Benkarin Holdings Inc. v. R., [1997] 1 CTC 2019 (Informal Procedure)

Rip J.T.C.C.: - The issue in these appeals (Informal Procedure) is whether in its 1989, 1990 and 1991 taxation years the chief source of income of Benkarin Holdings Inc. (“appellant”) was farming or a combination of farming and some other source of income or neither farming nor the combination of farming and some other source of income: subsection 31(1) of the Income Tax Act (“Act”). The corporation’s fiscal year end is September 30th.

In about 1964 Dr. Michael Bennett, a radiologist in Sarnia, Ontario commenced carrying on a business of breeding horses. He purchased his first horse from Winfield Farms in 1964, a three year old mare named Sweet Lady Briar. This horse was retained by Dr. Bennett as a brood mare and was bred to Neartic, the sire of Northern Dancer. Two horses were produced, Drawbridge in 1967 and Briartic in 1968. The former won 11 races and approximately $60,000; the latter won 19 races and approximately $200,000. Briartic also became a leading Canadian sire. Dr. Bennett also had Sweet Lady Briar bred to Northern Dancer in 1966 but the foal died within five weeks of birth. Briartic commenced breeding in 1974 for a fee of $2,500 and serviced 25 mares in that year. Soon thereafter, Winfield Farms purchased a two-thirds interest (or 24 shares) in Briartic for $120,000.

Dr. Bennett purchased 100 acres of land near Sarnia for use as a breeding farm in 1968. The land was used for grazing and to grow feed. He built a 20-stall barn and a training track on the land.

In 1976 Dr. Bennett caused the appellant to be incorporated under the name Bennett Farms (Wyoming) Inc. and transferred all of the farm property, including land, horses and equipment, to the appellant. [1] Dr. Bennett was the corporation’s sole shareholder. The breeding activities continued to be carried on by the appellant with Sweet Lady Briar, its main brood mare, being bred to Winfield Farms’ stallions, among others.

Unfortunately the newly bred horses did not have the same results as Drawbridge and Briartic. Nine additional foals, for example, had winnings of less than $50,000. Also, Dr. Bennett stated, he was of the view there was an over-supply of breeding horses in North America at the time. As a result, Dr. Bennett said he decided he “had to make changes in the operation. Things were going against me.” He said that he still had a profitable operation but he saw the “writing on the wall”. In November 1985 the appellant sold the farm and opted to change its horse operation from breeding to racing. Dr. Bennett explained that “when you move from breeding to racing you don’t need to own a farm”. The appellant’s last sales of horses were in 1989.

According to the 45th Annual Statistical Report for 1994 of the Ontario Racing Commission, Dr. Bennett’s concerns were well taken. The statistics in the report reflect a steady decline in the annual average price per yearling sold at September sales between 1985 and 1994, although there was an increase between 1992 and 1993. The median average price per horse, excluding the top ten per cent and the bottom ten per cent, was $39,179 in 1985 and $24,120 in 1994. The number of sales also declined over the ten year period.

Dr. Bennett believed that the financial structure for horse racing was improving in 1987. He had raced Drawbridge and Briartic and so was not inexperienced in horse racing. He thought that he had a “fighting chance to make money racing in the late 1980s”.

During the time the appellant was breeding and racing horses, Dr. Bennett was carrying on the full-time practice of medicine. From 1960 to 1989 he was Chief of Radiology at St. Joseph’s Hospital in Sarnia. He also maintained a private practice which he started in 1977. The practice was carried on in a building owned by Dr. Bennett. He employed “two to three” X-ray technicians and an office manager, “the equivalent of three full-time employees”. After resigning as Chief of Radiology, Dr. Bennett maintained privileges at the hospital. He continued in charge of the nuclear medicine unit of the hospital and would “fill in” in general radiology, if needed. Dr. Bennett estimated that he worked, and continues to work, at the hospital two hours a day, two days a week. He stated that his work day as a physician was six hours. Dr. Bennett worked as a physician weekdays only, on mornings. Dr. Bennett explained his work as a doctor is “concentrated in a short period of time”, leaving him time to devote to the horses. He estimated 30 per cent of his time goes to the horses and 70 per cent to his medical practice.

