Afzal v. R., [1998] 1 CTC 2125

Sarchuk T.C.J.:

These are appeals from assessments of the Appellant’s 1991, 1992, 1993 and 1994 taxation years. The sole issue is whether the Appellant is entitled to claim in the computation of his taxable income for those years certain losses he incurred in the operation of his farming venture or whether the claim for the deductibility of such losses was properly restricted in each year to the sum of $8,750 pursuant to the provisions of section 31 of the Income Tax Act (the Act).

At all relevant times the Appellant, who holds a Master’s Degree in Science, worked as a chemical engineer with the Department of National Defence (DND). In or about 1987, he became interested in Standardbred racing and came to believe that substantial revenues could be generated. His initial involvement was as owner, purchasing horses in claiming races. These were kept at the track and trained by other individuals. In November 1989, he purchased a farm for $84,000. The property consisted of a house, 175 acres of land, a dairy barn, outbuildings and some equipment. The farm was in poor condition and in 1990, the Appellant repaired fences and outbuildings and reseeded approximately 150 acres of land to create pasture and to provide hay. What revenues there were in 1990 came from his limited involvement in racing. The Appellant said he purchased the farm with the intention of combining a cattle operation with his horse racing venture. He hoped to develop a basic herd of some 60-70 cattle and proposed to do so by retaining the female calves born in each year until this number was reached. To that end, in 1991 he purchased six heifers which were to be the beginning of his herd. These, however, were sold in the Fall of 1991 since no over-wintering facilities were available.

His testimony as to the progress and the current state of affairs with respect to this aspect of his farm venture was at best imprecise. It appears, however, that he purchased 13 head in 1992, allowed the herd to increase to 22 in 1993 and to 30 in 1994. [1] He testified that in 1995 he had 37 cattle but that most or all of them were to be sold off in order to pay his bills. Whether he did so is not clear. He also testified that he currently owns 17 cows, all of which have been bred and that he expects to have 17 calves for Sale.

I turn next to the racing operation. The Appellant made his first purchase of a Standardbred in August 1987. Since that time all of his acquisitions save one have been made in claiming races at the Rideau Carleton Raceway in Ottawa and the Connaught Raceway in Aylmer. He has never owned or had an interest in more than three horses in any given year. Following his initial involvement in 1987, the Appellant spent two years as a groom and in December 1989, took the necessary examinations and qualified for an Ontario Racing Commission licence as owner/trainer (F category). This licence permits him to train his own horses. In actual practice, he warms up the horses for every race and attends to most of the pre- and post-race requirements. The Appellant is a member of the Canadian Trotting Association and the Ontario Federation of Agriculture. In September 1996, the Appellant purchased a 50% interest in a yearling, Final Destination, for $3,000. He says this horse is of better quality than his previous acquisitions and noted that it has been nominated and is eligible to run in a series of races called the Ontario Sires Stakes in July 1997. [2] In addition, in 1996 the Appellant claimed a second Standardbred he has high hopes for, Return to Breeder, for which he paid $4,039 (the claiming fee and costs). Until recently, any horses owned by the Appellant were kept at the race track. Currently, as a cost saving measure, he keeps one horse at a neighbour’s farm and one at the track.

The following table sets out the Appellant’s reported farm business income (losses) and his employment income during the taxation years in issue as well as in 1995 and 1996.

The gross income reported by the Appellant for tax purposes in years 1991 to 1995 reflected the aggregate of the revenue produced by the various sectors of his farm operation. He testified that his income from horse racing ranged from $1,420 to $17,500. With respect to cattle sales he stated, on the one hand, that cattle were first purchased and sold in 1991, but later testified that the available records only indicate sales in 1994, 1995 and 1996 in the amounts of $2,400, $4,770 and $4,700. In addition to racing and cattle, he derived revenue from land rental (approximately $750 per year - 1991- 1993 inclusive), hay sales ranging from $4,800 in 1991 to $9,000 in 1996 and from occasional sales of firewood.

The Appellant does not suggest that farming was his chief source of income. Rather, he says his chief source of income was a combination of farming and his employment with DND. The Appellant contends that there was a substantive change in his occupational and professional direction and argues that farming was at all relevant times the centre of his attention and his major preoccupation. His Counsel noted that the Appellant no longer sought promotion within DND in order to enable him to more precisely focus his efforts on the farming operation.

