The Minister of National Revenue v. John Kamoulakos and Chris Christakos, Taxpayers., [1981] CTC 2678, 81 DTC 615

D E Taylor:—This is an application by the Minister of National Revenue under paragraph 174(3)(a) of the Income Tax Act, SC 1970-71-72, c 63, as amended, for:

(a) a determination of the question whether Chris Christakos and John Kamoulakos were in equal partnership in the 1976 taxation year with respect to a business known as Europa Restaurant or Europa Pizza

(b) an order that Chris Christakos and John Kamoulakos are bound by the determination.

Mr Christakos did not attend the hearing and was not represented. The Minister’s affidavit and attached statement of facts were filed, as was an affidavit by Kamoulakos. These read in part as follows:

(From the Application)

A. Statement of facts on which the Minister relies

(1) The applicant, the Minister of National Revenue, by notice of reassessment dated March 19, 1979, reassessed the income tax liability of John Kamoulakos for his 1976 taxation year by adding to his income the amount of $4,091, income derived from a partnership between him and Chris Christakos, known as “Europa Pizza” or “Europa Restaurant”.

(2) The respondent John Kamoulakos objected to the reassessment dated March 19, 1979 on the grounds that the partnership had been dissolved on October 31, 1975.

(3) On September 10, 1973 John Kamoulakos and Chris Christakos registered in the Province of Nova Scotia a partnership pursuant to the provisions of the Partnerships and Business Names Registration Act.

(4) John Kamoulakos contributed the capital for the business and Chris Christakos operated the business.

(5) The business premises were purchased by John Kamoulakos and his wife on July 30, 1973 and transferred to Mr Christakos and Mrs Christakos on October 2, 1973.

(6) Chris Christakos reported the business as a partnership in the 1976 taxation year.

(7) By agreement dated June 19, 1977 attached hereto as Exhibit ‘A’ Chris Christakos agreed to purchase for $4,000 all interest of John Kamoulakos in the business known as Europa Restaurant and to assume all liens and liabilities to the creditors of Europa Restaurant.

(From the affidavit of John Kamoulakos)

2. THAT I am the uncle of Chris Christakos, and in order to assist him in setting up a business in 1973, I lent him approximately three thousand dollars ($3,000), and as security we agreed that I would become a partner for registration purposes only.

3. THAT from the time the business was set up in September, 1973, up until the present time, I have not received any income from the business, and in fact the intention always was that I would not receive any income from the business.

4. THAT In October, 1975, Chris Christakos and I decided to dissolve our arrangement and rent the equipment and fixtures to one Nick Nikolopoulos, and a lease was prepared accordingly. I instructed my solicitor, Alan J Stern, to prepare a dissolution of the partnership, and unfortunately the original document appears to have been lost, but for all intents and purposes, except for the ownership of the equipment, the arrangement was dissolved in October, 1975.

5. THAT in June, 1977, Chris Christakos arranged to sell the assets to another party, and in order to pay me back for the capital I invested, together with some interest, Chris Christakos agreed to pay me the sum of four thousand dollars ($4,000), and as a result we entered into an agreement which has been produced as Exhibit ‘A’ to the statement of facts.

6. THAT in all of the circumstances there never was any intention whatsoever that I would be a partner with respect to the profits of the business or that I would derive any benefit from the business, and I therefore was never concerned with the financial statements of the business and all of the financial operations of the business were in the sole control of Chris Christakos.

The “Agreement” dated June 19, 1977, referred to by the Minister, read as follows:

THIS AGREEMENT is made this 19 day of June, A.D., 1977;

BETWEEN:

CHRIS CHRISTAKOS, of Halifax, in the County of Halifax and Province of Nova Scotia,

hereinafter called the “Purchaser”,

OF THE FIRST PART

- and -

JOHN KAMOULAKOS, of Halifax aforesaid, hereinafter called the “Vendor”,

OF THE SECOND PART

WHEREAS the Parties hereto are equal partners in a business known as “Europa Restaurant”, which is located at 171 Main Street, Dartmouth, Nova Scotia:

AND WHEREAS the Purchaser has agreed to purchase the interest of the Vendor of the said business for a price of FOUR THOUSAND ($4,000) DOLLARS, upon certain terms and conditions;

NOW IN CONSIDERATION of the sum of FOUR THOUSAND ($4,000) DOLLARS and other good and valuable consideration, the Parties hereby agree as follows:

1. Chris Christakos hereby agrees to pay the sum of Four Thousand ($4,000) Dollars to John Kamoulakos, and John Kamoulakos hereby agrees to transfer his interest in the business known as “Europa Restaurant” to Chris Christakos. The transaction herein is to be completed on or before the 30th day of June, A.D., 1977.

2. Chris Christakos hereby agrees to assume all liens and other liabilities presently owing by Europa Restaurant to the creditors of Europa Restaurant, and from the date of closing, Chris Christakos will be legally responsible for all future debts of Europa Restaurant.