In 1987 Dr. Bennett entered into an agreement with the appellant for the appellant to manage his medical practice and to acquire the building in which he carried on his practice. Three other doctors and a laboratory were tenants of the building. The appellant employed “the equivalent of three full-time technicians” and a manager who worked part-time managing the practice and the building. Dr. Bennett continued to manage the farming operation but was also responsible for the ongoing activities of the appellant.

During the years in appeal, Dr. Bennett testified, he spent “as much time as ever, if not more” on the horses. The racing season ran from mid-March to early December. Dr. Bennett saw himself as a “hands on” owner. Almost every second weekend his horses raced in Detroit (in 1989) or Toronto (in later years) and he attended the races. He frequently attended weekday races as well. Also, during the week he was “constantly on the phone to the racetrack to trainers”. It was he, and not the trainer, who made the final decision to sell or claim a horse. The trainer also required Dr. Bennett’s approval to enter a horse in a given race. In addition Dr. Bennett attended yearling sales.

The purchase of the horses was financed by Dr. Bennett by way of loans to the appellant. The appellant also required funds to purchase medical equipment, including mammogram machinery.

Up to and including its 1985 taxation year the appellant’s sole source of income was farming. Starting in 1986 it also had investment income; the appellant invested a portion of its proceeds of disposition of the farm land in a term deposit. Then, in 1987, the appellant had income from at least four sources: farming, a term deposit, management and rents.

In 1989, 1990 and 1991 the appellant owned horses - a mix of race horses and stallions and mares from its breeding operations - estimated by Dr. Bennett to be worth $323,000, $225,000 and $200,000 respectively. Some of the horses were claimed in claiming races, some died, one was sold at a nominal fee and some were eventually given away. At the end of 1991 the appellant owned seven horses, two of them race horses and one of them was worth $100,000, according to Dr. Bennett.

An analysis of farm income for the years 1984 to 1991 is found in Schedule I to these reasons (Exhibit A-l). In its 1982 taxation year the appellant reported a profit of $100,292 from farming; the next year it reported a loss of $120,712. Other revenues and related expenses of the appellant for the 1986 to 1991 taxation years are found in Schedule II to these reasons (Schedule A to the Reply to the Notice of Appeal).

The appellant purchased horses for the following amounts:

YEAR COST OF HORSES

1987	$66,500
1988	24,005
1989	23,379
1990	35,551
1991	0
1992	12,636
1993	88,000
1994	27,025
1995	25,875

Dr. Bennett stated that after 1992 the appellant filed tax returns applying subsection 31(1) of the Income Tax Act (“Act”) to claim a restricted farm loss.

The introductory words of subsection 31(1) read as follows during the years in appeal:

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 ...

There then follows a formula which in effect places a limit of $8,750 on farm losses deductible.

Counsel for the appellant, Mr. Englander, submitted that the appellant’s “chief source” of income for the years in appeal was farming, or, in the alternative, a combination of farming and some other source of income. The appellant was incorporated in 1976 for the single purpose of carrying on the business of farming, in particular, to breed horses. There was, counsel declared, no intent to shelter income from other sources: the appellant had no other business until it took over management of Dr. Bennett’s practice and acquired a rental property in 1987.

Mr. Englander suggested that in determining the appellant’s “chief source” of income I consider and weigh three factors suggested by Dickson J., as he then was, in Moldowan v. R., (sub nom. Moldowan v. The Queen) [1978] 1 S.C.R. 480, [1977] C.T.C. 310, 77 D.T.C. 5213, at page 314: time spent, capital committed and profitability. Dickson J. stated:

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.

Further, Dickson J. stated, at page 315 that:

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 as a taxpayer, who looks to farming for his livelihood, is free of the limitation of [section 31(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 carries on farming as a sideline business. Such a taxpayer is entitled to the deductions spelled out in [section 31(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 carries 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.

Appellant’s counsel submitted that Dr. Bennett had sufficient time during the years in appeal to manage the appellant’s farming activities. He had experience with horses. He foresaw the drop in the price of horses in the mid-1980s and decided to change from breeding horses to racing horses. If the appellant had retained its breeding operation, counsel said, its losses would have been even more severe.

Mr. Englander stated that the appellant, with the aid of Dr. Bennett, devoted capital to its farming business. Throughout the years the appellant purchased horses to improve its business prospects. The costs of acquisition of capital assets, namely horses, were deducted from revenue, as permitted by the Act.

