Kroeker v. R, [1999] 4 CTC 2202, 99 DTC 1165

Beaubier T.C.J.:

This appeal pursuant to the General Procedure was heard at Regina, Saskatchewan on June 21 and 22, 1999. The Appellant testified and called Glen Budd, C.A., representing her chartered accountants. The Respondent called Ronald Swahn, the appeals officer of Revenue Canada on the Appellant’s file.

The Appellant has appealed the reassessments for her 1993, 1994 and 1995 taxation years which disallowed the deduction of farm losses based upon Sections 31, 28, 67 and 96 of the Income Tax Act (“Art”).

The assumptions of the Respondent in the Reply to the Notice of Appeal read:

12. In so reassessing the Appellant for the taxation year, the Minister made the following assumptions of fact:

(a) Facts above admitted.

(b) At all material times the Appellant was employed by REM Manufacturing, Swift Current, as controller of the Company.

(c) The Appellant earned the following amounts from employment during the taxation years 1993, 1994 and 1995 respectively:

TAXATION YEAR	INCOME
1993	$50,940
1994	61,240
1995	60,000

(d) The Appellant originally purchased a farm in 1982; since 1991 she and her husband Ben have treated the farm as a partnership in which each holds a 50% share.

(e) The farm is a combination of grain and cattle operation.

(f) The Appellant reported farming income (losses) during the taxation

years in issue as follows:
	1993	1994	1995
Gross Farm Income	92,235	83,564	108,332
Farm Expenses	171,540	186,784	169,595
Net Loss	( 79,305)	(103,220)	( 61,263)
Plnsp share (50%)	( 39,653)	( 51,610)	( 30,632)
(Claimed by Anna)

(g) The Appellant’s chief source of income during the taxation years in issue was neither farming nor a combination of farming and some other source of income.

(h) The farm has not realised profit since 1985.

(i) The farm partnership carried on a cash basis farming operation. It made the purported payments to Ben, described as salaries, in the amounts of $52,000, $61,000 and $57,000 during the taxation years 1993, 1994 and 1995 respectively.

(j) The farm partnership deducted the purported payments referred to in paragraph (i) as expenses in computing the farm income(losses).

(k) The amounts of salaries were determined by Appellant’s accountant at the end of the year, and no payroll deductions were made from the “salaries”.

(l) The salaries were not actually paid to Ben but were considered as accrued to him. As the farm partnership accounts on a cash basis, this accrual is not permissible.

(m) As the farm partnership accounts on a cash basis it is not permitted to deviate from the farm rules under Section 96 of the Act.

(n) The Minister did not take into consideration the unpaid “salaries” referred to in above paragraphs in determining the farm partnership’s income (loss) and the Appellant’s deductible farming losses including non contentious adjustments between the amounts claimed and the amounts determined by the Minister shown as follows:

	1993	1994	1995
Partnership Farming	$79,305.35	$103,220.60	$63,462.12
Loss as Claimed
Less: unpaid salary	52,000.00	61,000.00	57,000.00
Revised Farming Loss	$27,305.35	$ 42,220.60	$ 6,462.12
Partner’s 50% Share	$13,652.68	$ 21,110.30	$ 3,231.06
Deductible Farming Losses should be:
	1993	1994	1995
Her 50% share	$13,652.68	$21,110.30	$3,231.06
allowed per ss. 31(1)	2,500.00	2,500.00	2,500.00
	+5,577.00	+9,305.00	+366.00
	or	or	or
	6,250.00	6,250.00	6,250.00
	$ 8,077.00	$ 8,750.00	$2,866.00

(o) Ben did not receive any salary from the farming partnership. The accountant decided on the amount of “salaries” when doing the farm statements at the year-ends, based not on hours worked by Ben but to correspond salaries received by the Appellant from her employment as controller off the farm.

(p) The Appellant worked 40 hours per week off the farm as a controller. (q) The Appellant did not look to the farm for her livelihood. The farm has been in a cash loss position from 1990 to 1994 even prior claiming CCA.

(r) The Appellant has no plans or projections showing that she can make a profit from the farming activity.

(s) The farm has not provided the Appellant with a source of income during the years under appeal.

(t) The Appellant’s farming activity can not reasonably provide the bulk of her income either with or without purported payments of “salaries” to Ben.

