Moldowan v. R., [1975] C.T.C. 323, 75 D.T.C. 5216

Pratte, J:

1 This is an appeal from a judgment of the Trial Division which, confirming a decision of the Tax Review Board, held that the appellant was not entitled to deduct, in the computation of his income for the 1968 and 1969 taxation years, the whole of the farming losses that he had incurred for each one of those years.

2 In order to dispose of this appeal it is first necessary to consider section 13 of the Income Tax Act.

3 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 this 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. It must also be observed that section 13 does not abrogate that general rule since it presupposes that in certain circumstances there is no limit to the deductibility of farming losses. One should therefore avoid giving to section 13 an interpretation which would either absolutely prohibit such a deduction of farming losses or would confer an absolute right to so deduct all such losses.

13. (1) When 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 ...

• (a) When is farming a “source of income”?

• (b) When is farming a taxpayer's “chief source of income”?

• (c) What is the meaning of the expression “combination of farming and some other source of income”?

(a) Source of Income

5 It is apparent from section 3 of the Act that “business”, “property” and “offices and employment” are considered to be sources of income. Farming is, therefore, a source of income when it is carried on as a business.

6 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.

(b) Chief Source of Income

7 I must first observe that subsection 13(1) refers to the “taxpayer's chief source of income”; it does not refer to the “source of the bulk of the taxpayer's income”. In order to qualify as the taxpayer's chief source of income, it is not necessary, in my opinion, that farming be more important than all the taxpayer's other sources of income grouped together; it is sufficient that farming, as a source of income, be more important than any of the other sources of income.

8 However—and this is perhaps the crucial question—how does one assess the relative importance of the various sources of income of the taxpayer? The expression “sources of income” embraces not only “businesses” but also “property” and “offices and employment”. How does one compare the importance, as sources of income, of a business and of a property? Normally, one would be tempted to answer that the importance of a source of income in any particular year is proportional to the importance of the income it produces in that year. But such a simple and logical answer could not be reconciled with section 13 which presupposes that farming may be a taxpayer's source of income for a year in spite of the fact that the taxpayer has incurred a farming loss in that year.[FN1: <p>One does not give a satisfactory solution to that problem by saying thatthe word “income” in subsection 13(1) means “grossincome” instead of profit. If it were so, the farmer, whose whole cropwould have been destroyed just before harvest time, could not deduct thewhole of his farming loss since his farming business having yielded no grossincome for that year would not be considered as a source of income at all.</p>]

• (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.

(c) Combination of Farming and Some Other Source

10 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.

11 Moreover, if the expression “combination” meant nothing more than “addition”, section 13 would be devoid f 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”.

12 I now turn to consider the way in which the appeal should be disposed of.

13 The appellant had been engaged in the business of farming for many years. Save for two years, in which his farming activities yielded a small profit, he had, every year, incurred a farming loss. I find in the evidence ample support for the finding of the trial judge that the appellant, who was a man of some means, never seriously expected that his farming activities would ever yield more than an income of insignificant importance in relation to his income from other sources. In those circumstances, I am of the view that the trial judge was right in holding that farming was not the appellant's chief source of income. Moreover, as there was no connection or relation of any sort between farming and the appellant's other sources of income, the trial judge was also right, in my opinion, in deciding that the chief source of income of the taxpayer was not a combination of farming and some other source of income.

14 For these reasons, I would dismiss the appeal with costs.

Urie, J (dissenting):

15 This is an appeal from a judgment of the Trial Division dismissing the appellant's appeal in respect of reassessments for his 1968 and 1969 taxation years.

16 The Minister of National Revenue by the reassessments limited to $5,000 in each of the years in question deductions for losses claimed by the appellant arising out of his horse racing business. In so doing the Minister applied the provisions of subsection 13(1) of the Income Tax Act (hereinafter called the Act). It read in each of the taxation years under review as follows:

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.

(2) For the purpose of this section, the Minister may determine that 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.

