Ivan E. Schimmens and Mary Shushack v. Her Majesty the Queen, [1996] 3 CTC 2132 (Informal Procedure)

Bowie J.T.C.C.: — These two Appellants are husband and wife. Their appeals are from the disallowance by the Minister of their claims for restricted farm losses under section 31 of the Income Tax Act. The two appeals were heard together on common evidence, and Ms. Shushack was the only witness.

Ms. Shushack is a lawyer with a busy practice in Pembroke. Mr. Schimmens is employed by her as a law clerk. In the autumn of 1980 they acquired a 90-acre farm near Pembroke, together with an old farmhouse, and outbuildings. Shortly thereafter they added a contiguous six-acre parcel which had been part of the original farm. They have worked it since on the basis of an equal partnership. The farmhouse required considerable renovation, which they undertook soon after, along with a certain amount of work which was required to repair the outbuildings. The farm had been worked from about 1860 until about 1970; between 1970 and 1980 it had been used only for the raising of pigs, and the fields and fences had fallen into considerable disrepair. The Appellants acquired the farm with the intention of restoring the house for use as a residence, and restoring the fields and other accoutrements to the point where the farm could be used for the raising of cattle and sheep. It was their intention to work it on a part-time basis in the immediate future, with a view to engaging in full- time farming after retirement, which in the case of Ms. Shushack would not likely take place for some 30 years after the date of acquisition in 1980. Ms. Shushack comes from a farming family, and it was clear from her evidence that she has a good deal of knowledge related to farming operations, some of it no doubt acquired since 1980, but much of it predating that time. She also has a number of relatives in the area who are experienced farmers and to whom she could, and did, turn for advice and assistance from time to time.

In the years between 1983 and 1987 both Appellants put much effort into the restoration of the fields, which had become overgrown and weed- infested, and into the repair and building of fences. They acquired some sheep and goats in this period, more to assist in brushing the fields than with any expectation of being able to realize profit from raising them. Considerable losses were incurred during these years, but no claim was made for these losses as Ms. Shushack considered this to be a start-up period in which it was not reasonable to expect to make profits, and therefore not reasonable for them to deduct losses.

Ms. Shushack also gave evidence as to a business plan that she and her husband had prepared. This document indicated plans for a capital investment of some $21,000, primarily in fencing, over and above the acquisition cost of the land and buildings. It is silent as to other capital investment, and as to the apportionment of the purchase price as between the farming operation and the residential premises. Clearly it does not take into account the considerable necessary investment in machinery and equipment, for example, of which Ms. Shushack gave evidence. The plan also addresses the income expectations of the Appellants. In a pro forma income statement, said to represent optimum operations, it projects an annual profit of $5,800, but qualified by the following note:

This is after we have:

— cleared our mortgage

— completed our capital program

— before capital cost allowance

The loss history of this farming operation is substantial. In the three years under appeal the losses have been $10,281 in 1991, $13,610 in 1992, and $17,226 in 1993. The total losses in the four preceding years, which are immediately after the period which Ms. Shushack described as the start-up period in which it was not reasonable to anticipate profits, amounted to some $26,000. The accumulated losses over the seven-year period, therefore, total some $67,000. In her evidence Ms. Shushack explained these losses as being the result of several unfortunate and unforeseeable setbacks in the farming operation which prevented them from achieving the goals set out in the business plan. One was the loss of the flock of sheep as the result of a rare disease introduced from another farm. Another was a delay in the commencement of a feed cattle operation on their land as the result of advice given to them to postpone it because of a cattle disease which was then prevalent in the area. These events, she said, caused their gross income to fall short of the projection in the pro forma income statement. She went on to say that the farm has now reached the stage of maturity, particularly with respect to the number of animals, that they expect to make a profit next year, or the year after. It appears from the financial history of this operation, however, that it is a lack of gross income which has been at the root of its financial non-performance. The business plan projects gross income of $17,000 per year; in fact the gross income for the seven years ending in 1993 amounts to only some $5,000 in total.

It is true that the Appellants did acquire, gradually, both a flock of sheep and a herd of highland cattle for breeding purposes, as their business plan proposed. It is true as well that both Appellants have put in at least 35 hours per week working on the farm since their operation began. Ms. Shushack detailed in her evidence the considerable amount of manual labour which they have each contributed over the years. However, it is an indisputable fact that the operation would not have been profitable in 1993, even if the projected gross revenue of $17,000 had been achieved with no increase in the expenses.

The Federal Court of Appeal has recently considered the state of the law with respect to business losses in Tonn v. R. (sub nom. Tonn v. Canada), [1996] 1 C.T.C. 205, 96 D.T.C. 6001 (F.C.A.). Linden J., writing for a unanimous court, reviewed in some detail the judgment of the Supreme Court of Canada in Moldowan v. R. (sub nom. Moldowan v. Minister of National Revenue) (sub nom. Moldowan v. The Queen), [1978] 1 S.C.R. 480, [1977] C.T.C. 310, 77 D.T.C. 5213, as well as the recent jurisprudence applying it. He notes there at page 219-20 (D.T.C. 6009), that the cases invoking the reasonable expectation of profit test fall into two principal categories. This case, in my view, falls into the first category, comprised of those cases where there is a strong personal element, which is described by Linden J.A. as:

... personal benefit and hobby type cases where a taxpayer has invested money into an activity from which that taxpayer derives personal satisfaction or psychological benefit.

These he characterizes as cases in which the taxpayer is seeking a tax subsidy by deducting the cost of what, in reality, is a personal expenditure. Such an expenditure may be in the nature of personal or living expenses, or they may be expenditures incurred for the purpose of acquiring a capital asset, or both. In any event they are cases in which profit, if it is a motive at all for the activity, is at best a subsidiary one. Ms. Shushack testified that she works about 45 hours per week at her law practice, and that her gross income from it in a recent year was about $355,000. Even after the considerable expenses involved, it is clear that the income available to her from that source greatly exceeds any profit that she could realize in her farming operations.

It is simply not credible that she would work an additional 35 hours per week at farming for the purpose of making profit to augment her income when the most optimistic estimate of the income to be made from their substantial capital investment and many hours of manual labour per year is, as their own business plan shows, $5,800 per year, without taking either capital cost allowance or interest expense into account. Deducting the 1993 capital cost allowance figure of $3,765 from the projection of net profit of $5,800 leaves a profit of only $2,035 per year for a total of some 3500 hours work by the two partners, roughly 60 cents per hour, without taking any account of either interest expense or a return on their invested capital. This, I stress, is not the result of the misfortunes that have beset the operation in recent years, but is based upon the net income projected in the business plan, adjusted to take capital cost allowance into account, as Dickson J. indicates in Moldoxvan is appropriate to do. To suggest in these circumstances that this farming operation is conducted for profit simply lacks any air of commercial reality.

The appeals are dismissed.

Appeals were dismissed.