Her Majesty the Queen v. Douglas C Matthews, [1974] CTC 230, 74 DTC 6193

Mahoney, J:—The subject-matter of this appeal is the deduction by the defendant of $693.04 losses incurred in respect of his interest in two “tree farms” from other income in his 1969 income tax return. The Tax Review Board allowed his appeal from the Minister’s assessment and it was acknowledged by the plaintiff that subsection 178(2)* [1] of the Income Tax Act, as it now stands, is applicable regardless of the outcome of the appeal.

The defendant is an investment manager residing and carrying on business in Toronto. His primary investment interests are in the areas of high technology, petroleum and rental real estate. He is not a professional forester but has an informed amateur interest in the subject, inherited from his father who undertook a reforestation program on family property at Roches Point on Lake Simcoe in 1928 or 1929. The defendant reforested the same property in 1954. The defendant has been active in the Ontario Forestry Association since 1960. He has been a director and is presently a councillor of that organization.

In 1958 the defendant acquired sole ownership of 150 acres in Holland Township, Grey County, Ontario. About half of this property had been reforested by the previous owner in 1926, the balance was natural forest. The previous owner had not followed recognized good forestry practices with respect to the property. The defendant visits this property only for the purpose of managing the “tree farm”. If there is no activity, he visits it once or twice a year. If there is cutting, the visits are more frequent. There are no recreational facilities whatever on the property. There is a farmhouse rendered uninhabitable by vandals and a decrepit log cabin. Their municipal assessment is nil.

In 1965 the defendant acquired title to 76 acres in what was then North Gwillimbury Township, Regional Municipality of York, Ontario. He holds the title in trust, one-quarter interest being beneficially owned by each of himself and his sister and one-half by a neighbour. This parcel is located about one-quarter mile distant from the Roches Point property now owned by the defendant’s mother and enjoyed by him and his family. The property contains some riding trails and the defendant estimates that he spends 20 to 25 hours annually walking or riding through this property part of which is for the purpose of inspecting it.

The North Gwillimbury property had been a farm, 85% to 90% cleared, unused for a number of years and overgrown with dogwood and weeds in 1965. After deferring his reforestation program due to a very wet spring, the defendant flailed the brush and weeds, ploughed the cleared area and planted over 58,000 seedlings, of ten different species, both coniferous and deciduous, in September and October 1965. The winter of 1965-66 was very wet; the summer of 1966 was very dry and the combination of frost heave and drought, notwithstanding salvage efforts, resulted in the loss of about half of the 1965 planting. There was no further activity on this property until 1971 when a new planting program was undertaken pursuant to an agreement with the Minister of Lands and Forests of Ontario under The Woodlands Improvement Act, RSO 1970, c 502.

In September 1968 the defendant had entered into an agreement under The Woodlands Improvement Act with respect to the Holland property. The scheme of the Act is that the owner of a private forest can obtain financial assistance for such improvements to his holdings as the planting of nursery stock and the pruning of maturing trees with a view to obtaining as an ultimate crop a maximum quantity of knot-free, clear, premium value lumber at the end of the growing cycle. In consideration of this, the owner commits himself to follow the approved program and if he departs from it he is liable to repay the amounts advanced.

The defendant does not labour physically in the operation of his “tree farms”. He exercises a managerial function, hiring the men and equipment needed for those operations not carried out by provincial forces under the agreements such as the 1965 planting, thinning and pruning; he negotiates the sales contracts and, where necessary, contracts for cutting.

There has been no revenue to date from the sale of produce from the North Gwillimbury property. As a result of the thinning operation on the portion of the Holland property reforested by the previous owner in 1926, revenues totalling some $1,666 were derived from produce of the Holland property during 1960, 1962 and 1965. These did not, by any means, offset the expenses and result in a profit. The next revenue year was 1973 when $8,799 was realized from the clear cutting of 17 acres of scotch pine. The defendant expects 1974 to be profitable and says that 1973 certainly was. Of the $639.04 loss in issue, $35.32 is attributable to the North Gwillimbury property and $603.72 to the Holland property.

