Kuhlmann v. R., [1997] 1 CTC 2678, 97 DTC 865

Mogan J.T.C.C. — The appeals of Kuhlmann v. R. (Court File No. 92-1179) and Kuhlmann v. R. (Court File No. 92-1180) were heard together on common evidence. The Appellants are husband and wife. For convenience, I shall refer to them individually as Ruth and Peter because the word “Appellant” could apply to either one. The Appellants are both medical doctors. They practice together in a medical partnership in Windsor, Ontario. Peter has a family practice with an emphasis on Obstetrics. Ruth has a family practice with an emphasis on Paediatrics. They have practised together in Windsor since 1969 except for the year 1974-75 when they did one year of post-graduate work in Dublin, Ireland. Their respective medical practices have become intermingled over the years and, according to Peter, most patients are content to see either one of them. This gives them much flexibility.

In 1984, the Appellants purchased land and constructed a large stable containing 22 stalls for horses. They purchased 15 horses and, by the end of the year, had established an English riding facility just outside the eastern limits of Windsor. The English riding facility was operated as a partnership with Peter and Ruth as the only partners. The partnership operated under the name “Karterkroft Stables” in 1984-85 but the name was changed to “Southern Cross Stables” in 1986 and has operated under that name ever since. I shall sometimes refer to it as “Southern Cross” or “SCS”.

In each of the years 1986, 1987, 1988 and 1989, the Appellants reported in their income tax returns a substantial loss from the operation of SCS. That loss was allocated between Peter and Ruth on a 50-50 basis and each Appellant deducted his/her share of the SCS loss from his/her share of income from their medical practice partnership. By notices of reassessment, the Minister of National Revenue (the “Minister”) disallowed the deduction of the SCS losses for each year. The Appellants objected to and appealed from those reassessments and the years under appeal are 1986, 1987, 1988 and 1989. When issuing the reassessments for those years, the Minister applied section 31 of the Income Tax Act and assumed that:

(i) the activities of the SCS partnership constituted farming;

(ii) the chief source of income for Peter or Ruth in each year was neither farming nor a combination of farming and some other source of income; and

(iii) in each year under appeal, Peter and Ruth were each entitled to deduct the “restricted farm loss” (i.e. $5,000) under section 31 of the Income Tax Act.

The Appellants have consistently claimed that the activities of SCS do not constitute farming but are a business. Although the Minister assumed at the time of assessing that the SCS partnership was engaged in farming, the Minister later abandoned that position and claimed at trial that the SCS partnership had no reasonable expectation of profit. The Appellants argue that, by applying section 31 to permit the deduction of the restricted farm loss ($5,000), the Minister made a determination that the SCS partnership had a reasonable expectation of profit. The Appellants further argue that if the Minister wants to abandon his assessing position which was based on section 31 and claim that the SCS partnership had no reasonable expectation of profit, the burden is on the Minister to prove that there was no reasonable expectation of profit. Counsel for the Respondent accepted that burden of proof.

The amounts involved in these appeals are significant. Set out below are the losses of the SCS partnership before and after depreciation for the years under appeal.

Loss Before

	Depreciation	Depreciation	Net Loss
1986	$128,229	$27,590	$155,819
1987	169,976	21,165	191,141
1988	140,725	25,279	166,004
1989	177,880	23,746	201,626

The net loss of the SCS partnership for each year was allocated equally to Peter and Ruth as follows on their respective income tax returns:

The income of the medical partnership of Peter and Ruth was allocated equally between them; and each one had adequate income from the medical partnership to absorb his/her half share of the net loss from the SCS partnership. The amounts for Peter are the same as the amounts for Ruth and so I shall set out only the relevant amounts for Peter:

’Small discrepancies not explained in Exhibits A-l, A-2 and A-7.

Small discrepancies not explained in Exhibits A-1, A-2 and A-7.

1987	221,781	( 95,570)	126,211
1988	250,284	( 81,427)	168,857
1989	237,614	(100,813)	136,801

Section 31 has no application to these appeals. Therefore, the only issue is whether the Southern Cross Stables partnership had a reasonable expectation of profit in the years under appeal. On that issue, the Respondent has the burden of proof. It seems to me, however, that the burden of proof is significant in only two circumstances. First, if there were no evidence and no basic facts admitted, the party having the burden of proof would lose. And second, if the case were evenly balanced at the conclusion of evidence and argument, the party having the burden of proof would lose. In these appeals, the parties admitted the profit and loss history of SCS in the pleadings and by consenting to the entry of Exhibits A-3 to A-13 (the financial statements of SCS from 1984 to 1994 inclusive). In my opinion, the loss history of SCS makes a prima facie case for the Respondent. Counsel for the Appellants must have had the same opinion because he called as witnesses Peter and Ruth and an expert, Ian Millar. Counsel also read into the record part of the examination for discovery of Mr. Spiro, a representative of the Respondent. Counsel for the Respondent did not call any witnesses.