The appellant earned income from farming in its 1984 to 1987 taxation years inclusive. Before 1984 it had both profits and losses from farming.

Mr. Englander submitted that a taxpayer may retain a source of income as its chief source of income for a reasonable time, but not indefinitely, even when that source of income ceases to be a chief source in a year. I cannot agree with Mr. Englander that the Act contemplates that a taxpayer’s erstwhile chief source of income continues for any indefinite period as a taxpayer’s chief source of income notwithstanding that a new source becomes a taxpayer’s chief source of income. In the appeal at bar, the appellant deliberately changed its chief source of income from one source of income to another.

Mr. Bornstein, respondent’s counsel, was of the view that the appellant was a Class 2 farmer, that is, a 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 during the years in appeal: Mo Ido wan, supra, page 315. The appellant’s course of operations did not lend itself to farming, either alone or in combination with another source of income, as its chief source of income. Counsel submitted that to accept Mr. Englander’s submission I must ignore the fact that in 1987 the business activities of the appellant were diversified and, that a year earlier, the appellant’s farming operations were changed from breeding to racing horses.

Counsel stated the appellant’s business activities before 1987 were different from what it was during the years in appeal. The appellant was in a new business in 1987, a business that had the equivalent of at least three full-time employees and required additional investment. The new business was not a fortuitous acquisition, such as money from lottery winnings. It required additional time, effort and money which previously were concentrated in horse farming. Strayer J., in Mohl v. R., (sub nom. Mohl v. Minister of National Revenue) [1989] 1 C.T.C. 425, 89 D.T.C. 5236 (F.C.T.D.), at page 428 (D.T.C. 5238-39), stated that:

... for a person to claim that farming is a chief source of income, he must show not only a substantial commitment to it in terms of the time he spends and the capital invested, but also must demonstrate that there is a reasonable expectation of it being significantly profitable. I use the term “significantly profitable” because it appears from the Morrissey decision that the quantum of expected profit cannot be ignored and I take this to mean that one must have regard to the relative amounts expected to be earned from farming and from other sources. Unless the amount reasonably expected to be earned from farming is substantial in relation to other sources of income then farming will at best be regarded as a “sideline business” to which the restriction on losses will apply in accordance with subsection 31(1).

Accordingly, Strayer J. concluded that for farming to be a chief source of income, there must be a “realistic expectation of a substantial profit of the sort which would constitute a chief source of income” (page 428 (D.T.C. 5239)).

Counsel for the respondent also referred to the decision of the Federal Court of Appeal in Poirier (Trustee of) v. Canada, (sub nom. Poirier Estate v. R.), (sub nom. Poirier Estate v. The Queen) [1992] 2 C.T.C. 9, (sub nom. R. v. Poirier) 92 D.T.C. 6335, at page 10 (D.T.C. 6336), for the proposition that:

...what is required for a determination that farming is a chief source of income is a favourable comparison of farming with the other source of income as to such matters as the time spent, the capital committed, and the profitability, both actual and potential ...

More money was spent in the years in appeal on acquiring medical equipment than horses, argued counsel for the respondent. Without the profits from managing Dr. Bennett’s medical practice, counsel argued, the appellant could not survive.

The issue before me is whether the appellant was a class (1) or class (2) farmer. If its chief source of income was, in the years in appeal, a combination of farming and some other source of income, the appellant was a class

(1) farmer and would be entitled to deduct the full farming losses during those years. If its chief source of income was not a combination of farming and some other source of income, it would be classified as a class (2) farmer and its losses from farming would be restricted by subsection 31(1) of the Act.

Recently the Federal Court of Appeal considered the concept of “chief source of income” in Timpson v. Minister of National Revenue, [1993] 2 C.T.C. 55, (sub nom. R. v. Timpson) 93 D.T.C. 5281. At page 56 (D.T.C. 5282) MacGuigan J.A. stated that:

...what is required for a determination that farming is a chief source of income is a favourable comparison of farming with the other source of income as to such matters as the time spent, the capital committed, and the profitability, both actual and potential...

See also Poirier, supra.

