Gregory v. R., [1997] 1 CTC 2104

Sarchuk J.T.C.C.: - In computing income for the 1987, 1988, 1989 and 1990 taxation years, the Appellant sought to deduct full farm losses in the amounts of $20,439, $40,610, $38,134 and $36,620 respectively.

In assessing, the Minister of National Revenue, pursuant to section 31 of the Income Tax Act, allowed restricted farm losses in the amounts prescribed on the basis that farming was not the Appellant’s chief source of income. The Minister also made certain adjustments to both the farm income and the expenses reported by the Appellant. The effect of the assessments is demonstrated by the following table:

1987/1988/1989/1990

	1987			1988	1989	1990
Farm Income
Reported		$42,832		34,530	36,912	75.754
Revised	42,832		43,030		36,912	75.754
Adjustment	0		8,500	0	0
Farm Expenses
Reported	$63,271		75,940		83,046	115.400
Revised	50,360		63,985		60,840	115,400
Adjustment	12,911			11,955	22,206	0
Revised Farm Loss	(7,528)		(20.955)		(23,928)	(36.620)
Maximum Loss
Deductible per s. 31	(5,000)		(5,000)		(8,750)	(8,750)
Restricted Farm Loss	(2,528)		(15,955)		(15,178)	(27.870)

In his appeal, Mr. Gregory puts in issue the application of the provisions of subsection 31(1) of the Act and the allocation as between personal and business of expenses related to interest, costs and property taxes.

At the outset of the trial, the Appellant conceded that in large measure the Minister’s assumptions were in substance correct.

In summary, the following facts emerged from the evidence adduced and the assumptions.

Following a term of service in the RCAF, the Appellant settled in Calgary. In 1966 he became involved in the taxi business, both as an employee and as an owner.

He first became involved with horse racing in 1967, and for several years owned and bred thoroughbreds. The evidence is unclear whether he was operating in a partnership or to what extent this venture was successful.

In 1972 he left his post as general manager of Yellow Cab and, in partnership with the owner of Yellow Cab, Mr. Fowler, began to breed and raise thoroughbreds in British Columbia. This venture did not pan out and was terminated in 1974.

He returned to Yellow Cab and essentially managed that company since Fowler spent winters in the United States.

At some point in time in the late 1970s, the Appellant acquired Red Top Cab and operated it until 1981, at which time it was virtually insolvent and its assets were acquired by Yellow Cab. The Appellant at this point in time returned to Yellow Cab as general manager and vice-president.

He remained in that post until 1990 when the company was sold and shortly thereafter the Appellant resigned and from his evidence it would appear rather impulsively. Since that time he has occupied himself with his horse operation, albeit initially I believe on a smaller scale, as well as accepting part-time work on a sporadic basis.

In or about 1978 the Appellant decided once again to become involved in the horse business, albeit on this occasion in the standard bred industry. That year he and his wife bought approximately 20 acres of farmland and a house some 20 kilometres outside of Calgary. The price paid for the property was $127,000; $40,000 in cash and the balance financed by way of mortgage in favour of the Toronto-Dominion Bank.

The farm operation contemplated was to consist of the breeding, boarding, training and selling of race horses. At all material times the Appellant and his family resided on the farm.

In 1979 the Appellant commenced to make improvements to the farm and between that year and 1981 a new barn was added, fences were constructed and some improvements were made to the watering system. Stock was also purchased.

The capital additions during this period amounted to approximately $55,000, all or most of which was apparently financed by way of a loan from the Royal Bank.

In the taxation years in issue, the Appellant’s farm income came from horse racing, breeding and boarding fees, as well as from the sale of yearlings and horses. By then his inventory was as follows. It reads in brief:

No figures were given for the 1990 taxation year.

The Appellant’s estimate of a fair market value of his 1989 inventory was $100,000. This was according to the accountant who did the Appellant’s returns who testified that, as I said, was the first year in which the optional inventory adjustments were permitted by statute.

In December, 1992 the farm was sold for $207,000. Of that amount approximately $186,000 went to pay loans to the Toronto-Dominion Bank and the Royal Bank and to a private creditor. Each of these, according to the Appellant, represented a consolidation of monies borrowed at various times for the purchase of livestock and the payment of debts incurred in the operation of the farm, as well as some personal loans.

