Philrick Limited v. Her Majesty the Queen, [1977] CTC 217, 77 DTC 5158

Sweet, DJ:—This appeal from the plaintiff’s income tax reassessments for its 1967, 1968, 1969 and 1970 taxation years has two parts.

One arises out of its claim that in computing its taxable income for those years all of its farming losses should be deducted, farming having been one of its businesses. The Crown’s position is that the plaintiff’s chief source of income for those years was neither farming nor a combination of farming and another source of income within the meaning of subsection 13(1) of the Income Tax Act (the Act) and that the deductible farming losses are only the lesser of the amounts stated in paragraphs (a) and (b) of subsection 13(1) of the Act.

Subsection 13(1) of the Act was:

13. (1) 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, his income for the year shall be deemed to be not less than his income from all sources other than farming minus the lesser of

(a) his farming loss for the year, or

(b) $2,500 plus the lesser of

(i) one-half of the amount by which his farming loss for the year exceeds $2,500, or

(ii) $2,500.

The other facet of the appeal is in connection with a disallowance by the Minister (quoting from the statement of claim) “of one-half of the salary paid to Mr Richards on the basis that it is charged to the farm loss”. The Mr Richards referred to is H W Richards, the then president of the plaintiff and beneficial owner of all its issued shares.

It is common ground that one of the plaintiff’s businesses during the relevant years was farming and another, real estate.

The following is an extract from the statement of defence:

. . . In so assessing, the Minister of National Revenue relied, inter alia, upon the following findings or assumptions of fact:

(a) he relied on the facts hereinbefore admitted;

(b) at all relevant times the Plaintiff operated two businesses: that of a real estate developer and builder and of breeding and racing standard- bred horses;

(c) according to the Plaintiff’s financial statements its net income from its

business of real estate development and building was as follows:

1967	—	$43.314.00
1968		18,206.00
1969		45,541.00
1970		68,949.00

(d) according to the Plaintiff's financial statements its losses from the farming operations were as follows:

1967 — (15,196.00)

1968 — (18,252.00)

1969 — (25,142.00)

1970 — (53,704.00)

(e) The Plaintiff never realized a profit on its farming operations.

The present state of the jurisprudence makes it quite clear that farming does not cease to be a source of income in a year within the meaning of subsection 13(1) of the Act for the sole reason that it does not yield a profit within that year.

In Moldowan v The Queen, [1976] 1 FC 355; [1975] CTC 323 at 325; 75 DTC 5216 at 5217, Pratte, J said:

Section 13 presupposes that farming may be a taxpayer’s chief source of income for a taxation year in spite of the fact that the taxpayer may have incurred a farming loss for that year. A business does not cease to be a business in a year (and a source of income does not cease to be a source of income in a year) for the sole reason that it does not yield a profit in that year. Subsection 13(1) does not refer to the “chief source of the taxpayer’s income’’ but to the “taxpayer’s chief source of income’’. In my view, aS long as a taxpayer carries on the business of farming, farming remains one of the taxpayer’s sources of income regardless of the fact that the farming business may, in certain years, result in losses and regardless of the fact that the taxpayer may have no reasonable hope of operating his farming business at a profit in those particular years.

In the same case, Urie, J (who dissented in the result) said [p 330 [5223]]:

Reference then must be had to paragraph 139(1a)(a). This section, read in conjunction with section 3, leads to the conclusion that every business must be regarded as a source of income, irrespective of whether in any given year it produces any income, either gross or net.

Counsel for the respondent argued that since section 4 of the Act defines income as profit, ‘source of income” as used in section 13 means “source of profit”. With respect I do not agree with this submission.

And Ryan, J said [p 333 [5219]]:

I am also in accord with the view that farming or farming in combination with some other source may be a source of income for purposes of section 13, though the taxpayer sustained a loss through its operation during the taxation year. If this were not so, it would be difficult to make sense of the section.

