Entreprises L. Clancy Inc. v. R., [1999] 1 CTC 2763, 98 DTC 1976

Lamarre Proulx T.C.J.:

These are appeals from reassessments made by the Minister of National Revenue (the “Minister”) respecting the appellant’s 1991, 1992 and 1993 taxation years.

The issue is whether the appellant’s chief source of income is a combination of farming and some other activity, namely, the production and sale of a food product, for the purpose of subsection 31(1) of the Income Tax Act (the “Act”), which stipulates that where a taxpayer’s chief source of income is neither farming nor a combination of farming and some other source of income, his loss from the farming business is restricted to the amount specified in that subsection.

The facts of this case are not really in dispute. However, since their interpretation will determine the outcome of the appeals, it is important that these facts be stated. The following facts are set out in paragraphs 1 to 20 of the Notice of Appeal:

[TRANSLATION]

(1) Before 1989, Mr. Louis Limoges, the appellant’s sole shareholder, who had considerable knowledge of racehorses, carried on a business which involved selling and running racehorses, entrusting the animals’ care and training to professionals. In 1988, Mr. Louis Limoges earned $79,071 in purses through his business operations.

(2) In 1989, Mr. Limoges decided to restructure his business and invested in the appellant so that the latter could take over his inventory of horses.

(3) On July 1, 1989, the appellant, having legal capacity similar to that of an individual, acquired at fair market value the 17 (seventeen) race horses along with the goodwill of Mr. Limoges’s racehorse selling and running business, intending to pursue operations on its own.

(4) In developing its business plan, the appellant structured its business so as to draw income from two sources, namely:

(1) purses awarded to wining racehorses; and

(11) racehorse foal sales.

(5) The appellant carried on its business trom 1989 to 1994. Its operations can be divided in two distinct periods, that is:

(1) the initial phase with breeding mares, colts, fillies and a stallion, which phase was mainly supervised by Mr. Henri Coté;

(11) a subsequent phase under the supervision of Mr. Raymond Gingras, in which the breeding mares and the stallion were replaced by finer horses.

(6) On top of colts and fillies born of breeding mares, the appellant replaced, purchased and sold colts and fillies for as long as its business was in operation.

(7) Since the appellant did not own a farm and had not hired any staff, it entered into contracts with arm’s-length third parties for services involving the care and training of its horses, most notably with the trainer Mr. Gingras.

(8) After a few years, it became obvious that the company’s potential was not developing as it should and so the appellant decided to entrust the training of its horses to Mr. Gingras, to replace its main breeding mares with better quality mares, to mate these with better stallions and to consult with Mr. Gingras with a view to updating its business plan and identifying the better quality horses it should acquire.

(9) As one of Quebec’s most experienced trainers, Mr. Gingras was able to ensure the company’s success in the medium term.

(10) From 1989 to 1994, the appellant invested the following amounts to acquire horses, paid the following boarding, care and training costs and earned the following amounts from horse sales and race purses:

	1989 (6
	months)	1990	1991	1992	1993	1994
	$	$	$	$	$	$
Investments
Horse
Purchases	242,000	53,000	22,500	109,000	1.500	0
Expendi
tures
Boarding and
Training	83,877	138,505	129,133	159.297	103.323	101,938
Income
Race Purses:	19,624	35,972	21,888	1 13.280	22.608	37,123
Horse Sales:	0	13.240	25,308	20.350	4,400	57,050

(11) Colts “Vitesse de nuit” and “Speedy Dora”, both born of “Speedy Midnight” earned substantial purses in 1992 and 1993, thus demonstrating the potential of the business as carried on with Mr. Raymond Gingras’s assistance.

(12) In December 1994, the appellant’s shareholder, Mr. Limoges, decided to put an end to the company’s operations and accordingly sold his inventory of horses, including “Vitesse de nuit”, “Speedy Dora” and “Speedy Midnight” for a total consideration of over $35,000.

(13) By notices of reassessment dated January 2, 1996, which are being appealed, the Minister of National Revenue determined that the appellant had carried on its business with a reasonable expectation of profit over the relevant period and consequently the appellant’s business of selling and running racehorses constituted a source of income for it, but it was not the appellant’s chief source of income, either alone or combined with some other source.