3. The Parties hereby acknowledge that the total present liabilities of Europa Restaurant are approximately $9,586.03 (Nine Thousand Five Hundred Eighty-Six Dollars and Three Cents).

4. The Vendor hereby acknowledges that he shall have no further interest in the equipment, fixtures, stock-in-trade, or any other assets owned by Europa Restaurant following completion of the transaction herein.

5. The Purchaser shall indemnify and save harmless the Vendor from all liabilities of the business known as “Europa Restaurant”, following the completion of the transaction.

6. The Purchaser hereby agrees to continue the lease arrangement for the premises for a period of at least one year following completion of this transaction and the Purchaser hereby confirms that under the terms of the lease, Europa Restaurant shall pay rent equal to the total of the two mortgages presently against the property; Europa Restaurant shall also continue to pay occupancy taxes, real property taxes and all utility charges for the said property. All repairs of every nature and description shall be paid for by Europa Restaurant during the term of its occupancy.

THIS AGREEMENT shall inure to the benefit of and be binding upon the Parties hereto and their respective heirs, administrators and assigns.

IN WITNESS WHEREOF the Parties hereto have hereunto set their Hands and Seals, the day and year first above written.

Kamoulakos testified in support of his affidavit, and was questioned by counsel for the Minister. He stated he could not read or write English, and so he was not certain of the contents of the agreement he signed with Christakos in 1977, but his recollection was that it had been prepared by his own lawyer Mr Stern. The income tax return of Christakos which was filed with the Board did show a financial statement for the business with Kamoulakos and Christakos as partners, with the net income divided on an equal basis, $4,091.02 each.

Counsel for the applicant noted the evidence in the affidavit of Kamoulakos that there had been a partnership in 1973, and that the partnership was dissolved only in 1977, according to the agreement. There had been no evidence to support the statement of Kamoulakos that it had been dissolved in 1975. Counsel also noted that section 98 of the Income Tax Act provided that a partnership was not dissolved until the assets were sold or disposed. Counsel also read into the record certain relevant sections of the Partnership Act of the Province of Nova Scotia.

Counsel for Kamoulakos pointed out that the uncontradicted testimony of Kamoulakos had been that there had been no sharing of profits, nor any intention to so share.

In my view, neither the testimony of Kamoulakos nor the argument of counsel for Kamoulakos is persuasive in the light of the physical evidence. There was a partnership at least in 1973; no evidence that it was dissolved before 1977, but there is evidence that it was dissolved in that year. In addition, the 1976 financial statements of the partnership and income tax returns of Christakos would indicate that he was of the view that he shared profits with Kamoulakos. It is possible that Kamoulakos may have received no profits in other years or even in the year in question, but that has no bearing on the issue before the Board.

Accordingly, it is the determination of the Board that Mr John Kamoulakos and Mr Chris Christakos were in equal partnership in the 1976 taxation year with respect to the business known as “Europa Restaurant” or “Europa Pizza”. Both parties are to be bound by this determination.

3.28 The appellant explained that the main problems in raising horses are the contagious diseases (viruses and coughing), accidents in training or running (breakdown in front legs either by a bow tendon, broken ankle, fractured knee), and buckshin (inflammation of the periosteum, sheath over the cannon bone; it is a shin inflammation).

3.29 The appellant testified that he also had a herd of cattle:

I worked it up gradually. I started out buying four or five cows in calf and increased that and sold off the steer calves, kept the heifers and I built up a herd to about fifty odd head. (SN p 85)

It was the number he had when he sold the farm in 1978. He pointed out that the cattle provided the manure to help the fields. The inventory of the cattle at cost in the financial statements are as follows:

4. Law — Cases — Comments

4.01 Law

The main provisions of the Income Tax Act involved in the present case are subsection 31(1) and section 248 (definitions of “farming” and “personal or living expenses”).

Subsection 31(1) of the Act reads as follows:

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 in respect of expenditures described in section 37, 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 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’s ‘restricted farm loss” for the year.

Section 248 of the Act reads as follows:

“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 enagaged in the business of farming;

“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 a reasonable expectation of profit,

(b) the expenses, premiums or other costs of a policy of insurance, annuity contract or other like contract if the proceeds of the policy or contract are payable to or for the benefit of the taxpayer or a person connected with him by blood relationship, marriage or adoption, and

(c) expenses of properties maintained by an estate or trust for the benefit of the taxpayer as one of the beneficiaries:

4.02 Cases of Law

The counsel for both parties referred the Board to the following cases of law:

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

2. Oscar Dorfman v MNR, [1972] CTC 151; 72 DTC 6131;

3. Donald Preston McLaws v HMQ, [1976] CTC 15; 76 DTC 6005;

4. MNR v William R Kellough, [1976] CTC 82; 76 DTC 6060;

5. Nesthyr Rudniski v MNR, [1975] CTC 2019; 75 DTC 14;

6. Chester Douglas Brown v HMQ, [1975] CTC 611; 75 DTC 5433;

7. Robert E Mullin v MNR, [1979] CTC 2080; 79 DTC 113;

8. Bert James v MNR, [1973] CTC 457; 73 DTC 5333;

9. Philrick Limited v HMQ, [1977] CTC 217; 77 DTC 5158.

The appellant also referred to the Interpretation Bulletin IT-322R issued by the respondent concerning farm losses.

