs, especially when the actual change never occurs?

The Court is inclined to think that the actual change is not necessary if all the normal and appropriate steps were made to arrive at the change but that some special circumstances prevent the change. The evidence shows that all the appropriate steps were made. It would be normal that all the losses of one year be considered as start-up costs even if in that year the appellant was not yet a full-time farmer but a gentleman farmer. It is a reasonable interpretation of subsection 31(1) in the light of the Moldowan decision.

5. Conclusion

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

Appeal allowed.