The Flavour Crystals Business (L492/R3097/T2/BT2) test_linespace (236>217.60) 0.847 0941_3309_3445

(14) In 1991, the appellant started up another business involving the sale of flavour crystals.

(15) To this end, the appellant made an agreement with a manufacturer of crystals, with which it had a partnership, for the distribution and sale, mainly to food wholesalers, on the appellant’s own behalf, of the crystals produced by the manufacturer.

(16) The appellant also made an agreement with the said manufacturer to use the latter’s human resources to do all sales related work so that the appellant did not hire any staff to sell the crystals.

(17) Since the appellant’s business consisted of distributing and selling manufactured products through a subcontractor, it made no substantial financial investment in the flavour crystal sales business.

(18) From 1991 to 1994, the appellant invested the following amounts, paid the following subcontract amounts and made the following flavour crystal sales:

	1991		1992		1993		1994
	$		$		$		$
Investments		0		0		Q		0
Expendi
tures
Supply	320,456		338,042		234,987		217,339
Costs:
Subcontracts:	28,373		13,898		6,551		7,406
Income
Crystal	544,649		530,235		366,908		300,174
Sales:

Other (L504/R4699/T2/BT2) test_marked_paragraph_end (636) 0.904 0941_8937_9039

(14) Over the relevant period the appellant did not hire any staff to carry on its racehorse and flavour crystal businesses as it subcontracted all work related thereto.

(15) Over the relevant period the appellant used no stable or warehouse in carrying on its racehorse and flavour crystal businesses because the subcontractors handled all physical aspects of the operations.

With regard to paragraph 10 of the Notice of Appeal above, counsel for the appellant changed several figures during the hearing to make them con- sistent with the final version of the financial statements, which he did not have in hand when the Notice of Appeal was written. It is the corrected version that has been reproduced above. The Respondent had denied this paragraph in the Reply, referring in so doing to the financial statements. I therefore now consider this paragraph to have been admitted.

In its Reply to the Notice of Appeal the respondent admits the first sen- tence of paragraph 1, paragraphs 2, 4 to 7, paragraph 11 up to "1993", paragraphs 14 to 17, paragraph 18 as regards the years 1991 to 1993, and paragraphs 19 and 20 of the Notice of Appeal.

The facts on which the Minister based his assessment are set out in para- aph 17 of the Reply to the Notice of Appeal (the “Reply”) as follows:

[TRANSLATION I

(a) The facts admitted above:

(b) Before 1988, Mr. Louis Limoges carried on a racehorse business in his OWN name,

(c) In 1988, the Minister subjected Mr. Louis Limoges to a tax audit which resulted in an adjustment of his tax liability with a view to limiting Mr. Limoges’s eligible losses from the racehorse business, pursuant to section 31 of the Income Tax Act:

(d) Mr. Limoges never made any profit from this business and in the five (5) years before it ceased operating, namely on June 30, 1989, Mr. Limoges had incurred operating losses of about $432,467;

(e) On January 26, 1989, Mr. Limoges incorporated 2628-6526 Québec Inc., which later became Les Entreprises L. Clancy Inc.;

(f) On July 1, 1989, in a rollover pursuant to subsection 85(1) of the Income Tax Act, Mr. Limoges turned his horses over to the appellant at their fair market value in exchange for $214,000 worth of shares in the appellant’s capital stock.

(g) In 1990, Pied-Mont Dora Inc., a company controlled by Mr. Louis Limoges, began dealing in a new product, i.e. flavour crystals used in preparing food products;

(h) Starting in 1991, any income from the sale of crystals was declared by the appellant and not by Pied-Mont Dora Inc., even though all activities connected with the operation of this business were carried on by Pied- Mont Dora Inc.;

(1) Pied-Mont Dora Inc. is the owner of the trademarks used in connection with the above-mentioned flavour crystals;

(j) Net income generated by the appellant’s crystals business was $185,184, $147,249 and $121,102 for taxation years 1991, 1992 and 1993 respectively;

(k) Net losses incurred in the racehorse business and claimed by the appellant were $160,750, $70,522 and $193,229 for taxation years 1991, 1992 and 1993 respectively;

(1) The appellant deducted the losses suffered in the racehorse business from the income generated by the sale of crystals;

(m) The operation of the appellant’s racehorse business from July 1, 1989 to December 31, 1993 never generated any profits; rather it generated operating losses of about $651,195:

(n) In the years at issue, the appellant’s chief source of income was neither a farming activity nor a combination of farming and some other source.