(3) For the purposes of this section “farming loss” means a loss from farming computed by applying the provisions of this Act respecting the computation of income from a business mutatis mutandis.

17 The facts adduced in evidence are sufficiently set out in the reasons for judgment of the learned trial judge as follows:

The plaintiff has been actively engaged in horse racing from at least as far back as the early 1960's, and in his taxation years 1968 and 1969 he was buying and selling race horses, training, raising and boarding race horses and engaged in horse racing. He originally started racing with one or two horses and subsequently bought numerous race horses as shown in Exhibit P-5, which shows about 53 horses bought during the years 1962 to 1969, at a total cost of about $183,463. He owned all the horses outright, except for several whose ownership he shared with other persons. He bought the horses at auctions and privately and through claiming races. He raced his horses at race tracks in British Columbia and eastern Canada, and in eastern and western United States, including well known tracks in Ontario, Seattle, Oakland and Florida. He sold and disposed of the horses from time to time. Exhibit P-5 also includes a schedule of purses won by the horses to a total of $184,018, the largest year being 1966 when the purses amounted to $29,558.

In the early years the plaintiff boarded his horses with one Mr. T. Fenton, who had a farm and trained and cared for race horses, but in 1966 the plaintiff decided to dispose of his interest in a company, by which he was employed, Active Trading Ltd, and to expand his horse racing activities, so he leased an acre of a farm adjoining the Lansdowne Race Track in the Municipality of Richmond, which rented acre contained a small house, a corral and about 25 to 30 box stalls for horses, in reality a horse farm; he engaged Fenton as a trainer and paid him $300 per month, plus 10% of purses won; he also paid boys who exercized the horses. He had necessary facilities at Lansdowne farm for his expanded business. In 1968 he had 5 clients for whom he boarded and trained horses, fees for boarding being $80 to $100 per month, and for training $9 to $10 per day. He testified that he expected to be able to make a profitable living from his expanded operations and hoped to expand them further.

In the years 1960 to 1967 the plaintiff was employed by the said Active Trading Ltd and received salary in those years ranging from $11,500 to $15,900. He sold his 50% interest in that company in 1967 for $150,000, receiving $50,000 cash, with the remainder payable at the rate of $5,000 per month for the next 20 months. In 1969 he received salary amounting to $17,833 from Cascade Fasteners Ltd, a company that he started in 1968 and later sold. He also started another company, Cascade News, in 1967, whose business was the distribution of racing forms in British Columbia, and he received dividends from that company.

Exhibit D-3 is a summary of the plaintiff's income for the years 1960 to 1972, as follows:

Farming        Rentals
        Office or                   Business      Net Income     Net Income
Year    Employment    Investment      Income       or (Loss)      or (Loss)
1960    $11,500.00        --            --       $ (1,213.55)    $2,700.00
1961     15,600.00        --            --         (2,235.28)      (872.00)
1962     15,600.00    $   300.00        --         (1,718.48)      (750.00)
1963     15,900.00         38.66        --         (1,593.44)    (1,131.00)
1964     16,200.00         37.84        --         (1,368.64)       --
1965     15,900.00      1,364.08        --         (1,684.19)       --
1966     15,900.00      1,193.86        --           (885.05)       --
1967     13,500.00      1,625.43        --         (8,504.75)       --
1968      1,750.00      8,822.43    $12,500.00    (21,097.46)       --
1969     17,833.40     17,048.65        --        (20,810.72)       --
1970     17,309.39     19,919.72       (913.68)    (7,535.76)       --
1971      6,607.04      7,656.55     17,415.65     (7,538.42)       --
1972     22,306.00     13,384.66        --         (4,038.94)      (312.10)

There is no dispute as to the figures. They indicate that the plaintiff's horse racing activities realized a profit of $1,593 in 1963 and $1,368 in 1964, but in every other year in the period 1962 to 1969 he sustained losses totalling almost $55,000, the greatest being about $21,000 in each of those years.