Peter Kuhlmann was born, raised and educated in Australia. He finished medical school there in December 1966. Ruth Kuhlmann moved to Australia as a child with her family and was in medical school there at the same time as Peter. They married immediately after graduation in 1966 and came to Canada in 1968. Except for a year of post-graduate work in Ireland in 1974-75, they have lived in Windsor since 1969.

Peter became interested in horses as a child in Australia because his father had always owned and raced horses there. He accompanied his father to the stables where the horses were being trained and grew up with horses as part of his life. When the Appellants came to Canada in 1968, Peter’s parents moved to Dublin, Ireland, where his father established a practice and continued his interest in horse racing. Peter became a partner with his father in various horses that he (the father) was training and racing in Ireland. This association lasted from 1969 until the early 1980s. Peter does not ride horses at all because of some allergy, and he has not ridden a horse since he was about 14 years of age.

Ruth became interested in horses only through her marriage with Peter. She said that during their year in Ireland (1974-75) and whenever they visited Peter’s parents there, they attended race meetings, show jumping meetings and county shows. Ruth does not ride horses but, for a six-month period in 1983 when their two older children took riding lessons, she -accompanied them and took lessons herself from July to December. She ■las not ridden a horse since 1983. Peter and Ruth have three children who —were born around 1970, 1973 and 1985.

It was through the riding lessons of Ruth and the two older children in 1983 that the Appellants got the idea of establishing their own facility for English riding. The arena where they took their lessons was an old building; it was drafty, very dusty and cold in the winter. Also, it was located at the west end of Windsor when most of the potential clientele for riding lessons lived at the east end of the City. Ruth concluded that it was difficult to do English riding in Windsor because the facilities were inadequate and at the wrong end of the City. The Appellants reviewed the situation and decided that a new English riding school would be successful at the east end of the City because it would be close to potential customers and Windsor is an affluent industrial city.

In 1975, the Appellants had incorporated “Clinical Management Services Inc.” (referred to herein as “CMS Inc.”), a company which purchased land and constructed a building in which they carry on their medical practices. The building also contains an X-Ray Unit, a laboratory, a pharmacy, a chiropractor and a psychologist.

Early in 1984, the Appellants found 26 acres of land for sale just outside the eastern limits of Windsor. They caused CMS Inc. to purchase the land for $130,000. They tiled the whole property to achieve proper drainage, and then contracted for the construction of a stable/arena building. Exhibit A-21 is a series of 15 photographs of the property featuring the building. In addition to the stalls for 22 horses, there was an enclosed arena where riding lessons could be given through the winter and other times of bad weather. The Appellants put a great deal of thought into the design of this building with respect to the storage of hay, the removal of manure and two extra stalls for washing horses to ensure that the care of the horses would not be labour intensive. When the facility was completed at the end of 1984, CMS Inc. had invested $360,000 including the costs of the land, the tiling for drainage, the parking area and the stable/arena building. Over the next four to five years, the company invested another $100,000 in fences and run-in sheds.

The Appellants had made a policy decision that the fixed assets (land, building, parking area, fences, etc.) would be owned by CMS Inc. These are the assets which cost about $360,000 by the end of 1984 and $460,000 by 1989. Everything else required to operate the English riding School would be owned by the SCS partnership. This would include “tack” (saddles and bridles), stable equipment, feed, automotive equipment, and most important, the horses. In the latter part of 1984, the SCS partnership purchased 15 horses for an aggregate cost of $44,000. The SCS partnership also paid approximately $30,000 for automotive equipment and $20,000 for tack and stable equipment. The financial statements for SCS at December 31, 1985 (Exhibit A-4) show an inventory of horses at $32,230 and the undepreciated cost of equipment at $125,290. In 1985, SCS had sold and purchased a few horses. This is why the inventory value of horses at December 31, 1985 was down from the cost of the first 15 horses purchased in 1984.1 therefore conclude that SCS had invested not less than $160,000 in the English riding School by the end of 1985.

At the beginning of 1986, the first year under appeal, the Appellants directly or indirectly had invested $520,000 in the English riding School which was to be operated by SCS. They had invested $360,000 through CMS Inc. the shares of which were owned by a trust or otherwise for the benefit of the Appellants and their children; and they had invested $160,000 themselves by direct contribution to the SCS partnership. In order to provide a 10% return to the company on its investments ($360,000) in the fixed assets, the Appellants had agreed in 1984 that SCS would pay annual rent of $36,000 to CMS Inc. This rent was pro-rated for 1984 but shown as a full expense in the years 1985 through 1989.

The SCS operation had two quite different divisions. One could be called “lessons and boarding” and the other “horse development”. In the lessons and boarding division, SCS would earn fees by providing lessons for those persons (adults and children) who wanted to learn English riding, and would earn other fees by boarding (feeding and caring for) horses which belonged to individuals who did not own a stable facility. There was a basic fee for boarding a horse but SCS would charge an additional fee if the horse owner expected the SCS staff to wash and groom the horse. Some of the persons taking lessons would have their own horses which would be boarded at the SCS stable. These persons would ordinarily take lessons on their own horses. Other persons taking lessons would not own a horse and would rely on SCS to provide both the horse and the instructor. Peter described these horses as follows:

...the first thing we needed to get the initial business started was you had to have a series of school horses. By “school” horse, I mean a horse that is safe to put a beginner rider or any rider on, who knows enough to respond to the rider’s aids, which are the signals the rider gives the horse to get the horse to make different movements or to approach a fence or jump a fence or whatever. And so we needed a group of those horses, and we started off with a fairly extensive group.