In Brown v The Queen, [1975] CTC 611; 75 DTC 5433, decided after Moldowan, Cattanach, J said at page 615 [5436]:

It has been held in many instances that a source may be a source of income in a particular taxation year even though in that year the taxpayer suffers a loss. That being so, the simple mathematical task of comparing the net incomes from two sources is not a conclusive test for determining which of the two sources of income is the chief source. To so determine resort may be had to other criteria.

Although a farming business which suffers a loss in a taxation year may be a “source of income’’ in that year within the meaning of subsection 13(1) of the Act, that, in itself, may leave unresolved the question as to whether a combination of that farming operation and some other source of income would constitute the taxpayer’s “chief source of income’’ for that taxation year within the meaning of subsection 13(1) so as to relieve the taxpayer from the limitation on the deduction for a farming loss imposed by subsection 13(1). In this, three aspects may be considered:

1. The situation where there are only two sources of income, one of them being farming.

2. Characteristics (other than “connection’’) qualifying farming for inclusion in ‘‘a combination of farming and some other source of income’’ within the meaning of subsection 13(1) of the Act as indicated by Moldowan v The Queen (supra) where, however, there were more than two sources of income.

3. Whether there need be any “connection” between farming and the other source of income.

I deal first with the question as to whether the plaintiff had, during the relevant taxation years, two or more than two sources of income.

At the trial, no one took the position that there were more than the two sources of income, farming and the real estate operation. In the statement of defence the defendant, as previously indicated, pleaded “at all relevant times the Plaintiff operated two businesses: that of real estate developer and builder and of breeding and racing standard- bred horses”. However, the copies of financial statements filed as an exhibit indicated that there may have been some investment income per se, although this is not clear even from those financial statements. Accordingly, I do not consider I am relieved from the responsibility of considering that possibility. The balance sheets carry investments as an asset. For the fiscal periods ending February 28, 1967, 1968, 1969 and 1970 these are shown respectively at $7,000, $12,467, $8,001 and $1,001. I did not find in the statements any items designated as income from any investments in securities. If any such income there actually was, it would seem that it would be relatively small. In the statements of retained earnings for the years ended February 28, 1969 and February 28, 1970, losses on disposal of securities were shown respectively at $259 and $7,000.

The conclusion which I reach is that, having regard to all of the circumstances including the vagueness (if not the absence) of evidence regarding the possibility of investment income, that possibility should not, for the purpose of disposition of this appeal, be given any weight and that this case should be disposed of on the basis that during the relevant years the plaintiff had only two sources of income, namely farming and real estate.

As I read subsection 13(1) of the Act, the wording “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” implies that the subsection refers merely to situations where there are more than two sources of income. I think the use of the word “chief” makes this clear. For the combination of farming and another source to be the “chief source” as distinguished from the ‘‘only source” there would, as I interpret it, have to be some source or sources other than that combination. Here, as I view the matter, the combination of farming and the real estate operation was the only source. Accordingly, as I see it, subsection 13(1) with its limitation on deductions of farming losses is not applicable to and does not govern this situation.

Urie, J dealt with this phase of the matter in Moldowan v The Queen (supra) where he said [p 330 [5223]]:

An examination must be made of the various sources of a taxpayer’s income, if he has more than one, to ascertain whether farming income, combined with income from another source, represents his chief source of income. Of course, if he has only one other source, then his chief source must be farming together with the other source, in which event obviously the taxpayer is outside the purview of subsection 13(1). It goes without saying that this is also true if his only source of income is farming.

In Brown v The Queen (supra) Cattanach, J said at page 617 [5438]:

In view of the conclusion I have reached on the question of fact in these appeals it is not necessary for me to consider the question as to whether the plaintiff’s “chief source of income’’ is a “combination of farming and some other source of income”. If it were incumbent upon me to do so I could not refrain from pointing out that in these appeals there are but two sources of income. That being so, it seems to me to follow that the plaintiff's total income, from these two sources, must be a combination of farming and some other source of income. Different considerations might prevail if there were more than two sources of income thereby resulting in different possible combinations.