18 The interpretation of section 13 has been considered by the Exchequer Court and the Trial Division of this Court on a number of occasions and by the Appeal Division on one occasion in which the issue raised in this appeal was not dealt with. Among those cases are the following: MNR v Barbara A Robertson, [1954] C.T.C. 110, 54 D.T.C. 1062; MNR v Norman LeFevre Grieve and Toronto General Trusts Corporation, Executors of Estate of William Robert Grieve, [1959] C.T.C. 320, 59 D.T.C. 1186; Robert Charles Simpson v Minister of National Revenue, [1961] C.T.C. 174, 61 D.T.C. 1117; Ernest C Hammond v Minister of National Revenue, [1971] F.C. 341, [1971] C.T.C. 663, 71 D.T.C. 5389; Oscar Dorfman v Minister of National Revenue, [1972] C.T.C. 151, 72 D.T.C. 6131; The Queen v Fred Juster, [1973] C.T.C. 410, 73 D.T.C. 5325; Bert James v Minister of National Revenue, [1973] C.T.C. 457, 73 D.T.C. 5333; and James A Wilfley v The Queen, [1974] C.T.C. 510, 74 D.T.C. 6422.

19 In the Dorfman and James cases several principles were enunciated, which were not disputed by the parties to this appeal and with which I agree and which I accept. They are:

20 1. The maintaining of horses for racing and the training of horses, is “farming” within the meaning of the Act.

21 2. Whether or not in a given case a taxpayer is “farming” within the meaning of that term in the Act and for the purposes of the application of section 13, is a question of fact.

22 3. The determination of a taxpayer's “chief source of income” for a taxation year is also a question of fact. However, while there was no discussion on the point in these cases, it is clear that before that fact can be established the trier of fact must correctly apprehend the meaning of the term “chief source of income”.

23 4. There need not be any connection between farming and the business making up in combination therewith a source of income. In the James case (supra) Gibson, J reviewed the history of the legislation and concluded that:

I find no statutory authority for the proposition that in order for it to be possible to make a determination under section 13 of he 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.

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.

24 The interpretation of the phrase “chief source of income” is the real issue in this appeal and necessitates an analysis of the relevant sections of the Act.

25 Section 3 of the Act provides that the income of a taxpayer for a taxation year is his income for the year from all sources, one of which is his income from all businesses.

26 Paragraphs 139(1)(e), 139(1)(p), subparagraph 139(1)(ae)(i) and paragraph 139(1a)(a) read as follows:

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;

• (p) “farming” includes tillage of the soil, livestock raising or exhibiting, maintaining of horses for racing, raising of poultry, fur farming, dairy farming, fruit growing and the keeping of bees, but does not include an office or employment under a person engaged in the business of farming;

• (ae) “personal or living expenses” include

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

139. (1a) For the purposes of this Act,

• (a) a taxpayer's income for a taxation year from a business, employment, property or other source of income or from sources in a particular place means the taxpayer's income computed in accordance with this Act on the assumption that he had during the taxation year no income except from that source or those sources, and was allowed no deductions in computing his income for the taxation year except such deductions as may reasonably be regarded as wholly applicable to that source or those sources and except such part of any other deductions as may reasonably be regarded as applicable to that source or those sources; and

27 Paragraph 139(1)(p) defines “farming”. The learned trial judge found as a fact that the appellant was at the material times “farming” within the meaning of that subsection, and the respondent did not dispute this finding.

28 Paragraph 139(1)(e) defines “business” as including, inter alia, a “calling, trade ... or undertaking of any kind”. Certainly farming falls within one of those categories and thus is a “business” for purposes of the Act, as it is in the use of the word in everyday parlance.

29 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.

30 Reference then must be had to paragraph 139(1a)(a). This paragraph, 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.

31 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.

32 The appellant having been found to have been farming and farming being a business and thus a source of income, the fact that the business does not produce any kind of income in any taxation year is irrelevant in determining whether or not subsection 13(1) applies in a given case. The term “source of income” in the context of the Act means, in effect, “business”. It does not mean “source of profit”.