[Transcript page 174.]

Of the first 15 horses purchased in 1984, 10 were “school” horses and five were for development.

The horse development division was intended to acquire young horses of higher quality than the “school” horses and develop them to the stage where they could compete on the “A” Circuit. Mr. Millar (an expert witness) described the three stages of training as follows. Basic training gives a horse the skills of obedience; how to walk, trot, canter, do a small course of jumps and be ready for local competitions. Intermediate training brings a horse to the level where it can compete in a series of competitions throughout Canada rated by the national federation and known as the “A” Circuit. The top end of the sport is Grand Prix Jumping or Grand Prix Dressage which is international competition. In terms of a horse’s age, oasic training may take from age three to five or six. Intermediate training nay take from age five or six to age eight or nine. And depending on the horse’s ability, grand prix or international competition may go from age eight or nine to age 15 or 16. The Appellants’ business plan was based on the premise that training adds value. If they could buy good quality horses at a young age and develop them through basic and intermediate training to compete effectively on the “A” Circuit, they expected to sell those horses at a good profit.

It is apparent from the tables set out above that the SCS partnership had significant losses in the four years under appeal. Exhibits A-3 to A-13 are the financial statements of SCS for the years 1984 through 1994 respectively. Those exhibits disclose the following record of profit and loss.

1984 : $ 58,968 loss (part year)

1985 : 126,340 loss

1986 : 155,819 loss

1987: 191,141 loss

1988: 166,004 loss

1989 : 201,626 loss

1990: 190,754 loss

1991 : 167,142 loss

1992 : 14,883 profit

1993 : 10,691 profit

1994: 29,259 profit

The losses are staggering. The aggregate losses for the four years under appeal (1986 to 1989) are $714,590. The accumulated losses for the years 1984 through to 1991 are $1,257,794. The aggregate profits for the most recent three years (1992 to 1994) are $54,833; and that aggregate three- year profit amount is less than one-third of the loss suffered in any one of the preceding five years (1991 back to 1987). For the reasons set out below, I have concluded that the SCS partnership did not have a reasonable expectation of profit in any one of the years under appeal. Indeed, I am inclined to the view that the SCS operation was more of a hobby and less of a business to which section 9 of the Income Tax Act might apply.

One of the dominant facts in these appeals is Peter’s love of horses from his early youth. At the beginning of his evidence, he described in examination-in-chief his long association with horses:

I became interested in horses in the first place as a child in Australia because my father had always owned and raced race horses and I, therefore, was exposed to it. I liked the animals, I found them rather majestic, and whenever my father went to the stables where his horses were being trained, I would accompany him; and that would usually be on the weekends, occasionally on a Wednesday. I grew up with that.

And then subsequently, at the time period when I moved to Canada, my mother and father and younger brother moved to Dublin, Ireland. My father established a practice and he, of course, continued his interest in horse racing. And at that time, I became — not just an interested spectator but I became a partner financially with him in the various horses that he was racing at tha" time. And this association went basically from the late 1960s, that would be 1968-69, onwards until the early 19808.

to continue that aspect of it, of course, the year that I spent in Ireland doing my post-graduate work, I was very heavily involved with him in the horse racing, selection of horses and observing their training and decisions as far as where to race the horses, what class of race and so forth.

[Transcript pages 112-13.]

And under cross-examination, Peter gave the following answers:

Q. And with respect to the stable, you enjoy both parts of the business: the developing of the young jumpers, young horses, and teaching people how to ride?

A. Yes.

Q. And that’s important to you, to teach people how to ride, to introduce them to horses?

A. Yes, it is, because most people who get involved are attracted to the animals in the same way I am, so it is a pleasure to see them develop.

[Transcript page 300. ]

Although the Appellants paid out significant amounts in the operation of Southern Cross Stables and attempted to recover those amounts through revenues from riding lessons, the boarding of horses and the sale of development horses, I cannot avoid the view that the Appellants’ motive in operating SCS was more hobby than business. The Appellants’ love of horses and their determination to be known on the “A” Circuit (i.e. beyond the Windsor area) blinded their judgment and caused them to move forward when dispassionate business persons not in love with their “product” (i.e. horses) would have retrenched or changed direction. I will describe three specific situations when the objective business judgment of the Appellants was subordinated to their motive, as horse enthusiasts, to become known on the “A” Circuit as the owners of a good quality riding stable.

The first situation was a decision in 1986 to send certain development horses to Toronto for training on the “A” Circuit. Mark Carter was the first manager of SCS when it opened in late 1984. At that time, he was one of the most popular riding teachers in Windsor and had been the teacher for Ruth and the two older children. The Appellants’ plan was that Mr. Carter would teach riding on the school horses and develop the other horses to oerform on the “A” Circuit. Peter described this plan as follows:

First of all, you had to have a proper facility. That meant a facility that provided sufficient boarding, both for your school horses and for other people’s horses.