If I am right in my conclusions set out above, that is the end of the matter. Subsection 13(1) would not be applicable here and the plaintiff’s appeal must be allowed, bearing in mind the following comment by Pratte, J in Moldowan v The Queen [p 324 [5217]]:

Section 13 provides that, in certain circumstances, a taxpayer engaged in the business of farming is not allowed, in the computation of his world income, to deduct the whole of the farming loss that he may have incurred. It must be stressed that, apart from the section, under the general rules governing the computation of income, the farming losses of a taxpayer engaged in the farming business would, in the computation of his world income for the year, be entirely deductible from his profits from other sources.

If I am wrong in those conclusions and if, for the plaintiff to escape the limitations on deductions for farming losses imposed by subsection 13(1), its farming business must have at least some characteristics indicated in Moldowan (where there were more than two sources of income), the result, in my opinion, must nevertheless be the same. In my opinion, the plaintiff’s farming operation had sufficient of those characteristics to qualify it for inclusion in “a combination of farming and some other source of income” within the meaning of subsection 13(1) of the Act. Here I do not deal with the question as to whether there must be a connection between farming and the other source to qualify farming for inclusion in the combination. I leave that phase to be dealt with below.

Pratte, J in Moldowan, said [p 325 [5217]]:

However—and this is perhaps the crucial question—how does one assess the relative importance of the various sources of income of the taxpayer? . . .

In order to reach a conclusion in this case, I do not find it necessary to give an exhaustive answer to that question. It is enough for me to say that, In my view,

(1) the importance of a source of income cannot be entirely divorced from the importance of the income that it normally produces or that it is expected to produce in the future;

(2) a source of income which, for a taxpayer, has always been and is expected to remain a marginal source of income cannot be said, as long as it remains a marginal source of income, to be the taxpayer’s chief source of income.

The following are extracts from the judgment of Urie, J in the same case [pp 330, 331 [5222, 5223]]:

The reasoning process in the determination of fact leading to the conclusion that a person is engaged in the business of farming, it seems to me, may involve ascertaining from the evidence, as one of the indicia, whether or not the alleged farmer has a “reasonable expectation of profit”, as that term is used in subparagraph 139(1 )(ae)(i). In my view, it should be emphasized that this concept provides only one of the indicia, the weight to be given to which will vary with the evidence adduced in each case.

and

Without attempting in any way to exhaust the possibilities, some of those criteria which might be considered are the relative amounts of capital investment in the respective sources, the reasonableness of his expectation of profit therefrom, the amounts of gross income and of net income derived from each source, the proportion of time spent in each day by the taxpayer in respect of each source, and the prior history of the respective sources in respect of amount of income generated. If, on all the evidence it could not be said that the farming and some other source provided the chief source of income, then subsection 13(1) would apply.

Dealing with the same subject in the same case, Ryan, J said [p 333 [5219]]:

. . . and while it is true that a source may be a source of income in a particular year though it did not yield a profit in that year, it nonetheless appears to me pertinent to look at each of the taxpayer’s sources from the point of view of capacity for present or future profit or for both when one is seeking to determine his chief source of income in that year. The relative importance of sources as sources of income would seem to me to be in most part a function of their capacity to produce gain. In my opinion an appropriate path to a resolution of this difficult problem is to give significant attention to the taxpayer’s ongoing income-earning activities in a practical and businesslike way and in this way to determine which of the taxpayer’s sources of income, in the ordinary run of his affairs, but taking account of his plans and his activities in implementation of his plans, is the chief source of his income in the sense of its usual or its foreseeable profitability or both. In seeking an answer, gross income, net income, capital investment, cash flow, personal involvement, and other factors may be relevant considerations.

According to its financial statements the plaintiff’s total assets and the amounts included for horses per se (the latter without including any other asset connected with farming) were:

The following is a summary of some of Richards’ evidence in connection with the plaintiff’s farming activities.