The revenues previously referred to, and the expenses incurred in each year, and particularly in 1969, must be taken in the context of the normal crop cycle of a “tree farm”. The defendant’s notice of objection to the Minister’s original assessment herein contained the following:

The clear cutting of the scotch pine that led to the 1973 profit does not fall within this normal cycle. Rather it resulted from the fact that the particular species had not proved itself as satisfactory as had been expected in earlier years and it was decided to get rid of it and replace it with another species.

Based on the defendant’s 100-year cycle and bearing in mind the 29-year head start of the Holland property and excluding exceptional realizations such as the 1973 decision to clear cut the scotch pine, the anticipated revenue years would be:

The defendant called three expert witnesses, all with university degrees in forestry: Douglas Paul Drysdale, presently Director of Timber Sales for the Ontario Ministry of Natural Resources (successor to the Department of Lands and Forests); James Douglas Coates, Executive Vice-President of the Ontario Forestry Association, and Professor David Vaughan Love, Assistant Dean of Forestry at the University of Toronto. All had visited the Holland property but none had seen the North Gwillimbury property. All listened to the defendant’s testimony and were of the opinion that the defendant had a genuine understanding of forestry and was following procedures as good as could be recommended. Each felt that in view of increasing demand and prices, the development of faster growing species, economical methods of fertilization and new uses for less mature timber, the 100- year cycle was, if anything, conservative and that, depending on the product to be grown and its intended use, rotation periods of 40 to 70 years were feasible. All were agreed that, while the opportunity for profit cannot be guaranteed, an operation of the size in question was reasonably likely to produce an operating profit. None suggested that the original capital cost of the land would be recovered.

The $35.32 loss in respect of the North Gwillimbury property results from the payment of municipal taxes in that amount with no offsetting revenue. The $603.72 loss in respect of the Holland property results from the following outlays:

A total of $1,311 paid out during 1969 in respect of the Holland property for pruning 34 acres, thinning 8 acres and planting the nursery stock was reimbursed to the defendant by the provincial government under the agreement.

The plaintiff pleaded that the deduction of the loss was prohibited by paragraphs 12(1)(a), (b) and (h) of the Income Tax Act, the latter being modified by subparagraph 139(1){ae)(i). The relevant portions of these sections are:

12. (1) In computing income, no deduction shall be made in respect of

(a) an outlay or expense except to the extent that it was made or incurred by the taxpayer for the purpose of gaining or producing income from property or a business of the taxpayer,

(b) an outlay, loss or replacement of capital, a payment on account of capital or an allowance in respect of depreciation, obsolescence or depletion except as expressly permitted by this Part,

(h) personal or living expenses of the taxpayer. . .

139. (1) In this Act,

(ae) “personal or living expenses” include

(i) the expenses of properties maintained by any person for the use or benefit of the taxpayer... and not maintained in connection with a business carried on for profit or with a reasonable expectation of profit,

The plaintiff did not suggest that the capital cost allowance claimed was not expressly permitted. The outlays resulting in the 1969 loss appear, prima facie, not to be of a capital nature. I find that the deduction of the loss claimed was not precluded by paragraph 12(1)(b).

The term “business” is defined in the Act:

139. (1) In this Act,

(e) “business” includes a profession, calling, trade, manufacture or undertaking of any kind whatsoever and includes an adventure or concern in the nature of trade but does not include an office or employment;

Subject to the exclusion of an office or employment, this statutory definition does not, in my view, narrow the broad definition that:

... anything which occupies the time and attention and labour of a man for the purpose of profit is business.* [3]

The defendant must establish, in satisfaction of paragraph 12(1)(a), that the loss is comprised of outlays and expenses made or incurred to gain or produce income from a business and, in satisfaction of paragraph 12(1 )(h), that the business was carried on for profit or with a reasonable expectation of profit. Section 4 of the Act provides that the income for a taxation year from a business is its profit for the year. There is therefore no distinction to be made between the objective of gaining or producing income referred to in paragraph 12(1 )<a) and the objective of profit incorporated in paragraph 12(1 )(h) by virtue of subparagraph 139(1)(ae)(i).