You had to have the proper riding facilities, and by that I mean primarily you had to have a good indoor arena so that people could partake of the sport year round. You also had to have an outdoor arena for the summer time.

And the facility had to be placed in the right part of the city to make it easy for the people to access from their homes, the people who were likely to go there.

So, all of this we did. We established a suitable facility. On top of that, and looking at the sport, we realized that we needed to make a name for ourselves. We also needed to train and develop young horses to give us extra profit. And once the original facility was established and we had the appropriate employees in place, the development of young horses would be relatively inexpensive — in fact would be very inexpensive.

So that the original plan was to have the stable operation making income from lessons and boarding primarily, as well as developing young horses, which was more of a long-term project but would have the potential for excellent profits. But the idea was to run the two things in tandem and, as it developed on, I felt that we could make a small profit out of the boarding and lesson operation and then make the cream out of the developing of the younger horses.

[Transcript pages 118-19.]

Making the “cream” out of developing the younger horses was dependent upon the presence of a qualified trainer like Mark Carter at the Southern Cross Stables in Windsor. Mr. Carter had shown horses on the “A” Circuit and had extensive knowledge of the Circuit and the horses (transcript page 120). The original plan was that Mr. Carter would give the riding lessons on the school horses and also train the development horses for the “A” Circuit. This is what would make the development of young horses “very inexpensive” in the words of Peter. A problem developed at the end of 1985 when Peter and Ruth realized that Mark Carter was interested only in training the development horses. He did not have his heart in the business of giving lessons and attracting boarders which was the bread and butter of the operation (transcript page 181). He would sometimes miss lessons and be impolite with clients. Mr. Carter left SCS at the end of December 1985.

The departure of Mark Carter left the Appellants with a serious decision. It was necessary either to hire a new stable manager qualified to train the development horses or to send those horses out for training or to withdraw from the second division of the SCS operation (i.e. horse development). The Appellants were unable to attract a new manager with the necessary qualifications. They hired Kate Hoffman to run the stable and give riding lessons and increase the boarding revenue but she was not qualified to train a horse for the “A” Circuit. The Appellants decided that the two development horses (Matador and Forced Landing) which were farthest advanced in their training for the “A” Circuit would be taken ou of the home stable at Windsor and sent to Toronto for training by a well- recommended woman, Kim Kirton. Ms. Kirton did not operate a stable ofl her own and so the horses had to be boarded at a Toronto stable where Kim Kirton could train them. Forced Landing was sold in 1986 and Comber (a development horse) was purchased in that year.

When a replacement for Mark Carter could not be hired, the choice for the Appellants between sending the development horses to Toronto for further training or withdrawing from the horse development division of their operation was a real fork in the road. The decision to send the horses to Toronto started the Appellants down the road to truly significant losses which are reflected in the four years under appeal. Peter’s statement that “the development of young horses would be relatively inexpensive - in fact would be very inexpensive” was based on his assumption that SCS would have “the appropriate employees in place”. Peter and Ruth knew, or should have known, that without an “in-house” trainer for the “A” Circuit, the cost of developing horses would increase greatly if they were sent out for training.

In 1984, Peter thought that SCS could develop a horse for the “A” Circuit at a cost of about $8,000 per year because the basic costs (boarding and training) were covered at the home stable; and the only expenses directly connected with showing a horse were transportation, entry fee, and the stabling and feeding while at the show (transcript page 310). This evidence was not challenged and I accept Peter’s judgment that in 1984 the cost of developing a horse for the “A” Circuit would be about $8,000 per year per horse if the horse was kept and trained at SCS. The SCS financial statements provide some evidence of how much the development costs increased after 1985 when horses were sent to Kim Kirton at Toronto. The horses which were placed in the care of Kim Kirton at Toronto in the respective years were as follows:

The SCS financial statements for the years under appeal (Exhibits A-5 to A-8) list specific expenses for wages and boarding. Peter explained that the amount for wages included training fees paid to Kim Kirton and, under cross-examination, he allocated wages between the Windsor employees and Kim Kirton’s training fees. The boarding expense was the cost of keeping at Toronto those horses which Kim Kirton trained. The relevant amounts are as follows:

I obtained the “average per horse” by dividing the number of horses in the care of Kim Kirton in the second table above into the aggregate of boarding expenses plus Kim Kirton’s fees in the table immediately above. It is a most imperfect average because there is no evidence to show the particular month in a given year when a horse was sent to or brought back from Toronto. Also, other expenses directly connected with shows on the “A” Circuit like transportation, entry fees and stabling at the shows are not available to include in the annual development costs. In any event, this “average per horse” amount can be compared with Peter’s original estimate of $8,000 per horse per year to train for the “A” Circuit . Although this imperfect average per horse amount is not greatly in excess of the $8,000 estimate (except for 1987), it must be remembered that each horse was trained for more than one year, and these are the horses from which Peter expected to make “the cream” upon their sale. History has shown that the cream was not there.