In his Reply the Respondent however added paragraphs 18 and 19 as follows:

[TRANSLATION]

18. The appellant’s racehorse business was not carried on with reasonable expectation of profit.

19. Expenses incurred by the appellant in the racehorse business were personal or living expenses.

Counsel for the appellant filed as Exhibit A-1 a book of documents with 27 index tabs. Counsel for the respondent filed as Exhibit I-1 a book of documents having 15 index tabs.

Louis Limoges, the appellant’s sole shareholder, Constant Cadieux, the appellant’s financial advisor and in-house accountant since 1989, and Raymond Gingras, driver and racehorse trainer, all testified at the request of counsel for the appellant. John Kamio, tax auditor, testified at the request of counsel for the respondent.

Mr. Limoges is a businessman. In 1956, after completing his studies, he started working for the family business, Pied-Mont Dora Inc. In 1980, he became its director and sole shareholder. At that time, the company’s turnover was $300,000. In 1991, it had reached $7,000,000. A new factory was built. The company had about fifty employees. It produced jams, spreads and table syrups. It only sold to a few wholesalers that owned supermarkets.

In 1990, Pied-Mont Dora Inc. tried a few experiments with flavour crystals and started selling them near the end of that year. The production of flavour crystals required at the most two employees. It is this production that was transferred to the appellant in 199].

Mr. Limoges has always been interested in horse racing. He first got involved in the sixties when he owned a racehorse. He enjoyed going to the racetrack a few times a week. By 1985 he owned ten horses; a few of them were for racing and were kept at the racetrack stables and trained by a cer- tain Yvon Pelchat; others were for breeding and kept at the farm of a Mr. Henri Côté. Mr. Limoges’s aim had been all along to produce a champion. 1989, he entrusted Mr. Raymond Gingras with all of his racing and breeding activities. Mr. Gingras’s farm is located in Sorel. In the years at issue Mr. Limoges would have gone to the racetrack three or four times a month. He apparently rarely went to Mr. Gingras’s farm although he would seem to have spoken with him by telephone almost every day. In 1994, after selling his horses to Mr. Gingras, Mr. Limoges apparently stopped going to the races.

In 1988 and 1989, Mr. Louis Limoges’s income tax returns and those of the corporations of which he was the principal shareholder were reviewed by the Minister’s officers; this led to reassessments. According to Mr. Ca- the in-house accountant, Mr. Limoges’s business ran into trouble due to excessively rapid growth which the accounting system wasn’t able to keep up with. It was this situation that led to Mr. Cadieux being hired on the advice of the company’s outside accounting firm.

During the review, the Minister had allowed Mr. Limoges the amounts of $20,000, $60,000 and $120,000 in farm losses for the years 1985, 1986 and 1987 respectively, as may be seen at tab 9 of Exhibit I-l. It is based on this document that Mr. John Kamio, officer of the Minister, testified to ex- paragraph 17(d) of the Reply, which states that in the five years before June 30, 1989, Mr. Limoges suffered total losses of $432,467 from his racehorse business. Again during the same review, conducted in 1988 and 1989, the Minister apparently informed Mr. Limoges that in future he would be subject to section 31 of the Act and would only be eligible for a reduced amount of losses. In 1988 he was assessed on this basis.

On July 1, 1989, the appellant acquired Mr. Limoges’s inventory of hor- ses as stated in paragraph 17(f) of the Reply. In 1989 and 1990, the appel- lant’s only activity was the racehorse business. It incurred substantial losses in each of these years. On request, the appellant received a notice of deternation of loss for each of these years, see tabs 10 and 11 of Exhibit A-l. These notices indicated no amount of losses; rather, each of the boxes was marked n/a. Thus, the “non-capital loss”, “restricted farm loss” and “farm loss” boxes, among others, are only marked n/a. These determinations are under appeal according to information from counsel for the appellant.