33 But the matter does not end there. Because subsection 13(1) requires a determination of a taxpayer's chief source of income for a taxation year, in order to ascertain whether or not the section applies in a given case, the simple acceptance of farming as a business and thus a source of income is, in my view, insufficient. An examination must be made of the various sources of the 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.

34 The problem is created when a taxpayer has more than one source of income in addition to farming. In that event while farming is always a source of income, regardless of whether or not in a given year any revenue has actually been generated from its operations, it is necessary, in my view, to examine all of the sources to determine whether farming as one source and one of the others, together give him his chief source of income. If they do, again, subsection 13(1) is not applicable.

35 On the other hand, if his income from farming together with the largest of his other sources is less than the combined incomes from other sources, it might well be necessary to consider other factors before the conclusion is reached that subsection 13(1) applies to limit losses deductible. Such a situation might occur when, for example, in a given year, a farmer suffers total destruction of his crops. In such circumstances, since farming is still a source of income, although no income has been produced from the farm's operations, resort may be had to other criteria to determine whether it, as a business and thus a source of income, is, in combination with another, a chief source. 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 of 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.

36 While I have expressed my views on the application of subsection 13(1) somewhat differently, I think that my conclusions accord with the reasoning of both Collier, J and Gibson, J in the Dorfman, James and Wilfley cases (supra).

37 The only evidence on the record in this case to assist in the determination of the chief source of income utilizing any of the criteria to which I have above made reference is the profit or loss generated by each source of income of the appellant in each of the years 1960 to 1972, as shown on Exhibit D-3 above. In the case of income from office or employment and investment, it would appear that in each of the years the income is the gross income. From the appellant's tax returns for the years 1968 and 1969 the gross income derived from his farming operations is disclosed. In the year 1968 the gross income was $32,634, and in the year 1969, $24,903. In each case the earnings were derived largely from purses won, training and boarding fees and from the trading of horses.

38 In 1968 the appellant derived income of about $1,750 from office or employment, $8,822 from investments and $12,500 from a real estate transaction. In 1969 he earned about $17,833 from office or employment and $17,048 from investments.

39 In each of the tax years in issue, therefore, the largest single source of gross income was from the appellant's farming operations. This then, in combination with the largest of his other sources of income provided his chief source of income in each of those years.

40 It is interesting to note that in the taxation year 1967 the appellant claimed and was allowed to deduct a farming loss of $8,504.75, ie subsection 13(1) was not applied. His gross farming income in that year was at its peak having been $94,678. According to the evidence that was the year in which he began to operate his race horse business in a substantial way. The large income and relatively small loss generated in the first year of operation makes it somewhat difficult for me to agree with the observation of the learned trial judge that “I do not think that he could reasonably look to or depend upon it, either alone or in combination with some other source of income, as his chief source of income in any of the years ahead, including the years 1968 and 1969.” As I pointed out above, in my opinion, the test of reasonable expectation of profit is used as one of the indicia to determine whether or not a taxpayer is engaged in the business of farming not in the determination of the taxpayer's chief source of income. The trial judge's finding that the appellant was in the business of farming, on the evidence adduced in this case, would, I would have thought, involved the use of this test. Thus, the comment referred to is not only inconsistent with his prior finding but is not, in my view, relevant in the resolution of the issue in this appeal.

41 I think it is clear that the learned trial judge viewed “source of income” as meaning “source of profit”. With the greatest respect, for the reasons heretofore given, I think that he was in error in adopting this view.

42 Because the learned trial judge in my view improperly interpreted the meaning of the phrase “source of income”, his finding that “In none of the years can it be said that his chief source of income was farming or a combination of farming and some other source of income” was erroneous. If I am right in so concluding, then it would appear that he was wrong in deciding that subsection 13(1) applied to the appellant's farming losses in the years 1968 and 1969.

43 I would, therefore, allow the appeal. The reassessments for the taxation years 1968 and 1969 should be referred back to the respondent for further reassessment accordingly. The appellant should be entitled to his costs both in this Court and in the Trial Division.