At about the same time the Appellant sold off much of his inventory, containing eight animals, including the stallion Keystone Landmark and he continued with his operation on rented property.

The Appellant contends that he is a Class (1) farmer within the meaning of section 31 of the Act on the basis that farming comprises his chief source of income, in combination with his income as general manager of Yellow Cab.

Counsel for the Appellant argued that the criteria in Moldowan v. R., (sub nom. Moldowan v. Minister of National Revenue) [1978] 1 S.C.R. 489, [1977] C.T.C. 310, 77 D.T.C. 5213 as applied in Graham v. R., (sub nom. Graham v. The Queen) [1983] C.T.C. 370, 83 D.T.C. 5399 (F.C.T.D.) and [1985] 1 C.T.C. 380, 85 D.T.C. 5256 (F.C.A.), Hadley v. R.; (sub nom. Hadley v. Minister of National Revenue) (sub nom. Hadley v. The Queen) [1985] 1 C.T.C. 62, 85 D.T.C. 5058; R. v. Wiley, (sub nom. Canada v. Wiley) [1992] 1 C.T.C. 236, 92 D.T.C. 6294; and Hover v. Minister of National Revenue, [1993] 1 C.T.C. 2585, 93 D.T.C. 98, have been met and that he is entitled to the benefit of full farm losses in the taxation years in issue.

The Respondent contends simply that the Appellant’s chief source of income for the taxation years in issue was neither farming nor a combination of farming and some other source of income and that the Minister properly applied section 31 of the Act in restricting the Appellant’s farm losses.

The leading authority in respect of the interpretation to be given to subsection 31(1) of the Act is Moldowan v. R..

Dickson J., as he then was, suggested that the test for determining whether source of income constitutes the chief source of income for a taxpayer is both relative and objective. He noted at page 314 (D.T.C. 5315-16) that:

The distinguishing features of “chief source” are the taxpayer’s reasonable expectation of income from his various sources in his ordinary mode and habit of work.

In describing more fully the taxpayer who farms for his livelihood, Dickson J. stated at page 315 (D.T.C. 5216):

That for such an individual for whom farming may reasonably be expected to provide the bulk of income or the centre of work routine.

Dickson J. further said at page 315 (D.T.C. 5216):

The reference in section 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.

In this context it is also instructive to refer to Morrissey v. R., (sub nom. Morrissey v. The Queen) (sub nom. Canada v. Morrissey) [1989] 1 C.T.C. 235, 89 D.T.C. 5080, where Mahoney J. said, at pages 241-42 (D.T.C.

5084):

Moldowan also says, dealing with the difference between Classes 1 and 2, “while a quantum measurement of farming income is relevant, it is not alone decisive”. While the determination that farming is a chief source of income is not a pure quantum measurement, it is equally not a determination in which quantum can be ignored.

Moldowan suggests that there may be a number of factors to be considered but we are here concerned only with three: Time spent, capital committed and profitability. In defining the test as relative and not one of pure quantum measurement, Moldowan teaches that all three factors are to be weighed. It does not, with respect, merely require that farming be the taxpayer’s major preoccupation in terms of available time and capital.

From this it is clear that no single factor is necessarily determinative of the issue but each must be considered and given the weight it deserves in the particular circumstances before the Court.

In considering these criteria, I turn first to the time spent by the Appellant in his various endeavours. It is fair to conclude that he made a substantial commitment of time to the farming operation. It is equally fair to say that there was a correspondingly substantial commitment of time to his employment at Yellow Cab.

Although he had the necessary flexibility in his employment to suit the needs of the farm, it is evident that the Appellant in the taxation years in issue did not and could not jeopardize the income earned from his employment without which the farm operation probably could not have survived.

The importance of his employment income as the financial bulwark for an unprofitable farm operation is quite evident.

I add also the fact that the owner of a cab company who was not here during the winter clearly indicates that certain additional responsibilities were probably attended to by the Appellant during that period of time.

