James C Luchuck v. Minister of National Revenue, [1981] CTC 2819, 81 DTC 766

Guy Tremblay:—This case was heard in the City of Winnipeg, Manitoba on February 9, 1981.

1. The Point at Issue

The issue is whether during the 1975 and 1976 taxation years the appellant, a mechanical inspector, was correct in claiming deductions in the amount of $6,028.99 and $3,655.23 respectively as farming losses, from raising horses for resale. The respondent contends that the appellant’s activities concerning horses were merely a hobby with no reasonable expectation of profit, and therefore that they are personal expenses as provided in the Income Tax Act.

2. The Burden of Proof

2.01 The burden 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 assumptions of fact on which the respondent based the assessment are also deemed to be correct. In the present case, in paragraph 5 of the reply to notice of appeal, the respondent described the facts on which he based his assessment:

5. In re-assessing the Appellant for his 1975 and 1976 taxation years, the Respondent made the following assumptions of fact, inter alia:

(a) The Appellant in his 1975 and 1976 taxation years was a mechanical inspector

employed by the Department of Highways, Province of Manitoba;

(b) the Appellant’s income from office or employment during the 1975 and 1976 taxation years was $15,415 and $17,530 respectively;

(c) during the latter part of the 1975 taxation year the Appellant acquired one mare at a cost of $1,500;

(d) during the 1976 taxation year the aforementioned mare was bred to a sire unsuccessfully;

(e) during the 1977 taxation year the aforementioned mare was bred once more to a Sire, again unsuccessfully;

(f) during the 1975-1977 taxation years the appellant owned but the one aforementioned mare;

(g) the Appellant was not maintaining horses for racing;

(h) the Appellant, during the 1975 and 1976 taxation years, with respect to his activity concerning horses, was merely indulging in a hobby with no reasonable expectation of profit,

(i) the amounts of $6,028 and $3,655 sought to be deducted by the Appellant in his 1975 and 1976 taxation years respectively as farming losses were personal or living expenses.

3. The Facts

3.01 During the 1975 and 1976 taxation years, the appellant resided at 1785 Balgona Road in the City of Winnipeg, Manitoba.

3.02 The respondent’s assumptions of fact described in subparagraphs (a) to (f) inclusively of paragraph 5 of the reply to notice of appeal were admitted by the appellant. However, he denied the facts alleged in subparagraphs

(g) to (i).

3.03 The figures of the expenses incurred by the appellant are not in dispute except for the 1975 taxation year. For the said year, the appellant claimed an amount of $3,734.74 as a capital cost allowance (cca). The contention of the respondent is that for the said year the maximum cca allowable to the appellant was $1,783.88.

3.04 One can read the following figures in the 1974 to 1979 income tax re- turns of the appellant:

In 1978, the appellant in his return described his work as “hobby farmer” and explained his “schedule of loss” as follows:

James Luchuck

Hobby Farmer

Schedule of loss

Net Loss — 1978	(6,462.58)
Claim 78	($2,500.00)
1 / ($6,432.58 — $2,500)	($1,966.29)
	($4,466.29)
Loss Forward to 79	($1,996.29)
	($6,462.58)

3.05 In his 1974 return and for the following years, the appellant declared as self-employment:

3.06 The appellant testified that he had chickens for a short period in 1976. In 1978 or 1979, he had some turkeys.

3.07 The appellant testified that in 1975, he bought a mare named Lady Question. She was bred four times, and three times she lost her foals. This mare was sold in 1976 for $6,000.

3.08 Two other mares were purchased. One was sold in 1977 and one in 1979; the latter was sold for $1,800.

3.09 Out of four foals only one, in fact, was born.

3.10 The appellant explained that he had some experience in farming in the 1930’s when he had worked on farms. In 1976, he attended 10-night lectures of two hours each at the University of Manitoba on horse breeding.

3.11 The appellant testified that his intention was to buy, to breed and to sell thoroughbred horses. However, he did not realize at the time all the risks involved. He said that people who were selling and breeding horses really painted an overly bright picture of the possible prospects.

3.12 In his testimony, the appellant claimed that his wife worked approximately three hours a day and that they both worked at least six hours on the weekend. He also said that he himself worked from one hour to two hours every evening. This works out to a minimum of 44 hours per week.

4. Law — Cases at Law — Analysis

4.01 Law

The main sections of the Income Tax Act involved in the present case are subsections 31(1) and (2). The definitions of “farming” and “personal or living expenses” of section 248 are also important. They read 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 busi- nessess 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.

(2) For the purpose of this section, the Minister may determine that 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.