Ryan, J:

44 The facts of this case are fully set out in the reasons for judgment of my brother Pratte, J and my brother Urie, J. I agree that the appellant's horse racing and related activities constituted farming. I agree also that the appellant's farming was a source of income within the meaning of that term as used in section 13 of the Income Tax Act.[FN2: <p>The relevant statutory provision is the<em>Income Tax Act</em>, RSC 1952, c 148, section 13 (as amended), as applicable to the taxation years 1968 and 1969.</p>] The learned trial judge found, and his finding was not disputed, that “in the years 1968 and 1969 the plaintiff was operating a business of buying and selling race horses, boarding and training race horses owned by other persons, and racing his own horses, and that he was doing so not as a hobby but in the course of a commercial enterprise with a view to profit”. This finding is decisive of the question whether farming was a source of income during the years in question.

45 I am also in accord with the view that farming or farming in combination with some other source may be a source or 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.

46 The critical question is whether farming or farming in combination with some other source was the appellant's chief source of income during the taxation years in question. Once one accepts that a source may be a source of income in a particular year though, through it, the taxpayer suffers a loss in that year, one loses the possibility of simply comparing net income from each source as the test for determining the chief source. One must therefore seek some other guide; and while it is true that a source may be a source of income in a particular year through 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,[FN3: <p>See, for example,<em>Wilfley</em>v<em>The Queen</em>, [1974] C.T.C. 510, 74 D.T.C. 6422.</p>] is the chief source of his income in the sense of its usual or its foreseeable profitability or of both. In seeking an answer, gross income, net income, capital investment, cash flow, personal involvement, and other factors may be relevant considerations. Following this approach in this case, I am not satisfied on the facts that during 1968 or 1969 farming was the appellant's chief source of income. Indeed, I would agree with the learned trial judge that it was not.

47 I am also of the opinion that the appellant has not made out a satisfactory case to establish that in 1968 or in 1969 farming, combined with another of his sources, was his chief source for the year. 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. Such an approach might be put in the alternative: (a) assuming that chief source means the most important single source, then in every case, by combining farming with the most important other source, the result must always be that the combination is the chief source; or (b) assuming that chief source means the source that is more important than all others combined, then the combination of farming with the most important other source must be the chief source whenever there are three sources or less. Only if the assumption made in alternative (b) were valid and there were more than three sources (including the combination) would the Minister's discretionary power under subsection 13(2) have room to operate, or, in the absence of an exercise of the Minister's discretion, would the Court have an effective authority to make the decision. In my opinion this approach is inappropriate when viewed under the aspect of the purpose of the section, which is to place some limit on the deductibility of commercial farming losses. 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 analogy to the process appropriate to determining whether farming alone is the chief source. In making this assessment, the comparative importance of the combination must be assessed as if the decision were being taken by a reasonable and informed observer. The question to be decided is one of fact: Was the combination the taxpayer's chief source? The answer is to be sought in a context which, depending on the facts of the particular case, may embrace the past and predictions about the future as well as the present. The determination in a particular case may be difficult, but the section is itself far from being a model of clarity. It appears to be a remanet of a section which, before serious amendment, had as its purpose the fixing of a minimum sum, the taxpayer's income from his chief source of income, below which his income was deemed not to fall for taxation purposes. I confess to being somewhat puzzled over the objective which was sought to be attained by the continuance of this portion of the former section. Because of it, a limit is placed on the deductibility of commercial farming losses where farming is carried on as a subordinate activity even though no such limit appears to have been placed on the deductibility of other types of subordinate commercial loss.

48 I am not satisfied on the evidence that a reasonable and informed observer, viewing the taxpayer's activities in a practical way, would regard the appellant's farming activities (having in mind the record of past performance and prospects for the future) in combination with any other of his sources during 1968 or 1969 as his chief source of income for the year. I am not satisfied that he would so regard the combination whether chief source means most important source or more important source than all others combined.

49 I would dismiss the appeal.