In 1964 it was decided to buy some sort of facility for the horses. A farm, 5 miles east of Markham, was purchased and registered in the plaintiff's name. It was 23’6 acres and had on it a house into which Richards moved with his family. Fourteen stalls, a hay room and a tack room were installed. A rough track was built. There were then about 8 horses. Later, a trainer was hired who stayed until early spring 1967. Richards wanted to get out of the real estate business. His interest was in the horses. By 1966 or 1967 he was pretty well settled in looking after the horses.

Filed as an exhibit is a copy of a lease dated May 15, 1969 from the plaintiff to Audrey M Downing of what appears to have been the plaintiff’s farm.

According to Richards, the plaintiff leased another farm across the road consisting of 100 acres at a rental of $1,200 per month and on it was a racing stable and a track. Richards indicated the plaintiff leased it because it needed the track. In his evidence he said this might be 1971 or 1972. I think it may be that he was mistaken about the date because of the lease dated May 15, 1969 mentioned above.

It seems to me that a significant amount of the plaintiff’s assets was used, or committed, for its farming operation.

It is my conclusion that by 1967 Richards personally found involvement with the race horses much more interesting than the real estate operation. I think that from then on he spent more time with that branch of the business than with the land operation. I believe he had high hopes and expectations for the raising, breeding and racing of standard-bred horses. He said that he had “unbelievably bad breaks” and had no reason to doubt the horse business. I think he actually believed this, though the results show that for the relevant years, at least, he seems to have been too optimistic. On the other hand, I think it must be accepted that horse racing is a hazardous business. I feel that Parliament must fully have recognized the hazards when it included in the definition of farming “maintaining of horses for racing” (paragraph 139(1 )(p)).

My conclusion is that the plaintiff’s farming operation was a significant branch of its business notwithstanding the farming losses.

I deal now with the question as to whether there must be a “connection” between farming and the other source of income in order that farming may qualify as part of “a combination of farming and some other source of income” referred to in subsection 13(1) of the Act with the result that the taxpayer avoids the limitation on allowable deductions for farming losses imposed by that section.

In Moldowan v The Queen, Pratte, J said [p 326 [5218]]:

I do not share the view that a taxpayer’s chief source of income may be “a combination of farming and some other source of income” even if there is no “connection” of any sort between the farming activities of the taxpayer and his other source of income. In my opinion, the word “combination” means more than “addition”; it implies, in my view, a certain degree of association or integration. It is only if two sources of income are, in some way, integrated or interconnected that it can be said that their combination constitutes one source of income.

Moreover, if the expression “combination” meant nothing more than “addition”, section 13 would be devoid of any effect since the taxpayer engaged in the business of farming and having also other more important sources of income could always claim (by adding “farming” to his most important source of income) his chief source of income to be “a combination of farming and some other source of income”.

In Moldowan, Urie, J referred to Dorfman v MNR, [1972] CTC 151; 72 DTC 6131, and James v MNR, [1973] FC 691; [1973] CTC 457; 73 DTC 5333, saying that several principles were enunciated there with which he agreed and which he accepted. One was: “There need not be any connection between farming and the business making up in combination therewith a source of income.”

Mentioning the conclusion of Gibson, J in the James case [at p 464 [5337]], namely:

. . , I find no statutory authority for the proposition that in order for it to be possible to make a determination under section 13 of the Act, whether or not the chief source of income for a taxation year of a taxpayer is a “combination” of farming and some other source of income that there must be some “connection” between the business of farming and the business from which such other source of income is derived.

Urie, J continued [p 329 [5222]]:

With that conclusion I agree and merely add that if it were intended that there should be some sort of a connection between farming and the other source of income with which its income might be combined, Parliament could very easily have used language clearly to express this intention. Instead, it used the word “combination”. The Shorter Oxford Dictionary, 3rd ed, defines “combination” as follows:

“1. The action of combining two or more separate things 1613

2. Combined state or condition; conjunction 1597

3. Concr. a group of things combined into a whole 1532.”

There is no implication from this definition of the necessity for a connection between the things which are combined. In fact the opposite appears to be the case. To so imply would require that additional words be read into the section and would strain the natural meaning to be given to a word. Neither result is desirable. I thus conclude that neither the legislative history nor the dictionary definition require that there be a connection between the businesses or source of income making up the combination.