I will trace the history of the five development horses (Matador, Comber, Shawline, Antartic and Timmy) sent to Kim Kirton to see if I can determine whether SCS made a profit or loss on the ultimate disposition of those horses. I am required to attempt this determination of profit or loss by extrapolating relevant amounts from the SCS financial statements and other evidence because the Appellants put forward no evidence to show whether they made a profit or loss on any particular development horse after taking into account its purchase price, accumulated annual training costs and selling price. I find the absence of this evidence disappointing and detrimental to the Appellants because (i) Peter said that they expected to make significant profits (i.e. the “cream”) from developing younger horses; and (ii) the significant losses in the years under appeal should have persuaded the Appellants to perform a cost analysis of each development horse computing its current cost on the books of SCS by taking into account its purchase price plus accumulated annual development costs whether they be oin-house” at Windsor or fees paid to train and board the horse away from Windsor. If this kind of analysis was performed, it was not put in evidence. If it was not performed, then the Appellants could not know whether they made a profit or loss on the disposition of any development horse. The Appellants are intelligent and sophisticated individuals. If they were operating SCS as a business, a current cost record of each development should have been a necessary tool of that business.

Peter clearly stated in evidence that training increases the value of a horse and, if it is taken out of training and competition and put in a field for six months, it will lose its skills (Transcript pages 121 and 198). Also, after a certain age a horse will depreciate. The value of a horse depends upon its age and its possession of the necessary skills for the “A” Circuit. Therefore, after training has developed a horse’s skills to the “A” Circuit level, it must continue if the horse is to develop and maintain its best skills and achieve its highest value. Training is costly, and it is not optional. Any horse owner wanting to compete and sell a horse on the “A” Circuit must hope that the accumulating annual costs of training will be recovered in the ultimate sale price. For example, SCS did not recover its training costs when it sold Matador as shown in the following paragraph.

Matador was purchased in 1984 for $14,000 as a four year old and sold in 1990 for $42,000 as a 10 year old. The profit on sale appears to be $28,000 ($42,000 minus $14,000) but Matador was in training every year from 1984 to 1990; six years at a minimum cost of $8,000 per year. If I assume that the cost of training Matador was $8,000 in 1985 because he was at SCS under the care of Mr. Carter, and if I assume that the cost of training him in the years under appeal was the “average per horse” in the table immediately above, the total cost of training Matador in the years 1985 through 1989 was:

I will ignore any training/boarding costs for 1984 the year Matador was purchased and for 1990 the year he was sold. If the above total training costs of $57,600 are added to the purchase price of $14,000, SCS had invested not less than $71,600 in Matador when he was sold in 1990 for $42,000. For SCS, there was no profit but only a significant loss in the purchase, training and sale of Matador.

Comber was purchased in 1986 for $10,000 and placed in the care of Kim Kirton for training on the “A” Circuit. It performed well on the “A” Circuit in 1986 (Exhibit A-17) but then broke a bone in his foot and became valueless as a jumper. SCS made no profit on Comber.

Shawline was purchased in 1987 for $30,000 when he was 14 or 15 years old and near the end of his career as a competing jumper. Shawline had competed on the grand prix circuit in international competition but, in 1987, it was on its way down. Shawline was purchased to give Southern Cross Stables a higher profile on the “A” Circuit. Exhibit A-17 shows that Shawline competed effectively in 1987, 1988, 1989 and 1990 before it was retired. Shawline was retired after the 1990 season when it was about 17 or 18 years old. Shawline was not sold and so there was no profit made on its purchase and training. Indeed, if the training costs of approximately $40,000 for the years 1987 to 1990 are added to the purchase price of $30,000, there was a loss of about $70,000 on Shawline when it was retired after 1990. Shawline’s presence on the “A” Circuit, however, may have given SCS a higher profile, whatever that means in the purported business of SCS.

Antartic was given to SCS as a gift from Peter’s father in 1987. At that time, Antartic was almost four years old. His basic training was not completed at that time and Peter said: “We did the basic training on him”. That could mean that his basic training was done at Windsor but Exhibit A-17 shows that Antartic was competing on the “A” Circuit in 1988, 1989, 1990 and 1991.1 therefore infer that he was in the care of Kim Kirton in 1988, 1989 and until August 1990 when he was transferred to the care and training of Ian Millar. Peter described Antartic as follows:

“ANTARTIC” was probably the best jumping form horse I have ever seen in my life. The only problem is he could not jump much more than four foot. In fact, with good riding, you could sneak him around a 4’6” course with a little bit of luck, and that is because his jumping form was so perfect. So, as a young horse, he looked very very promising. He had the breeding and we thought he would go to a lot higher. He did not.

[Transcript page 247.]

Notwithstanding the training by Kim Kirton for two years and by Ian Millar for two years, Antartic was sold in 1992 for $25,000. Although Antartic was a gift to SCS from Peter’s father, the $25,000 proceeds of sale was much less than the accumulated training fees paid to Kim Kirton and Ian Millar over the five-year period 1988 to 1992. In other words, SCS lost money on the acquisition (gift), training and sale of Antartic.