Leaving aside for the moment the reasonableness of the defendant’s expectation of profit, I am satisfied that the defendant was carrying on the “tree farming” operations on both properties during 1969 as a business and not merely pursuing a hobby or avocation in a businesslike way. The mere fact that a person enjoys a business activity, as the defendant undoubtedly enjoys his forestry, or incidentally derives pleasure from a personal activity on a business property, as the defendant no doubt does when he walks or rides about the North Gwillimbury property, does not. per se alter the “business” nature of either the property or the activity. On the basis of the evidence before me, ! cannot find that the defendant’s “tree farm” operation on either property was a mere sham or device. I think it most unlikely that he would be engaged in “tree farming” if it were not for his abiding interest in forestry but I am convinced that he is bona fide engaged in it as a business, in the ordinary sense of that word, with the intention that it be profitable.

There is a valid question as to the capacity for profit in circumstances where the capital investment in the land is most unlikely to be recovered out of those profits over a reasonable period of time. Without defining “tree farming” as “farming”, this is by no means a unique situation. It is notorious that profits from many agricultural businesses are, by most standards, inadequate when related to the value of the land devoted to the business. The cost of land to someone wishing to get into the business cannot, in many instances, be justified by the projected return. On the other hand the improbability of recovering the cost of the land and the inadequacy of the return on its value is not entirely unrealistic in the commercial sense. With good husbandry, farm land is not a wasting asset. In the case of a “tree farm”, it is as able to yield a new “crop” in a matter of several decades as, in the case of a conventional farm, the land is able to yield an annual crop. The Supreme Court of Canada held, in Dominion Taxicab Association v MNR, [1954] SCR 82; [1954] CTC 34; 54 DTC 1020, per Cartwright, J at 85 [37, 1021]:

.. . whether or not the sum in question constitutes profit must be determined on ordinary commercial principles unless the provisions of the Income Tax Act require a departure from such principles.

The conduct of a business whose profits are not expected to reimburse the capital cost of an asset that is not subject to waste or depreciation in the process of production nor to obsolescence by the passage of time or the development of technology does not violate ordinary commercial principles so as to lead to the conclusion that the business is not being carried on for profit or with a reasonable expectation thereof.

It is apparent that “tree farming” on the scale in question involves relatively few revenue years over a long period of time, perhaps much longer than normal human life expectancy. Equally, it may be inferred that, given a number of “tree farms” or a very large one with a number of plots in varying stages of maturity, a more or less frequent recurrence of revenue years could be achieved, after, of course, a rather lengthy initial waiting period if the undertaking were started from scratch. Accepting, as I do, the proposition that “tree farming” is capable of being a business, I cannot agree with the plaintiff’s argument that these essential characteristics of the business, when it is carried on in a small way, somehow alter its nature so that it is no longer a business. It is important to note that in subparagraph 139(1(ae)(i) the word ‘‘reasonable” modifies “expectation” not “profit” and that the term “reasonable expectation of profit” is not synonymous with “expectation of reasonable profit”.

Each case where the realization of profit is so postponed will have to be examined on its own merits. to ascertain that the profit is not merely notional and that the expectation of profit is indeed reasonable. I am, however, satisfied, in this instance, that the defendant was, during his 1969 taxation year, carrying on the “tree farming” operations on both the Holland and North Gwillimbury properties as a business with a reasonable expectation of profit and that deduction of the losses claimed was proper.

The defendant argued that “tree farming” is farming, as defined in the Act, and that the losses claimed were deductible pursuant to section 13 in any event even if it was found that the “tree farming” operations were not a business. This was the ratio decidendi of the learned member of the Tax Review Board herein. While 1 agree with him in the result it is not necessary for me to comment on his finding that “a reasonable expectation of profit is not a criterion for farming per se” nor is it necessary for me to decide whether “tree farming” is farming within the meaning of the Act and I expressly decline to do so.

The appeal is dismissed. The amount of the costs to be awarded pursuant to subsection 173(2) was not spoken to at the trial. I therefore award the defendant his costs to be taxed.