Shoebottom v. R., [1997] 1 CTC 2580

Sarchuk J.T.C.C.: — Thomas J. Shoebottom (the Appellant) appeals from assessments of tax with respect to this 1989 and 1990 taxation years. In computing his income for those years, the Appellant deducted the amounts of $28,864 and $14,166, respectively, as farm losses. By his reassessment, the Minister of National Revenue (the Minister) restricted the Appellant’s income to allowable farm losses of $8,750 and $5,388 as provided in subsection 31(1) of the Income Tax Act (the Act) on the basis that farming was not a “chief source of income” for the Appellant. In taxation year 1990, the Minister also disallowed expenses in the amount of $4,850 on the basis that they were not incurred by the Appellant for the purpose of gaining or producing income from a business.

The Appellant’s testimony with respect to the expense item in the amount of $4,850 established the bona fides of the expense and Counsel for the Respondent properly conceded that this was no longer an issue. To that extent, the appeal from the assessment for taxation year 1990 will be allowed.

Facts:

The Appellant comes from a farming background. Both his father and grandfather farmed and he assisted them from the time he was a child. In 1960, while still in his final year of high school, he negotiated the use of a 100-acre apple orchard from a neighbour on the basis that he would clear the trees in exchange for permission to farm the land for two years thereafter. He worked the land on this basis until 1965 when he purchased the farm for $15,000 and also rented another 100 acres. Concurrently, he completed his education obtaining certification as a school teacher. In 1970, he rented a further 300 acres from his father and uncle at which point of time he was farming a total of 500 acres, producing primarily corn, soy beans, hay and livestock. At all times during the period 1965 to 1972, he both taught school and farmed.

In 1972, he left teaching with the intention of farming fulltime. However, in the fall of that year, in order to assist his cash flow, he accepted employment as a driver for Ready Mix, a concrete supplier. He continued farming and his employment until 1980 when he purchased 1,200 acres of farmland in Orangeville, intending to cash-crop soy beans and corn. The Orangeville farm, which had not been cultivated for some time, was in a substantial state of disrepair. The Appellant tiled, drained, cleared and fenced it and in his words “made a good farm out of it”. The costs of acquisition and improvements were approximately $800 per acre, most of which was borrowed.

In the early 1980s, interest rates surged upwards with the result that in 1984, the Bank forced him into selling off some land. Matters did not improve and ultimately, the Orangeville farm and the 100 acres he owned at London were sold. He resumed employment with Ready Mix and continued to farm the remaining 400 acres (1.e. the 100 acres his wife owned and the rented land). In 1986 a receiver was appointed. The Bank continued to press him, garnisheeing his wages at Ready Mix and ultimately, he was forced into personal bankruptcy.

The Appellant was left with two good brood mares and an old truck, but since he still had available the rented farms and the land his wife owned, he refused to give up farming. He was also intent on continuing his breeding program for the hunter/jumper market which he had developed and which provided him with a steady flow of customers. From 1986 to 1988 he continued to farm using his father’s and uncle’s machinery. He took cattle in for feeding and over-wintering and grew corn, grain and hay. In 1988, the Appellant and his wife separated. Ultimately, an agreement was reached which provided that he would pay all debts on the farm owned by his wife and all of her personal debts in exchange for which she would transfer the farm to him. He paid some of the debts in 1988 and then in January, 1989 sold the farm and paid the balance amounting to some $220,000.

That same year the Appellant, with the remaining $125,000 left from the sale, purchased the 150 acres previously rented from his uncle. In May he moved into the house on the farm. He had virtually no equipment and in order to put a crop in, entered into an arrangement to use the neighbour’s machinery in exchange for 50% of the product. He continued his employment at Ready Mix which, he said, was necessary because both teenage children had remained with him. The farm operation the Appellant envisaged in 1989 was to be restricted to cash crops, principally corn, soy beans and buckwheat and the horse breeding operation. He phased out his involvement in cattle by the end of 1990. During these two years he built up a small inventory of equipment (used for the most part) and increased his horse inventory to 12 in 1989 and to 23 by 1992. With respect to the horse business, the Appellant testified that based on sales in previous years he expected a top quality hunter/jumper would fetch between $4,000 and $5,000 on the market.! [1]

With respect to the two taxation years in issue, the statements of farm income and expenses disclose the following: [2]

The Appellant referred to several factors to account for the lack of profitability in the tax years in issue. The interest expense of $34,185 claimed in 1989 reflected accumulated arrears dating back to 1985, years in which the Appellant was having financial difficulties. The separation forced immediate payment of this expense since pursuant to the Agreement he was required to pay all existing farm debts. The Appellant also observed that in both 1989 and 1990 the gross income from crop sales reflected only 50% of the actual receipts because of the crop-share arrangement.

Statements of farm income and expenses for taxation years 1991 to 1994 inclusive were filed with the Court. [3] The relevant numbers are: [4]

I make no reference to the financial statements for taxation years 1987 and 1988 other than to note that there was an excess of expenses over income amounting to $9,100 and $18,990, respectively. I consider these statements to be of limited value for comparison purposes since the events of 1988 led to substantial changes not the least of which was altered capitalisation and the need to operate on a share-crop basis.