The evidence established that assumptions (b), (c), (d), (e), (f), (i), (j), (k), (n), (0), (p), (q), (r) and (s) are true. In the course of the Hearing Respondent’s counsel stated that the Respondent’s position is that deduction of the allocation to Ben was unreasonable, and that it is for the Court to decide if the allocation falls within Section 28 of the Act. Mr. Swahn testified that the auditor did not disallow the deduction of the allocation to Ben; the appeals officer disallowed it. Mr. Swahn asked the Appellant’s chartered accountants for the partnership’s capital account record and for any documents supporting the deductions of the allocation to Ben and he never received anything. As a result, the deduction of Ben’s allocation by the partnership was disallowed because Revenue Canada considered that it represented an allocation of capital. Thereupon Revenue Canada calculated that the Appellant was entitled to a restricted farming loss as calculated in assumption (p). An appeal of a restricted farming loss assessment is subject to the premise described by Robertson, J.A. in R. v. Donnelly (1997), [1998] 1 C.T.C. 23 (Fed. C.A.), paragraphs 12 and 13 as follows:

12. 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.

13 In the present case, it was incumbent on the taxpayer to establish what he might have reasonably earned but for the two setbacks which gave rise to the loss: namely the death of Mr. Rankin and the decline in horse prices. I say this because the Tax Court Judge concluded that but for these setbacks the taxpayer would have earned the bulk of his income from farming in the three taxation years in question. While there is no doubt that the loss of Mr. Rankin, and the changes in American tax law had a negative and unexpected impact on the business, no evidence was presented to show what profit the taxpayer might have earned had these events not occurred and whether the amount would have been considered substantial when compared to his professional income. It was not enough for the taxpayer to claim that he might have earned a profit. He should have provided sufficient evidence to enable the Tax Court Judge to estimate quantitatively what that profit might have been. (emphasis added)

The Appellant admitted that she and Ben have operated the farming partnership since 1991. There was never a written partnership agreement. Nor was there an express unwritten partnership agreement between Ben and the Appellant. Anna testified that she and Ben had agreed that his income would approximately equal hers when they decided that he would work full-time on the farm and that she would work full-time off the farm. She testified that Ben’s allocation reflected Ben and Anna’s equal partnership. However, it is clear that their intention in carrying out Ben’s allocation was to reflect an equal partnership in their marriage in all things and not just the farm partnership. Thus it was not a business decision which resulted in an implied term of their farm partnership. Rather it was a reflection of a decision that they had made and previously carried out in their marriage relationship. Ben’s income allocation was deducted as an expense to the farm partnership by the Kroekers’ accountants after each year end on the basis proposed by Anna and Ben; its allocation put Anna and Ben in an equal position in their view. They felt that they should be approximately equal in all things and the allocation was done for this reason. Ben reported the allocation as his income in each year in question. Anna relied on their accountant’s calculations to carry out their wish. On the evidence there were no profits in the farm partnership from which to allocate any profits to Ben. The partnership operated on the cash method under Section 28 and there was no cash or source pursuant to Section 28 from which to allocate to Ben, nor was any such money ever paid to Ben.

Based upon Section 28 of the Act, the Court finds that the Minister was correct in disallowing the deductions by the partnership of its allocation to Ben under the heading of expenses. The partnership was accounting on the cash method and it could not make the purported deductions. Thus the question of the “reasonableness” of these deductions under Section 67 and a review of this concept as set out in Zahid Mohammed v. The Queen (F.C.A.) 97 DTC 6603 need not be dealt with by the Court.

The only question remaining to be dealt with is whether there is evidence to support a finding of a reasonable expectation by the partnership or by Anna of “substantial” profits from farming during 1993, 1994 and 1995. The restriction applied to the partnership under Section 31 can be upset if the Appellant can establish that the farming partnership had an expectation of reasonable profits that are substantial during the years 1993, 1994 and 1995.