4.03 Analysis

4.03.1 The criteria of the Moldowan case

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

The first point in the present case is whether or not the farming operation of the taxpayer had a “reasonable expectation of profit”, and the second point is whether the appellant’s main source of income is farming, or farming and some other source of income in the sense of section 31. When these points are settled the Court will decide whether to allow the expenses in total, up to the amount of $5,000 or not at all.

Section 31 quoted above speaks of “source of income” and on that point it is important to cite the Moldowan case:

Although originally disputed, it is now accepted that in order to have a “source of income’’ the taxpayer must have a profit or a reasonable expectation of profit.

Source of income, thus, is an equivalent term to business: Dorfman v MNR (72 DTC 6131), (1972) CTC 151. See also s 139(1 )(ae) of the Income Tax Act which includes as “personal and living expenses” and therefore not deductible for tax purposes, the expenses of properties maintained by the taxpayer for his own use and benefit, and not maintained in connection with a business carried on for profit or with a reasonable expectation of profit. If the taxpayer in operating his farm is merely indulging in a hobby, with no reasonable expectation of profit, he is disentitled to claim any deduction at all in respect of expenses incurred.

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.

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 again the Moldowan case when Mr Justice Dickson, explains how the Income Tax Act envisages 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 nonbusiness 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 disentitled to deduct the full impact of start-up costs.

4.03.2 From the evidence, it is clear that the experience of the appellant in the field of “livestock raising . . . maintaining of horses for racing” (see definition of farming quoted above) cannot be disputed. In fact, it is not disputed by the respondent (paras 3.01 to 3.07).

4.03.3 The preponderance of the evidence is also in favour of the appellant concerning the time spent by him on the farm (para 3.17), and the capital committed in his farm (paras 3,07, 3.21 and 3.23).

4.03.4 Concerning the profitability of the source of income, the Board stated from the evidence, on the one hand, that during the four years on the Strawbrook Farm there were only losses and, on the second hand, that since the appellant was sixteen years old he had experience as a full-time employee on the farm until 1930. From that date, first on a partial basis, he leased farms, was a member of a partnership in farming businesses, and later (after the second World War from 1945 to 1969): (1) He owned his own farm in the Okanagan Valley, he cultivated this farm with success until 1952, but hired men from 1952 to 1959; the time he spent in the Korean War, he rented it in 1959 and sold it in 1969. (2) He inherited from his uncle Allan Case the Valley Brooke Farm which he cultivated and then sold in 1972. (3) In 1972, he bought the Strawbrook Farm.

In fact, before purchasing the Strawbrook Farm in 1972, he had not only 38 years of experience with horses, if one computes the 10 years he worked as a judge for the Ontario Racing Commission, but he was also the owner of his own farm for 27 years and cultivated it as his own for 10 years.

The farming from 1930 to 1939 was not a financial success, as with other people during that time, because there was a “crisis” all over the world. However, the farming of the Okanagan Valley farm was a financial success until the time he left for the Korean War.

Although, the Valley Brooke Farm could have been a financial success, the appellant had to sell it because of troubles of another nature (para 3.07).

Therefore during the useful period preceding the purchase of the Strawbrook Farm, the Board arrives at the conclusion that the appellant was a farmer. When the Board says “useful period”, it does not take into account the 13 years the appellant as a soldier in the army. It was, in fact, an obligation. Concerning the period of the ten years spent as a judge for the Ontario Racing Commission Mr Straubenzee was under no obligation to accept this job, but since the job was accepted one cannot see how a judge of the ORC could have been racing horses on the tracks at the same time. The fact, however, that in the same period the appellant owned a farm (Okanagan Valley) that he rented, the Board cannot consider this period as not being useful, even if it was not as useful as the time he cultivated it by himself.

Despite this period of ten years and because of the distinction made above, the Board considers that the preponderance of the evidence is to the effect that before he purchased the Strawbrook Farm, the appellant could be considered as a farmer, or that his main source of income was farming.

The Board refers to the words of the Supreme Court of Canada in the Moldowan case:

A man who has farmed all of his life does not become disentitled to class (1) classification simply because he comes into an inheritance.

His inheritance which, in fact, resulted in a large number of investments cannot affect his status as a farmer. In theory, the farming indeed constituted his main source of income for his livelihood, although his main source of income was in reality the investment income, and although he actually suffered farming losses during the years involved.

Considering the above conclusion and considering the comments of Mr Justice Dickson, in the Moldowan case, the Board allows the appeal, despite the weakness of the evidence concerning the inventory of the cattle.

5. Conclusion

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

Appeal allowed.