The Appellant’s income tax returns for 1993 and 1994 were filed in September of this year. There is no indication whether a return for 1995 has been filed and no mention of that year was made by the Appellant in his testimony. Nineteen ninety-five is significant in that it was the first year following the termination of the share-cropping arrangement with his neighbour. He did produce a handwritten, one-page estimate of income and expenses for 1996 and 1997 which warrants comment. [6] For 1996, the Appellant estimated income of $40,000 and expenses of $27,000. With respect to income the amount of $24,000 reflects the sale of 2400 bushels of soy beans on the futures market. The Appellant says he expects a larger yield, in the range of 2800 to 2900 bushels and a proportionate increase in income. With respect to income from custom work, I note that in previous years the Appellant has on occasion earned more than the amount projected for 1996. On the other hand, his estimate of $9,6000 with respect to hay sales is almost double the actual sales in the years 1989 to 1994 inclusive.

It is also fair to say that for both 1996 and 1997, the Appellant’s expenses are somewhat understated in comparison to previous years. There was no explanation as to what made up the “crop input” expenses. The Appellant indicated that expenses had been reduced by changes in farming practice, particularly vis-à-vis fuel costs. That may be so but there appear to be a number of obvious expenses which have been ignored in his projections. [7] Suffice it to say that his estimates for both 1996 and 1997 are optimistic in respect of the income; sufficiently inaccurate with respect to the expenses and do not provide much assistance. The best that can be said is that the Appellant’s farm operation might break even or show a marginal profit in those years.

The issue is whether the income from the Appellant’s farming business was his chief source of income within the meaning of subsection 31(1) of

The Appellant’s employment was terminated in the latter part of 1994.

the Act thereby enabling him to deduct the entire amount of farming losses suffered by him in the 1989 and 1990 taxation years. It is not disputed that the Appellant was engaging in farming activities which constituted a source of income for the purposes of the Act. He contends that farming comprised his chief source of income and that his employment was a subsidiary interest and accordingly should not limit the deductibility of the losses which were suffered by him in the taxation years in issue.

In respect of the interpretation of subsection 31(1) of the Act, Dickson J., as he then was, stated in Moldowan v. R., (sub nom. Moldowan v. The Queen)^: [8]

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 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 (F.C.A.), leave to appeal to S.C.C. refused, (sub nom. Morrissey v. Minister of National Revenue) 100 N.R. 157 (note) 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”.

Moldowan suggests that there may be a number of factors to be considered but we are here concerned with only 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.

Counsel for the Appellant argued that the distinguishing features of “chief source” enumerated in Moldowan, supra have been met and that he is entitled to the benefit of full farm losses in those years. First, Counsel emphasised that the Appellant was totally committed throughout his life to farming and that he devoted more time to the farm income-producing activity than to his employment at Ready Mix. I accept that the Appellant spent more than adequate time on the operation of his farm and there is no evidence that it in any way suffered as a result of his outside employment.

Second, the Appellant had committed all of his capital to the farm operation. That is true. However, a simple comparison between farming and his employment in this context is not by itself of great probative value since no capital investment was required to maintain the latter. What is of greater significance is that the farm operation was under-capitalised with the result that the Appellant had to enter into a crop-sharing arrangement which made profitability in the foreseeable future questionable. It is undisputed that the income earned by him was absolutely essential if the farm operation was to continue to exist.

Third, Counsel argued that the Appellant’s reasonable expectation of profitability, both actual and potential, supported a conclusion that farming was his chief source of income. He submitted that the farm business was becoming self-sufficient and that profits are projected for taxation years 1996 and 1997. I have already indicated my discomfort with those projections.

Last, the Court was urged to favourably consider the fact that as of 1995, farming was the Appellant’s only source of income. Aside from the fact that the statement is not entirely correct, [9] it begs the issue, which is whether farming was his chief source of income in the taxation years before me. Furthermore, there was no evidence nor was it argued that the Appellant in the taxation years in issue contemplated or intended to quit his employment.

The Appellant also took the position that the taxation years in issue were start-up years and that since the bulk of his time and capital was committed to farming as a main source of income, he was entitled to deduct the full impact of start-up costs. Even if I were satisfied that these were “start-up” years, the Appellant could not succeed. The start-up concept reflects an intention to allow “what is in effect a grace period for emerging operations” [10] and is one factor which may be considered in determining whether a particular venture has a “reasonable expectation of profit”. That however is not the issue before me since the Minister has conceded by his assessment that the Appellant’s farm business will be at some point of time capable of showing a profit. There is no dispute that the Appellant is entitled to deduct farm losses and the sole question remaining is whether subsection 31(1) of the Act operates to restrict the amount of such losses which may be deducted. A conclusion that the Appellant is entitled to “start-up costs” does not lead to the further conclusion that farming was his chief source of income thereby entitling him to deduct unrestricted farm losses in those years.

In my view, the correct approach in determining a taxpayer’s “chief source of income” is that expressed by 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:

It now appears clear from the Supreme Court decision in Moldowan 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).

Applying the foregoing principles, I am not able to find that there was, in the taxation years in issue, a realistic expectation of a substantial profit of the sort that would constitute a chief source of income within the meaning of subsection 31(1) of the Act.

The appeal with respect to taxation year 1989 is dismissed. The appeal with respect to the taxation year 1990 is allowed and the matter is referred back to the Minister for the purpose of increasing the allowable expenses by the amount of $4,850. The Appellant is entitled to no further relief. There will be no costs in this matter.

Appeal dismissed.