248. (1) In this Act,

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

“personal or living expenses” 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 at Law

The counsel for the parties referred the Board to the following cases:

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

2. Joseph Shiewitz v MNR, [1979] CTC 2291; 79 DTC 340;

3. Fred L Johnson v MNR, [1978] CTC 2122; 78 DTC 1109;

4. Ernest Radies v MNR, [1978] CTC 2601; 78 DTC 1448;

5. McCleary Drope v MNR, [1978] CTC 2639; 78 DTC 1483;

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

7. Donald J Gillis v HMQ, [1978] CTC 44; 78 DTC 6103;

8. J R Zavitz v MNR, [1978] CTC 3021; 78 DTC 1730;

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

10. C A Burns Limited v MNR, [1981] CTC 2001; 81 DTC 14;

11. The Deputy Minister of Revenue of Quebec v Julius Lipson, [1979] CTC 247;

12. F George Walker v MNR, 76 DTC 1224.

4.03 Analysis

4.03.1 In cultivating vegetables and in buying, breeding and selling horses, the appellant was “farming” for the purposes of the Income Tax Act, sections 31 and 248. Concerning section 31 of the new Act (subsection 13(1) of the former Act) and the definition of “personal or living expenses”, it is appropriate to quote Dickson, J of the Supreme Court of Canada in William Moldowan v HMQ, [1977] CTC 310 at 313; and 77 DTC 5213 at 5215:

The next thing to observe with respect to subsection 13(1) is that it comes into play only when the taxpayer has had a farming loss for the year. That being so, it may seem strange that the section should speak of farming as the taxpayer’s chief source of income for the taxation year; if in a taxation year the taxpayer suffers a loss on his farming operation it is manifest that farming would not make any contribution to the taxpayer’s income in that year. On a literal reading of the section, no taxpayer could ever claim more than the maximum $5,000 deduction which the section contemplates; the only way in which the section can have meaning is to place emphasis on the words “source of income”.

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, [1972] CTC 151, 72 DTC 6131. See also paragraph 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, 74 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.

and William Moldowan v HMQ, [1977] CTC 310 at 315, and 77 DTC 5213 at 5216:

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 activités as a hobby. The losses sustained by such a taxpayer on his nonbusiness farming are not deductible in any amount.

4.03.2 In the present case, it is clear from the evidence that Mr Luchuck cannot be classified in class one of the former three classes of farmers determined by the Supreme Court of Canada. Therefore, the appellant can be classified in class two (and the deduction would be the restricted losses of section 31) or in class three (and there would be no deduction at all). To sum up, the crux of the matter is whether the appellant’s interest in farming is a sideline business or a hobby. The difference can be minimal.

4.03.3 According to the cases at law referred to by the parties, the different items to be considered are, inter alia, experience in farming, time spent, intent, capital committed and profitability both actual and potential.

4.03.4 Items analysed

(a) Experience in farming

The evidence concerning the item (para 3.10) is not in favour of the appellant. The fact that he worked on farms in 1930 and that he went to 10 lectures on horse breeding is not sufficient, certainly not to realize the risks involved in such business as he himself admitted. The Board states that when he went to lectures in 1976, he had already had a mare for at least one year.

The Board states also that the assessments issued by the respondent disallowed all the farming expenses including those concerning vegetables and chickens. The appellant appeals only the breeding and raising of horses. However, the evidence given about vegetables and chickens (paras 3.04, 3.05 and 3.06) is far from convincing that he was an experienced farmer.

(b) Time spent

If the Board accepts the evidence given on the time spent by the appellant and his wife (para 3.12) despite the fact it is not confirmed by another witness, the Board concludes that this item is in favour of the appellant’s thesis.

(c) Intent

The affirmation of the appellant about his intention of breeding, raising and selling horses is clear, but not confirmed. However, from other evidence, the Board would be ready to accept it if the item profitability was in favour of the appellant.

(d) Capital committed

No particular evidence was given concerning the capital committed. However, it is admitted that the appellant has a five acre farm with a house and a Stable.

(e) Profitability both actual and potential

The evidence given is that there was no profit at all during the taxation years 1975 and 1976 involved in this appeal, and there was no profit during the years 1977, 1978 and 1979 as well.

Moreover, the appellant has chosen not to declare the sale of the mare as revenue, because, according to his counsel, it was on a cash basis accounting system. No evidence was given concerning the method of payment by the purchaser. Although, it was possible to give better evidence concerning the actual profitability, it was not given.

Concerning the potential profitability, it seems that the remaining foal is the only potential source. It is not the most convincing evidence.

4.03.5 In the Board’s opinion, the time spent and the intent (even if it would be accepted) which are the two items in favour of the appellant, are not sufficient to reverse the burden of proof. The most important item was the profitability. The preponderance of the evidence on this point is not in favour of the appellant. His testimony in paragraph 3.11 confirms that in his case the reality was far from the picture given.

With the evidence given by the appellant, it is the Board’s opinion that the appellant has well described his whole farming operation from 1975 to 1979, when in his 1978 income tax return, he described himself as a “Hobby Farmer”.

5. Conclusion

The appeal is dismissed in accordance with the above reasons for judgment.

Appeal dismissed.