The Court of Appeal held in Morrissey, supra that the factors referred to by Dickson J. in the Moldowan case, of time, capital committed and profitability, must be weighed cumulatively rather than disjunctively. I adopt Bowman J.’s statement in Hover v. Minister of National Revenue, [1993] 1 C.T.C. 2585, 93 D.T.C. 98 at pages 2595-96 (D.T.C. 105), that this means that “no single factor may be taken as determinative in isolation”.

In order for farming to be considered a chief source of income it must be a major preoccupation for the taxpayer. In Moldowan, supra, at page 315, Dickson J. said that:

The reference in [subsection 31(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.

[Emphasis added.]

The Federal Court of Appeal used the same language in Roney v. Minister of National Revenue, [1991] 1 C.T.C. 280, (sub nom. R. v. Roney) 91 D.T.C. 5148, at page 286 (D.T.C. 5153-54):

The ratio in Moldowan is that the reference in subsection 31(1) of the Act, to a taxpayer whose source of income is a combination of farming and some other source, contemplates a man whose major preoccupation is farming. It

recognizes that such an individual may have other pecuniary interests such as income from investments or income from a sideline employment or business. These however remain auxiliary to his chief source of income.

I agree with Bowman J.’s definition, in Hover, supra, at pages 2597-99 (D.T.C. 107), that the word preoccupation means “a matter of dominant economic concern”.

Finally, in order for farming to be a chief source of income in combination with another source, the farming activity must be capable of producing a profit: Monette c. Ministre du revenu national, (sub nom. Monette v. Minister of National Revenue) [1988] 2 C.T.C. 2089, 88 D.T.C. 1467 (T.C.C.). The taxpayer must be acting in a manner consistent with a long-term involvement with farming and a reasonable expectation of future profit: Kasper v. R., (sub nom. Kasper v. The Queen) [1982] C.T.C. 178, 82 D.T.C. 6148 (F.C.T.D.).

I agree with respondent’s counsel that there was a change of occupational direction in the appellant after 1986 when the appellant, amongst other things, began managing Dr. Bennett’s radiology practice. However, this by itself is not dispositive of the issue.

I agree, with appellant’s counsel that I should compare three criteria with respect to the appellant’s farming business and its other business and activities. The criteria are time spent, profitability, both actual and potential, and capital commited to each.

The appellant is a corporation and during the years at issue employed the equivalent of three full-time employees in the medical practice. Additionally, the time spent by Dr. Bennett, the sole shareholder is important. Dr. Bennett was the controlling force of the appellant. Dr. Bennett estimated that during the years in question he spent 70 per cent of his time on his medical practice and 30 per cent of his time on farming.

According to the figures in Schedules I and II, the appellant’s income and profitability were as follows (all figures have been rounded off to the nearest thousand):

During 1989, 1990 and 1991, the years in appeal, the farming activities of the appellant resulted in the following losses: $89,000, $98,000 and $44,000 respectively. On the other hand, the net income of the appellant’s other activities excluding the income from term deposit, was $121,000, $126,000 and $103,000 respectively in 1989, 1990 and 1991. Even if the farm loss in each year is reduced by adding to it the income from the term deposit, the appellant would still report a loss from farming.

I consider the capital committed to be an important indicator, but not the only indicator, of whether the taxpayer considered the farming business to be a potentially profitable one. During the five-year period, 1987 to 1991, the appellant spent the aggregate of $150,000 on horses. [2] During the same period, the appellant purchased $305,000 of medical equipment and invested $281,000 in the medical building used in Dr. Bennett’s radiology practice. [3] A comparison of the capital committed in the five-year period is $150,000 for farming versus $586,000 for the medical practice. Thus, during the five-year period, 1987 to 1991, the appellant committed 20 per cent of its capital to farming versus 80 per cent to the medical practice.

The appellant’s primary economic activity during the years in appeal was the management of the radiology practice and the ownership of the medical building. The appellant was not investing in its farming business in a manner consistent with a realistic expectation of future profit from that business to the extent that farming, either by itself or in combination with another income source, would be its chief source of income. The taxpayer has not demonstrated that its major economic preoccupation during the years in question was farming. Farming was a sideline business and of lesser economic importance to the appellant than its other business activities during the years in appeal.

The appeals are therefore dismissed.

Appeal dismissed.