During the hearing the Appellant led evidence that purported to establish that the partnership had changed its direction in the period 1990 through 1992 to become a cow-calf operation, rather than a mixed farm with an emphasis on grain operations. Despite the fact that the Appellant has a strong history as a working accountant and controller of a short line farm manufacturer in Swift Current and despite the fact that she produced numerous calculations and projections:

(1) She did not introduce any written projections from 1990 until the date of trial projecting a profit from a cow-calf operation;

(2) She did not calculate on the stand how net profits could be obtained from a cow-calf operation; and

(3) She did not introduce any evidence that the mixed farm operation had changed appreciably from 1990 through 1999 to emphasize the cow-calf operation over the grain operation or even to vary the farm’s gross income on any large percentage basis from 1990 to 1999.

(4) The Appellant did not do any calculations respecting the cow-calf operation when asked to do so during cross-examination.

Anna testified for herself and the partnership. In giving her evidence the Appellant was evasive in cross-examination and did not answer many important and germane questions. At times she argued with Respondent’s counsel and at other times she simply declared her views on another topic. Her testimony under cross-examination was not credible and it also reflects on her testimony in chief.

With respect to the remaining matters assumed in the Reply to the Notice of Appeal, the Court finds:

(g) The Appellant’s husband farmed full time during the years in question. The couple’s children were at home in those years and the Appellant and her husband shared their domestic duties equally. From the Appellant’s testimony, it is apparent that she spent more time on her duties at REM than on the actual business of farming, although her time spent on the business of farming was substantial. She had no net income from the farm partnership and she testified that all of her REM income went into the farm. This testimony has to be untrue since money had to be spent for food, clothing, family and household needs and care for the children and her REM income was the only source for this. The Appellant committed all of her capital to the farm. It should be noted that her house was on the farm’s home quarter; '/; of its expenses were deducted in 1993 and $7,505.60 in “house repairs” were deducted in 1995. The Appellant testified that in 1993, 1994 and 1995 she felt that the farm would be her ultimate source of livelihood, but she did not demonstrate how that was to be achieved, when it would happen, or fix a quantum of profit and state when that profit would be substantial. Rather, she relied on the position that a refinancing with Farm Credit Corporation in 1992 plus an alleged emphasis on Red Angus cattle constituted a start-up so that she should be allowed a further start-up period. But in Donnelly (supra), Robertson J.A. stated that “it was incumbent on the taxpayer to establish what he might reasonably have earned but for the two setbacks which gave rise to the loss...”. That is also the case here. Anna testified that an inappropriate capital purchase and grain farm conditions were the cause of the losses. But she did not provide sufficient evidence to enable the Court to estimate quantitatively what the profit might have been in 1993, 1994 and 1995 had the causes not occurred. Nor did she prove that the farm underwent a change of direction to become a cow-calf operation so as to entitle the partnership to a further start-up period during the years in question. The evidence is that the herd was enlarged incrementally over the years and simultaneously the grain operation was varied and improved. What occurred was a normal mixed farm evolution.

(h) The farm partnership had no profit from 1991 until 1997 inclusive. In 1998 the Appellant had very little outside employment income, Ben received no deducted allocation and the farm partnership had its first net income: $24,411. The Appellant’s share was $12,206.

(1) See paragraph [6] and the numerous findings of fact.

(t) Thus, there is no evidence that the farm partnership could in 1993, 1994 and 1995, reasonably be expected to provide “substantial” prof its from farming to the Appellant either with or without the purported payments of “salaries” to Ben.

On the foregoing basis, the Court finds:

(a) that the Appellant’s chief source of income was not farming or a combination of farming and some other source of income during the taxation years in issue.

(b) that the Minister properly allowed the Appellant the restricted farm losses under subsection 31(1) of the Act during the taxation years in issue.

(C) that the Minister properly disallowed the purported payments of salaries to Ben as expenses in determining the farm partnership’s income (losses) during the taxation years in issue.

(d) that the Minister properly reassessed the Appellant under subsection 165(3) of the Act, to disallow as expenses the deduction of the purported payments to Ben as salaries from the farm income (losses) and restrict the Appellant’s farming losses under subsection 31(1) of the Act.

(e) that under subsection 96(1) of the Act the determination of income (losses) of the Appellant’s farm partnership was properly computed at the partnership level as though the partnership was a separate person and her restricted farm losses were properly determined at personal level under subsection 31(1) of the Act.

Pursuant to the application of the Appellant’s counsel, the Registrar is instructed to contact the parties’ solicitors to fix the date and time for a telephone conference in which the matter of costs will be argued.

Appeal dismissed.