It is also evident that the bulk of the labour intensive work on the physical plant, and I am referring to building the barn and the fences, was completed by 1982 or perhaps 1983. It is also a fact that the training and racing of the horses was conducted by people hired for that purpose.

I further note that Mrs. Gregory, who grew up on a ranch and has a fairly extensive farm background, did much of the necessary work as a paid employee of the farm operation, she also had no outside employment.

By these comments I do not mean to belittle in any sense the amount of work done by the Appellant on the farm, particularly during the breeding and foaling season. I also accept that ongoing maintenance and repair work can be time-consuming and certainly onerous, as can the regular chore of hauling feed to the farm. Nonetheless the Appellant’s evidence in this regard must be weighed carefully and balanced in light of the above facts insofar as the taxation years in issue are concerned.

In terms of the capital committed to the farm, the amounts were, for obvious reasons, greater than with respect to the Appellant’s other activities. Although general manager and vice-president of Yellow Cab, he was not an investor in the business. Furthermore, there is little evidence regarding the capital committed to the operation following the start-up years, since other than maintenance, no improvements of any import were made to the farm. The equipment relating to the farm consisted of no more than a truck and a lawnmower.

In the taxation years in issue, the capital expenditures appear to reflect basically the purchase of horses. I must add that there was very little evidence as to the amounts of money that were spent in acquiring stock, or indeed as to the acquisition over the years of horses, excepting the purchase of two stallions, one in 1984 and the other in 1988, the latter at a price of $15,000.

As for the farm itself, no crops were grown and all feed was purchased at substantial expense. While the Appellant had fenced a sizeable portion of the farm as pasture, he conceded that it provided no more than minimal summer grazing. In terms of capacity, the farm appears to have reached its maximum capacity. Nonetheless, the Appellant did not expand the operation by purchasing more land and had no plans to do so in the future.

I observe in this respect that it appears from an analysis of the evidence that the operation was consistently shy of capital.

I turn next to the profitability, both actual and potential, of the Appellant’s operation. It showed a profit in but three of the 17 years that he has farmed and that in two of those three years there was in fact an operating loss. The losses in most years, including those under appeal, were quite substantial as shown in the following table:

Taxation Year/Farm Loss Reported

1979: (42,455)

1980: (11,868)

1981: (15,303)

1982: (7,533)

1983: (16,439)

1984: (67,008)

1985: (40,842)

1986: (34,029)

1987: (20,439)

1988: (40,610)

1989: (38,134)

1990: (36,620)

The table ends with taxation year 1990. From the material submitted during the course of the trial I note that in 1991 the Appellant reported total farm expenses of $64,270, income of $58,982, which after taking the optional inventory adjustment, produced a net farming income of $1,012.

In 1992 the Appellant reported gross farming income of $36,166, total farm expenses of $41,226, including an optional inventory adjustment from the previous year and a net farming income of $6,240 after an optional inventory adjustment of $11,300.

In his 1993 return, the Appellant declared a gross farm income of $13,900, with the total farm expenses of $34,486 for a net loss of $14,255 before adjustment and reported net farm income of $5,744, again after inventory adjustment.

In 1994 and 1995 the farm operation was for tax purposes reported as an equal partnership between the Appellant and his wife, Betty. There was an operating loss of $22,149 in 1994, with a net loss of $17,149 after adjustment.

The 1995 income was $53,359, the expenses were $50,036, operating income of $3,323 and a net loss of $1,677 after adjustment.

I should note at this point that the Appellant’s accountant in his calculations seemed to be comparing incomes and expenses in years subsequent to 1989 with those incurred or earned in the taxation years in issue. However, from 1989 or 1990 onwards, adjustments were made to inventory, quite properly I might add, but in my view it is extremely difficult to compare statements of income and expenses which are calculated prior to the use of the optional inventory adjustments with those subsequently without reflecting or having the accountant prepare some pro forma to reflect the effect of the inventory adjustments so that the different years can be compared on a relatively equal basis.

With respect to the more recent returns, I note also that in 1991 and 1992 no expenses for training horses were reported, as contrasted in fairly sizeable amounts in most preceding and subsequent years.