In 1991, as pointed out in the Notice of Appeal and the Reply, the business of selling flavour crystals, first experimented with by Pied-Mont Dora Inc., was turned over to the appellant. Mr. Constant Cadieux informed the Court that it was he who had suggested this plan. The product being new, the outcome was uncertain. It was better to isolate it in a corporation separate from the main business. He was also the one who had advised Mr. Limoges to transfer the racehorse business to a corporation, i.e. the appellant. Although paragraphs 17(h) and 17(i) of the Reply seem to indicate the contrary, the respondent does not dispute the fact that any income from flavour crystal sales rightfully belong to the appellant.

Mr. Raymond Gingras began working for his father, a driver and racehorse trainer at the Blue Bonnets racetrack, at the age of 13. When he was 24, Raymond Gingras set up his own business. In 1981, he bought a farm which he called “Ferme Yana-Moray”. In 1981, he won the drivers’ championship at the Montreal racetrack. He met Mr. Limoges at the racetrack paddock. He said that in 1989 the race industry began a downslide for reasons having to do with the way racetracks were run. Caring for and training the appellant’s horses accounted for 75% of his business’s turnover. He did not have complete control in managing the horses. He provided advice but also took directions from Mr. Limoges as regards managing the stable. In 1994, after he purchased Mr. Limoges’s horses, he disposed of some of them, bred others and, according to his testimony, managed to win substantial purses.

Argument and Findings (L4/R3690/T0/BT0) test_linespace (270>257.09) 1.012 0945_7085_7251

Counsel for the appellant submitted that farming was the appellant’s chief activity and that the production of crystals was a secondary activity, so that the appellant drew its income from a combination of farming and another source of income. He argued that according to the criteria developed in the case law, to determine whether a business undertaking is chiefly a farming operation, one must look at the amount of capital and time that is invested as well as the possibility of profit. He further argued that the amount of capital invested in this case was almost identical to that invested in the other activity, that the amount of time invested was greater than in the other activity, and that, in looking at the possibility of profit, one must con- sider the many purses won by the horses while and after the appellant was

in business.

Counsel for the respondent referred to the same case law criteria and arrived at conclusions contrary to those of his confrere on each point.

Subsection 31(1) of the Act reads as follows:

31(1) Loss from farming where chief s s source of income not farming — (L460/R256/T2/BT2) test_left_indentation (2) 0.847 0946_2369_2519

Where a taxpayer's chief source of income for a taxation year is neither farming nor a combination of farming and some other source of income, for the purposes of sections 3 and 111 the taxpayer’ loss, if any, for the r from all farming businesses carried on by the taxpayer shall be deemed to be the total of

(a) the lesser of...

(Emphasis added.)

The leading case on farm losses remains that of the Supreme Court of Canada in Moldowan v. The Queen, [1978] 1 S.C.R. 480. It was recently applied again by the Federal Court of Appeal in The Queen v. Andrew Don- nelly, 97 D.T.C. 5499, and even more fully clarified. Both of these cases, just as the present case, involved racehorses. Yet the appellants were indi- viduals in both previous cases whereas, in this case, the appellant is a cor- poration. I will address the corporate aspect further on. For the moment, I shall refer to Dickson J.’s analysis in the Moldowan case. To better under- stand that analysis, one should bear in mind that what is now section 31 was section 13. I quote from pages 486 to 489:

There has been difference of opinion on whether the word “combination” in s. 13(1) requires some “connection” by way of physical relationship or integration or inter-connection between farming and the subordinate activity which provides another source of income....

It is clear that “combination” in s. 13 cannot mean simple addition of two sources of income for any taxpayer. That would lead to the result that a taxpayer could combine his farming loss with his most important other source of income, thereby constituting his chief source. I do not think s. 13(1) can be properly so construed. Such a construction would mean that the limitation of the section would never apply and, in every case, the taxpayer could deduct the full amount of farming losses.