Timmy was acquired as a weanling (three months old) in 1984 when SCS purchased his mother (“Caprice”) as a school horse. Timmy’s basic training was done at Windsor but at the end of 1987 or early in 1988, he was sent to Kim Kirton at Toronto. He competed on the “A” Circuit in 1988 and 1989 but developed ring bone and went lame in 1990. He was disposed of in 1990 with no proceeds of sale. Therefore, the costs of keeping Timmy as a colt from 1984 to 1986 plus the further costs of developing and training Timmy in 1987, 1988 and 1989 (not less then $30,000 in total) were lost.

I have traced the history of the five development horses which were placed in the care of Kim Kirton at various times in the years under appeal to determine whether SCS made a profit or loss on the ultimate disposition of those horses. According to my analysis, and in the absence of any such evidence from the Appellants, SCS lost money in excess of the following respective amounts through its acquisition, training and disposition of these five horses: Matador ($30,000), Comber ($18,000), Shawline ($70,000), Antartic ($75,000) and Timmy ($30,000). I repeat that SCS lost money in excess of the above amounts for each horse. Although Antartic was a gift to SCS, his training and development costs were very high because he was with Kim Kirton for two and one-half years and with Ian Millar for two years. Peter testified: “Ian was expensive”. I will comment below on Mr. Millar’s involvement with SCS.

The second situation in which the business judgment of the Appellants was subordinated to their desire to become known as serious players on the “A” Circuit was their purchase of three expensive horses. In 1989, SCS purchased an eight year old horse called David for $78,000. In 1990, SCS purchased Infinity (sometimes called “Frenchie”) for $50,000 (US) and Code Blue (sometimes called “Sam”) for $25,000 (US). Assuming that a Canadian dollar in 1990 was worth 80 cents US, the cost of Infinity and Code Blue can be stated in Canadian dollars as $62,500 and $31,250 respectively. Although these were expensive horses, they were fully trained and ready to compete on the “A” Circuit. It must be remembered, however, that any SCS horses competing on the “A” Circuit in 1989 and 1990 had to be boarded away from Windsor with a qualified trainer like Kim Kirton because the Appellants did not have a similarly qualified trainer at the home stable in Windsor.

David competed well in 1989 and 1990 but then died of cancer. His death was a great blow to the Appellants and their stable, resulting in a loss of not less than $90,000 (training fees included). Infinity competed in 1991 and 1992 but then went lame. At the time of hearing these appeals in 1995, Infinity was back at the SCS stable at Windsor and still lame but Peter said that there was a small chance that he might come back to compete if the lameness went away. Code Blue competed well in 1990, 1991 and 1992 and was sold for $40,000(US). Exhibit A-15 indicates that Code Blue (“Sam”) was sold in 1994 but Peter stated in oral testimony that he was sold in 1992 (transcript page 254). I will assume that Code Blue was sold in 1992 for an apparent profit of $15,000 (US) or $20,000 (CAN). This profit is only apparent because Code Blue was trained by Ian Millar from August 1990 until August 1992 at a cost of approximately $30,000 per year. If the training fees of approximately $60,000 are added to the cost of $31,250, the sale at $40,000 (US) or $50,000 (CAN) resulted in a significant loss.

In summary, the Appellants lost not less than $90,000 on the death of David. They have expended about $122,500 on Infinity (cost of $62,500 plus $60,000 for two years of training under Ian Millar), a horse which is now lame at the SCS stable. And they lost about $40,000 (cost of $31,250 plus training fees of approximately $60,000 less sale price of $50,000) on the sale of Code Blue. These three horses were purchased in 1989 and 1990 when the SCS stable had lost an aggregate of $512,000 in 1986, 1987 and 1988. If riding lessons and boarding horses at Windsor were the “bread and butter” of the business as stated by Peter, why would the Appellants lay out $171,000 ($78,000 plus $62,000 plus $31,000) for these three horses which were trained and ready to compete on the “A” Circuit when the Appellants did not have an “in-house” trainer for that circuit. The three horses were costly. The outside training by Kim Kirton and Ian Millar was costly. And yet the Appellants embarked in 1989 and 1990 upon a campaign to compete on the “A” Circuit which was destined to lose money because they did not have an “in-house” trainer which would have permitted them to keep the horses at Windsor. The aggregate losses on David, Infinity and Code Blue are about $250,000 ($90,000 plus $122,000 plus $40,000). In business, as in life, people walk before they run. The Appellants were too anxious to be running on the “A” Circuit before they were walking steadily in the business of riding lessons and boarding horses and developing their own horses with their own trainer. This is more the anxiety of people engaged in a costly hobby than the objective judgment of people determined to build a successful business.