The Appellant himself did not train or race his horses and since 1988 he had hired a trainer to break and train his yearlings to make them more marketable, in addition to using a trainer for racing purposes. There was no explanation forthcoming from the Appellant with respect to the absence of training expenses in those two years and is but one of several unexplained accounting oddities found in the statements of farm income and expenses between 1987 and 1994.

Another item which actually created a difficulty for the taxpayer was an apparent failure to include rent expense for property leased to continue his operation after the Appellant’s farm was sold. It was not included in the income tax return for that year, although on the evidence such rent was indeed paid.

The Appellant testified that his operation was potentially profitable, he saw the success of his endeavours as being founded on the acquisition of superior breeding stock. To that end he says he acquired what he believed were two good well-bred stallions. The first in his words was “a dud.” The second purchased in 1988 is showing some signs of being a good sire. The lack of results with the first, it is alleged, coupled with disease and illnesses which caused the death of some eight foals in the years in issue were, according to the Appellant, pure bad fortune and were in great measure what prevented him from generating greater income and perhaps even profits in those years.

I have no doubt that these events played a role in the poor financial results. However, my analysis of the statements of income and expenses for the years in question leads me to conclude that even if there had been no loss of stock, there was still little likelihood of profit in those years.

I was also struck by the absence of any substantial evidence of financial projections which took into account the high risk nature of the horse business. Injuries, disease and just generally the vagaries inherent in attempting to breed race horses are factors of which the Appellant was clearly aware but there is little evidence to suggest that he took the necessary contingencies into account when he made such plans as he did with respect to the farming operation. Indeed, on all of the evidence, it would appear that the operation was constantly under-capitalized.

One final comment, a comparison of the income/profit generated by the Appellant’s sources shows that he reported employment income from Yellow Cab of $47,567; $48,247; $47,189; and $44,411 for the taxation years in issue. In those same years he reported the farm losses previously referred to. Both sets of figures are net figures and are a useful indicator. While such a comparison is not determinative of the issue, the disparity between the two is a factor which cannot be ignored.

I turn finally to the law cited by counsel. Some of the decisions relied on by the Appellant are fact-driven, as indeed most farm loss cases are, and must be scrutinized in that context. In my view, they are not entirely consistent with the decision of the Federal Court of Appeal in Morrissey and I choose not to follow them.

Hover v. Minister of National Revenue, [1993] 1 C.T.C. 2585, 93 D.T.C. 98, is distinguishable on its facts. In particular, there was reference by the trial judge, Bowman J., to evidence given by a witness. In that context Bowman J. noted:

In 1988 he hired a farm manager, Mr. Barry, an impressive witness with outstanding qualifications. Mr. Barry’s testimony persuaded me that the operation had the potential of yielding significant profits, even in comparison to Dr. Hover’s income from dentistry.

There is unfortunately no similar evidence in the present case.

The decisions in Hadley and Graham predate Morrissey and Poirier, and must be read in that context.

In my view the correct approach in appeals involving the provisions of subsection 31(1) of the Act is that expressed by Strayer J. in Mohl v. R., (sub nom. Mohl v. Canada), (sub nom. Mohl v. Minister of National Revenue) [1989] 1 C.T.C. 425, 89 D.T.C. 5236, at page 428 (D.T.C.

5238):

It now appears clear from the Supreme Court decision in Mo Ido wan as recently interpreted by the Federal Court of Appeal in Her Majesty the Queen v. Morrissey 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 the farming and from other sources. Unless the amount reasonably expected to be earned from farming is substantial in relation to the 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).

With respect to Mr. Gregory’s farming operation, not only was there no profit experienced in the years in issue but in my view, there was little realistic expectation of a substantial profit of the sort which would constitute a chief source of income within the meaning of subsection 31(1) of the Act.

Applying what I perceive to be the current view of the law to the present appeal, I am satisfied that farming was in a subordinate position to the Respondent’s employment occupation.

Farming came closest to rough equality on the time factor but it is far behind on the capital and income tests. I add that in view of my conclusion with respect to the application of subsection 31(1) of the Act the allocation of expenses issue is moot and need not be considered.

Appeal dismissed.