In my opinion, the Income Tax Act as a whole envisages three classes of farmers:

(1) a taxpayer, for whom farming may reasonably be expected to provide the bulk of income or the centre of work routine. Such a taxpayer, who looks to farming for his livelihood, is free of the limitation of s. 13(1) in those years in which he sustains a farming loss.

(2) the taxpayer who does not look to farming, or to farming and some subordinate source of income, for his livelihood but carries on farming as a sideline business. Such a taxpayer is entitled to the deductions spelled out in s. 13(1) in respect of farming losses.

(3) the taxpayer who does not look to farming, or to farming and some subordinate source of income, for his livelihood and who carries On some farming activities as a hobby. The losses sustained by such a taxpayer on his non-business farming are not deductible in any amount.

The reference in s. 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. A man who has farmed all of his life does not become disentitled to class (1) classification simply because he comes into an inheritance. 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.

In the instant case, it is common ground that the appellant was farming and that his farming constituted a source of income. There are concurrent findings below that farming was not his chief source of income. 1 would not disturb those findings. Additionally, I do not think it can fairly be said that appellant was a person whose chief source of income was a combination of farming and some other source of income in the sense I have indicated. He devoted considerable effort towards launching new ventures. Horse-racing consumed only several hours of his day and that for part of the year only. His commitment of capital was cautious. The nature of the enterprise is risky. It is difficult reasonably to plan to devote energies to it principally in the expectation of a steady living. He suffered constant and increasing losses with the exception of two years in which minor profits were made. Although none of the above is alone determinative, together they suggest only one business venture of several, with nothing distinguishing in the way of “a chief source of income.”

As Dickson J. explains in Moldowan (supra), it is not a matter of adding up sources of income to determine whether an individual’s chief source of income is a combination of farming and some other source of income because that would render section 31 of the Act nugatory. It must be determined whether the farming activity is the chief source of income, possibly in combination with another source. In other words, the question is whether the taxpayer carries on mainly a farming activity.

A person who carries on mainly a farming business is someone whose major concern is farming, for whom farming constitutes his way of life. In actual fact, we are dealing in such a case with a genuine farmer or farming business. A genuine farming business, like a genuine farmer, is concerned with being profitable. A farming business may not be profitable some years over a number of years. For those years, a genuine farming business is entitled to deduct all its losses. A genuine farmer can be identified by the fact that he will generally have been raised on a farm and/or will have taken courses directly related to farming and that he devotes himself entirely to farming in the hope of earning his living therefrom. Should his activity not be sufficiently profitable, he may augment his farming income through other economic activities.

Sometimes, people whose major occupational concern is not farming will be nevertheless be sufficiently interested in farming and invest enough effort and financial resources for their farming business to be considered a business for restricted farm loss purposes. I say may be considered a busi- ness for restricted farm loss purposes because such an operation will only rarely be classified as a business for the purposes of sections 3 and 9 and 18( 1)(a) of the Act. Since it is not the chief work activity, such business’s profitability is not the primary objective and losses are usually substantial.

The last category consists of farming businesses that are carried on with- regard to standard agricultural practice, without the knowledge required to carry on farming or without hiring people qualified in that particular field,

In Donnelly (supra), the Federal Court of Appeal, speaking through Robertson J.A., again applied Moldowan, explaining it afresh and adding thereto certain analysis points developed through case law over the years:

... According to Moldowan, the taxpayer must satisfy two tests in order to succeed. First, he must establish that the farming operation gave rise to a “reasonable expectation of profit” and, second, that his “chief source of income” is farming (the so-called “full-time” farmer). If the taxpayer is unable to satisfy the first test no losses are deductible (the so-called “hobby” farmer). If he satisfies the first test but not the second then a restricted farm loss of $5,000 (now ($8,500) is imposed under section 31 of the Income Tax Act (the so-called “part-time” farmer)....

À determination as to whether farming is a taxpayer’s chief source of income requires a favourable comparison of that occupational endeavour with the tax- ayer s other income source in terms of capital committed, time spent and profitability, actual or potential. The test is both a relative and objective one. It is not a pure quantum measurement. All three factors must be weighed with no one factor being decisive. Yet there can be no doubt that the profitability factor poses the greatest obstacle to taxpayers seeking to persuade the courts that farm- ing is their chief source of income. This is so because the evidential burden is on taxpayers to establish that the net income that could reasonably be expected to be earned from farming is substantial in relation to their other income source....