It is the Appellant’s position that his employment was an essential adjunct to his farming operation and although while not subordinate in terms of generation of cash, was nonetheless subordinate to his overall objective. In this context, Counsel for the Appellant referred to Hover v. Minister of National Revenue? [3] and in particular to the following passage:

Given the amount of income that the dental practice produced and the amount of cash it contributed to the farming operation it cannot be described as either subordinate to farming, in terms of the revenue that it produced, or a sideline business. It was an essential adjunct and complement to the farming operation. Without it the farming operation could not have been commenced nor could the substantial capital expenditures and start-up costs have been incurred. In this sense it formed an integral part of the combination. While I am of course bound to follow the principles enunciated by Dickson J., I must attempt to apply them to the facts before me and I must conclude, if I am to give effect to the word “combination”, that by “subordinate” he intended to include a source of income that although substantial is integral to the very existence of the farming operation.

Counsel for the Appellant also submits that the years in issue can appropriately be described as start-up years and that, as contrasted to many other cases, including Moldowan v. R.*, [4] this Appellant’s gross farm income has been growing while his expense and loss “line is trending downwards”.

It is common ground that the Appellant was engaged in farming activities which constituted a source of income for the purposes of the Act. Subsection 31(1) of the Act restricts the deduction available for such losses to $8,750 in circumstances where the chief source of income of a taxpayer is neither farming nor a combination of farming and some other source of income. Notwithstanding the passage of time and a number of attempts at revisionism, Moldowan remains the leading authority in respect of the interpretation to be given to subsection 31(1) of the Act.

Dickson J. (as he then was) suggested in Moldowan that the test for determining whether a source of income constitutes a chief source of income for a taxpayer is both relative and objective. In this regard “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”. He concluded that the Act as a whole contemplates the existence of discrete classes of taxpayers who farm as a livelihood, as sideline businesses and as hobbies. Only those who farm for their livelihood are entitled to the full deduction for farm losses while those who engage in sideline businesses may deduct losses of $8,750 in a taxation year. In describing more fully the taxpayer who farms for his livelihood, Dickson J. stated [5] that for such individual the farming “...may reasonably be expected to provide the bulk of income or the centre of work routine”. Dickson J. further said:

The reference in subsection 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 Morrissey v. R.^ [6] Mahoney J. made the following observation with respect to the test enunciated by Dickson J.

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 only with three: time spent, capital committed and profitability. In defining the test as relative and not one of pure quantum measure- ment, 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. With this in mind I turn to the evidence before me.

First, with respect to the relative amounts of time which this Appellant spent at his various endeavours, it is fair to conclude that he devoted at least as much time to his farming venture as to his regular employment. In fact, at times during the racing season, he may well have spent more time at the race track than on any other aspect of his farm operation and his employment combined. However, it is equally evident that in so doing, he was careful not to jeopardize his employment and the income earned therefrom without which, I might add, the farm operation would not have survived. I make one further observation. It was obvious from the Appellant’s testimony that there was a very strong personal element in his involvement in horse racing. While the Appellant may believe that he carried on the horse operation as a business, this personal element may have blinded him to the realities of the situation. I make this comment because it is apparent that when resources were lacking, it was the cattle operation which was cut back while the horse racing activity (a substantially riskier operation) continued unabated. On the evidence, it is difficult to conclude that the expenditure of time (and money) on the horse racing venture reflected commercial necessity with a view to making the business profitable.

As to the capital committed, I note that the purchase price of $84,000 for the farm was paid by way of a first mortgage in the amount of $42,000 and a second mortgage in the amount of $20,000. The balance of $22,000 represented most, if not all, of his savings at that time. In the ensuing years, he improved the fences at a cost of some $5,000, purchased a tractor in 1996 for $5,000 and says he spent approximately $25,000 purchasing beef cattle over the years. Since his purchases were mixed-breed, that amount seems to be on the high side and is unsupported by any documents, accounting records or other evidence [7] . He says that since 1987 he invested approxi- mately $44,000 in the acquisition of horses. This represents the purchase of some 13 or 14 horses, all with one exception, in claiming races. He also estimates that the gross revenues from horse sales in that period amounted to $23,000 or $24,000. The difference, he says, reflected the amount of capital invested. The Appellant testified that he has in effect invested all of his savings into the farm operation. He admits that an inadequate cash flow for the last few years has resulted in substantial borrowing through a line of credit with his Bank. On all of the evidence, it is fair to say that the Appellant’s operation was, at all times, under-capitalized.

Although reasonable expectation of profit is not in issue per se (the Minister by his assessment having conceded that farming is a “source of income” for this Appellant), in order to demonstrate that farming was his “chief source of income” in the taxation years in issue, the evidence adduced by the Appellant must, inter alia establish that there was a reasonable expectation that the farm operation will be significantly profitable. As Strayer J. noted in Mohl v. R.: [8]

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 farming and from other sources. Unless the amount reasonably expected to be earned from farming is substantial in relation to other sources of income then farming will at best be regarded as a ‘sideline business’ to which the restriction on losses will apply in accordance with subsection 31(1).