The third situation in which the Appellants’ desire to compete and become known on the “A” Circuit overrode their business judgment was their decision to send certain horses to Ian Millar for training. Ian Millar testified as an expert witness for the Appellants in these appeals. Mr. Millar is one of Canada’s leading equestrians. He has represented Canada on equestrian teams at the Olympics in 1972, 1976, 1980 (alternate Olympics at Rotterdam - Gold Medal), 1984 and 1988. In 1986, he was awarded the Order of Canada for his contribution to the equestrian sport in this country. In August 1990, the Appellants transferred Antartic, Infinity and Code Blue to Mr. Millar for training at his stable near Perth, Ontario. Those three horses were with Mr. Millar until August 1992. The financial statements of SCS indicate that the Appellants paid fees to Mr. Millar of $30,000 in 1990; $117,000 in 1991; and $75,000 in 1992 (Exhibits A-9, A-10 and A-l 1) for the training of the above three horses plus a fourth horse which Mr. Millar sent back after a few months. The decision to send those horses to Mr. Millar in 1990 after the staggering losses in 1985 through 1989 is similar to the decision to buy Infinity, Code Blue and David. The very expensive training fees, all for the “A” Circuit, contributed to the losses suffered on the sales of Antartic and Code Blue and on the retirement of Infinity.

I have reviewed the three situations above with the benefit of hindsight but, if the Appellants had been operating SCS like a business, they would not have had to wait for the sale or other disposition of a development horse to know whether the “A” Circuit portion of their business was making a profit. Each development horse had the potential for profit or loss. The Appellants knew the purchase price of each horse. They also could estimate with reasonable accuracy the annual costs for training. It is not too much to expect that they would have kept a log for each development horse showing its current cost at any time by accumulating its purchase price and its annual training costs. If such a log had been kept, they could have appraised each horse at any time and compared its market value to the current cost to know how they stood. There is no evidence that any such log was kept.

I have the impression that in these three situations (sending certain horses to Kim Kirton, buying three expensive horses, and retaining Ian Millar as a trainer), both Appellants were plunging forward in the “A” Circuit portion of their business not because they had, with appropriate reflection, a reasonable expectation of profit but because they could afford to be on the “A” Circuit and were determined to be there. More than once, Peter referred to English riding as a luxury sport or luxury occupation (transcript pages 116 and 192). English riding, as a business, is very different from making pencils or light bulbs; and very different from growing potatoes or wheat. Each horse is given a distinctive and personal name; it receives a great amount of care and training; it may be regarded by its owner as a majestic animal; and a bond develops between the owner and the horse. A different kind of bond develops among the horse owners. They meet on the “A” Circuit to compete and compare in a sporting environment very different from the competition among persons who make pencils or light bulbs. There is a social element to English riding: a desire to see the horse achieve in competition like a gifted child, and a desire to meet with other owners having similar horses at the same level of competition. English riding is motivated by factors beyond the bottom line” which is the principal motive for persons who make pencils or light bulbs and who grow potatoes or wheat.

Ian Millar appeared as an expert witness and his report, entered as Exhibit A-18, contains the following description of English riding:

16. The International Equestrian Federation and the Canadian Equestrian Federation recognize the following equestrian disciplines:

(a) show jumping;

(b) dressage;

(c) three-day eventing;

(d) endurance;

(e) vaulting; and

(f) combined driving.

17. Of this group, three equestrian disciplines are Olympic sporting events. These are:

(a) show jumping;

(b) dressage; and

(c) three-day eventing.

18. These three events are commonly referred to as English riding. English riding focuses on the training and obedience required of a good hunter/jumper horse.

At another place in his report, Mr. Millar states:

30. A very good living can be made from the business of English riding. The sources of income from the business are varied but they generally include:

(a) giving lessons and the training and stabling of horses owned by others. (b) the sale of trained horses: and

(c) earnings from show jumping events.

I have great respect for Mr. Millar as an equestrian but I put little weight in his opinion that “a very good living can be made from the business of English riding”. That is like having Wayne Gretzky state that a very good living can be made from playing hockey! Mr. Millar has outstanding achievements with horses and an extraordinary personal goodwill which he brings to his own stable, very different from horse owners and enthusiasts like the Appellants who must start with no reputation as equestrians.

After these two appeals were heard, the Federal Court of Appeal delivered its decision in Tonn v. R., [1996] 1 C.T.C. 205, 96 D.T.C. 6001. In that case Mr. Justice Linden, on behalf of the Court, reviewed the jurisprudence concerning “reasonable expectation of profit” and, in particular, the decision of the Supreme Court of Canada 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. Linden J.A. stated, at page 225 (D.T.C. 6013):

I otherwise agree that the Moldowan test should be applied sparingly where a taxpayer’s “business judgment” is involved, where no personal element is in evidence, and where the extent of the deductions claimed are not on their face questionable. However, where circumstances suggest that a personal or other- than-business motivation existed, or where the expectation of profit was so unreasonable as to raise a suspicion, the taxpayer will be called upon to justify objectively that the operation was in fact a business. Suspicious circumstances, therefore, will more often lead to closer scrutiny than those that are in no way Suspect.