There is no question in this case that the taxpayer committed significant capital investment to the horse-farming activity. As noted earlier his losses were approaching the $2 million mark. This factor is in his favour. It is the two remaining elements of time spent and profitability which are more problematic for the taxpayer....

...the taxpayer acknowledged that he required his medical income to live off and fund the purchase of new horses and other aspects of the horse operations....

Any doubt as to whether the taxpayer's chief source of income is farming is resolved once consideration is given to the element of profitability. There is a difference between the type of evidence the taxpayer must adduce concerning profitability under section 31 of the Act, as opposed to that relevant to the reasonable expectation of profit test. In the latter case the taxpayer need only show that there is or was an expectation of profit, be it $1 or $1 million. It is well recognized in tax law that a “reasonable expectation of profit” is not synonymous with an “expectation of reasonable profits”. With respect to the section 31 profitability factor, however, quantum is relevant because it provides a basis on which to compare potential farm income with that actually received by the taxpayer from the competing occupation. In other words, we are looking for evidence to support a finding of reasonable expectation of “substantial” profits from farming....

As is well known, section 31 of the Act is aimed at preventing “gentlemen” farmers who enjoy substantial income from claiming full farming losses: see The Queen v. Morrissey, supra at 5081-82. More often than not it is invoked in circumstances where farmers are prepared to carry on with a blatant indifference toward the losses being incurred. The practical and legal reality is that these farmers are hobby farmers but the Minister allows them the limited deduction under section 31 of the Act. Such cases almost always involve horse-farmers who are engaged in purchasing or breeding horses for racing. In truth, there is rarely even a reasonable expectation of profit in such endeavours much less the makings of a chief source of income.

(Emphasis added.)

The case law seems to leave no doubt that the fact the appellant is a corporation makes no difference in how the application criteria developed by the Supreme Court of Canada in Moldowan are applied. I specifically refer to two decisions: that of Judge Rip of this Court in Gestion S.A.P. Inc. v. M.N.R, 94 D.T.C. 1349, at page 1353, and that of Teitelbaum J. of the Federal Court Trial Division in Buchanan Forest Products Limited v. M.N.R., 86 D.T.C. 6282, at page 6292. The same principles apply.

I shall now analyze the evidence based on the criteria applied in Don- nelly (supra). As regards capital invested, I accept that such investment was almost identical in both the farming and industrial activities. However, with respect to the investment of time, counsel for the appellant argued that the appellant devoted much more time to the farming activity since the time of the person who kept and trained the horses should be taken into account. Counsel for the respondent maintained that only the time of the director or the actual employees of the appellant should be taken into account. In my view this is how the principle should be applied since it is necessary to determine what is the appellant’s major concern. It is possible that the di- rector spent a little more of his time on the farming activity than on the activities related to the manufacture and sale of the food product in ques- tion, but not significantly more.

As for the farming business’s profitability, this activity was personally carried on by the appellant’s director and sole shareholder for several years before it was turned over to the appellant. The profitability of that activity since 1985 is accordingly relevant as are also profit figures since 1989, the year in which the operation was transferred to the appellant. Referring then to the allegations in paragraphs 17(d) and 17(k) of the Reply, which allega- tions have been proven and were in fact not disputed, one can readily con- that it is unreasonable to claim that there was an expectation of rea- sonable profit from this activity, which is the criterion set out in Donnelly (supra).

There was no expectation of reasonable profit from the appellant’s farm- activity. It is even doubtful that there was a reasonable expectation of However, Parliament has provided for the possibility of deducting a certain amount of losses from farming activities which have certain attrib- utes of a business given the scope and quality of the work done, but with regard to which there is little concern for profitability since this is not the primary reason for their being carried on. Based on the evidence in the in- stant case, the appellant’s farming activity falls under this category. The Minister has therefore properly assessed the appellant, both in fact and in

The appeals are dismissed, with costs.

Appeal dismissed.