This decision was approved by the Federal Court of Appeal in Connell v. Minister of National Revenue? [9] and was followed by that Court in R. v. Poirier^. [10]

The Appellant’s farm business has never shown a profit in its nine years of operation. The losses, particularly those in the taxation years in issue, were quite substantial. Nonetheless, the Appellant consistently maintained that both the beef cattle and horse racing ventures were potentially profitable. In considering this assertion it is relevant to consider the scope and nature of his plans from inception and throughout the years to the present. With respect to the cattle operation, beyond his statement that the initial objective was a basic herd of some 60-70 head of cattle, there is no evidence that the Appellant made any real projections of the capital required or of the potential revenues and expenses. Subsequently, in a hand-written document captioned “Business Plan Effective 1995”, [11] he attempted to summarize the progress made by both the cattle and racing ventures and to indicate his expectations for the future. Suffice it to say that this summary does not accurately reflect income, expenses or asset values. In the same “Business Plan” he also spoke of his intention to establish a bee-keeping and a lumber-cutting operation, [12] but there is no indication that he took any steps to implement these proposals. The pattern of inadequate planning continued, vide his current business plan [13] which incidentally was prepared a week before trial. The Appellant now says he has adjusted his “cattle operational plan to include the sale of adult cattle as freezer beef’ and for that purpose will be keeping more new calves. As part of this plan he proposes to target the kosher meat business and to purchase freezers to keep this beef until pick-up or delivery, as well as to provide a freezer storage rental service to his customers. To improve quality, he intends to change from his current mixed breed cattle herd to another variety, a French exotic. All of this, he asserts, will dramatically increase revenues from the cattle operation. His optimism has not been dampened by previous results as can be seen from his comment that “when I have more orders for beef than I can accommodate, I will purchase additional cattle at auction to fill my orders”. Cash poor by his own admission, the source of capital for these projects remains a complete mystery. In my view, his statements are nothing more than wishful thinking. If he has performed even the most rudimentary financial analysis for this “operational plan” it remains known only to him.

From his testimony, it is obvious that the Appellant views horse racing as the key to the farm’s financial success in the future. He places particular emphasis on the recent acquisition of Final Destination, stating that the better the quality of the horse, the more likely it is to win and produce larger revenues. That may be so, but his track record is far from encouraging. From the material submitted by the Appellant and from his testimony it would appear that the average price of the horses he purchased was approximately $4,000. [14] His horses race at what are referred to as C tracks at which the purses are relatively insubstantial. Even operating in this milieu, he has never generated much in the way of gross revenue. By way of example, in 1995, the three horses that he owned for periods of time in that year were in the money on 19 occasions. [15] Total purses amounted to $4,870, an average of some $256 per successful entry. I was also struck by the fact that the Appellant’s projections appeared not to have taken into account the high risk nature of the horse business, even though in 1994 he was required to destroy two horses due to injury and illness.

One final observation, the Appellant submitted a pamphlet “So You Want to Buy a Harness Horse” which provides information to prospective purchasers of race horses. It contains the following comment:

Can I Afford a Race Horse? You should know specific costs in great detail prior to your purchase, and your calculations must be based on whether you can afford to own the horse even if he doesn’t win a race or collect the purse. If you rely on a horse winning in order to pay the bills, you have over-extended yourself.

That is precisely what the Appellant has done.

With respect to this Appellant’s farming operation I have concluded that in the years in issue there was no 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.

Counsel for the Appellant also argued that the Minister acted prematurely in making these assessments. Reference was made to Moldowan v. /?., [16] in support of the submission that the Appellant was a person who had changed his occupational direction and had committed his energy and capital to farming as a main expectation of income and therefore, ought not to be disentitled to deduct the full impact of start-up costs. The inference I drew from this submission was that this Court ought to consider and recognize start-up costs in the taxation years in issue as a basis upon which to allow the appeal. In this context, I make reference to Roney v. Minister of National Revenue^ [17] where Desjardins J.A. noted:

Start-up costs, contrary to what the trial judge said, cannot be considered as the basis for an alternative ground of decision. The permissible amount to be deducted depends on the class the taxpayer finds himself in. Indeed, Dickson J., as quoted by the trial judge, said the following in Moldowan:

...On the other hand, a man who changes occupational direction and commits his energies and capital to farming as a main expectation of income is not disentitled to deduct the full impact of start-up costs.

[Emphasis added]

For the foregoing reasons, the appeals are dismissed, with costs.

Appeal dismissed.