Ryan, J said [pp 333, 334 [5219]]:

In my view, the decision as to whether the combination of farming and some other source of income was the taxpayer’s chief source of income involves the making of a practical judgment on the question of whether in fact the combination constituted the chief source. I do not think the question is answerable simply by saying that farming can be combined with the taxpayer’s most important other source, no matter what it may be, and thus concluding without more that the combination is the chief source. . . . Just as in the case of determining whether farming alone is the chief source, so in the case of determining whether farming combined with another source is the chief source, a practical judgment must be made, and in my opinion the judgment is to be made by way of an apology to the process appropriate to determining whether farming alone is the chief source.

Having regard to the context in which it appears, it does not seem to me that when Ryan, J said:

I do not think the question is answerable simply by saying that farming can be combined with the taxpayer’s most important other source, no matter what it may be, and thus concluding without more that the combination is the chief source.

he was holding that what was required in addition to the mere combination was some connection between farming and the other source. As I construe his Lordship’s statement in its context, he did not consider “connection” a requirement.

If I am not right in my interpretation of Ryan, J’s statement, and if only two diverse views were expressed on the matter in Moldowan v The Queen, then I must deal with the point, because, in my opinion, in all other respects, the farming part of the plaintiff’s business met all requirements so that it could be part of the combination of farming and some other source of income mentioned in subsection 13(1) to the end that the deduction for the loss from the farming was not limited by subsection 13(1).

My respectful opinion on the point is that in order that there may be a “combination of farming and some other source of income” within the meaning of subsection 13(1) of the Act, there need not be any connection between the farming and the other source of income. As I construe it, there is nothing in subsection 13(1) which says there must be any such connection. Respectfully, I do not think there is anything in the wording of this section which implies that there must be any such connection.

I find that for the purpose of computing the taxable income of the plaintiff for its taxation years 1967, 1968, 1969 and 1970 deductions for its farming losses for those years respectfully are not limited by section 13 of the Act and that section 13 of the Act is not applicable to the situation existing in this case.

I now turn to that part of. the plaintiff’s appeal which is against the disallowance “of one-half of the salary paid to Mr Richards on the basis that it is charged to the farm loss”.

It seems to have been accepted by the Crown that Richards’ salary was in order except for its claim that half of it should be charged to farming operations. In the statements re income in the financial statements, under the heading of “expenses”, there are items called “management salary”. Presumably, Richards’ salary is included in these. Thus it would seem that in the plaintiff’s accounting none of Richards’ salary was charged to the farm operation.

Having regard to the time spent by Richards on the farming operation during the relevant years I consider that the plaintiff could have no good objection to an allocation of 50% of Richards’ salary as an expense of that operation.

However, having regard to the disposition of the other branch of the appeal and the Crown’s objection appearing to be confined to allocation, the result would be the same regardless of how Richards’ Salary is allocated as between the two activities. Instead of charging all of it to the real estate operation, the allocating of half to the farming operation, as the Crown has done, of course increases the profit on the real estate operation and increases by the same amount the loss on the farming operation.

Nevertheless, the point may become important in the event of a review of this decision. I find that the Crown’s allocation of 50% of Richards’ salary to the farming operation should not be disturbed. Otherwise, I find that all of Richards’ salary is an item properly deductible in respect of the relevant years.

The appeals of the plaintiff are allowed.

The reassessments for the plaintiff’s taxation years 1967, 1968, 1969 and 1970 are referred back to the Minister of National Revenue for further reassessment on the basis of what is set out in these reasons for judgment.

The plaintiff will have its costs of these proceedings, payable by the defendant.

Either party may prepare a draft of an appropriate judgment to implement the Court’s conclusion and move for judgment accordingly pursuant to the General Rules and Orders of the Court.