In Tonn, the Federal Court of Appeal allowed an appeal by certain taxpayers and the reasoning is summarized by Linden J.A. in the following passage, on pages 226-27 (D.T.C. 6013):

As should be readily apparent, the most important factor in this case is the nature of the operation from which the deductions were claimed. This operation was purely commercial. It was a real estate venture, and did not involve an element of personal satisfaction for those operating it. By personal satisfaction, of course, I mean that the rental operation had neither a hobby nor a personal benefit element about it. The taxpayers purchased the property as a form of business investment. It was not a residence for them. It was not a future retirement home in some balmy southern climate. Neither was it a residence for children or other relations. It was a residential property purchased for commercial purposes. There was nothing suspicious about it.

The recent decision in Tonn restricts the application of the Moldowan test but, where a personal or hobby motive exists, the taxpayer must justify objectively that the operation was in fact a business.

In Tonn, the Federal Court of Appeal could accurately state: “This operation was purely commercial”. I cannot make that statement about the operation of Southern Cross Stables. If it had been purely commercial, SCS would have been bankrupt before 1990 as it was in fact operated or, alternatively, the Appellants would have cut back on the development of horses for the “A” Circuit and built a more solid revenue-producing business from riding lessons and boarding horses. I find that the operation of Southern Cross Stables was at least in part a hobby for the Appellants. I also find that the Appellants derived a personal satisfaction from having their own horses on the “A” Circuit; and their determination to be on the “A” Circuit was motivated more by personal satisfaction than by commerce or business or any objective view that there was a reasonable expectation of profit.

In one of the tables above, SCS showed modest profits in the year 1992, 1993 and 1994. That profit was possible only because Clinical Management Services Inc. (the Appellants’ family corporation which owned their medical office building plus the SCS land and stable building) exchanged its position as landlord for a position as partner in SCS. This eliminated the annual rental expense of $36,000 which was charged to SCS in the years 1985 through 1989 inclusive. The rent of $36,000 was started in 1984 because the Appellants thought that CMS Inc. should earn a 10% return on the cost of land plus stable building. If that was a reasonable arrangement in 1984 (and I am satisfied that it was), the transformation from landlord to partner in 1990 was certainly not a reasonable business decisions from the viewpoint of CMS Inc. having regard to the loss record in SCS. If CMS Inc. had been at arm’s length with the Appellants, I am satisfied that it would not have exchanged its position as landlord for a new position as partner. There was an element of artificiality about the transaction. It permitted SCS to increase its chances of showing a profit by getting rid of a $36,000 annual rental expense. Also, the participating percentage of CMS Inc. in the SCS partnership appears to be very arbitrary from year to year.

The assessments under appeal were based upon section 31 of the Income Tax Act and each Appellant was allowed the “restricted farm loss”. The parties agree that section 31 has no application to these appeals and the only issue is whether the Appellants had a reasonable expectation of profit with respect to the operation of SCS. Counsel for the Appellants relied on the decisions in Hover v. Minister of National Revenue, [1993] 1 C.T.C. 2585, 93 D.T.C. 98 (T.C.C.), First Farm Inc. v. R., (sub nom. First Farm Inc. v. Canada), [1994] 1 C.T.C. 2584, 93 D.T.C. 1237 (T.C.C.) and Binks

V. R., (sub nom. Binks v. Canada) [1994] 2 C.T.C. 2105 (T.C.C.). In Hover, Bowman J. made the following statement, at page 2596 (D.T.C. 106):

It was not pleaded or contended by the respondent that the appellant did not have a “reasonable expectation of profit”. The relevance of the expression in the context of section 31 is that to obtain even the limited deduction granted by section 31 the taxpayer must have a business. Without a reasonable expectation of profit no business exists. That is not in issue here. Once it is conceded, either by the very fact of applying section 31 or otherwise, that a business exists, the taxpayer’s reasonable expectation of profit ceases to be a factor in determining whether he is to be subject to the restrictions of section 31. It is true that the concession implicit in the fact that the Minister applied section 31 is not necessarily binding on the court if the facts clearly establish that there was no hope of ever making a profit....

In my opinion, the concession made by the Minister of National Revenue in applying section 31 would be relevant only if the Respondent in these appeals were attempting to defend the assessments as based on section 31. Counsel for the Respondent conceded in argument that the Minister should not have applied section 31 and should not have allowed the restricted farm loss. The Minister cannot now retract that allowance but, on the other hand, counsel for the Appellants has made no attempt to claim or argue that the Minister is estopped by the concession he made in his erroneous application of section 31.

The Respondent has the burden of proving that SCS did not have a reasonable expectation of profit in the years under appeal. Counsel for the Appellants emphasized that burden in his argument. The pleadings, however, disclosed the magnitude of the losses in the years under appeal. Those losses, in my view, make a prima facie case for the Respondent. Counsel for the Appellants must have had the same view because he led off by calling the Appellants and Mr. Millar as witnesses. The onus of proof would be relevant if these appeals had been evenly balanced at the conclusion of evidence and argument. These appeals were not evenly balanced by any standard. The appeals are dismissed with costs.

Appeal dismissed.