Maruya v. R., [1997] 3 C.T.C. 2230

Watson, D.J.T.C.:

1 These appeals were heard on common evidence with consent of the parties in Toronto, Ontario on February 24, 1997.

2 In computing income for the 1991 and 1992 taxation years, Lori Maruya (“Lori”), deducted the amounts of $25,921.15 and $22,847.44 respectively as farming losses with respect to her interest in a horse racing operation known as Martwest Racing Stable. The Minister of National Revenue (the “Minister”) in reassessing Lori for the 1991 and 1992 taxation years by concurrent Notices of Reassessment dated November 2, 1994, restricted her farming losses in accordance with subsection 31(1) of the Income Tax Act (the “Act”).

3 In so reassessing the Appellant for these taxation years, the Minister made the following assumptions of facts:

(a) at all material times the Appellant was employed full time by the Peel Board of Education as a high school teacher;

(b) the Appellant earned the following amounts from the Peel Board of Education during the 1991 and 1992 taxation years:

TAXATION YEAR	INCOME
1991	$41,170.04
1992	$46,805.52

(c) during the years under appeal, the Appellant was not a horse trainer or driver;

(d) the Appellant reported farming losses during the 1991 and 1992 taxation years from her interest in Martwest Racing Stable as follows:

Taxation Year	Gross Income	Net Loss
1991	$115,641.34	$25,921.15
1992	$ 80,359.23	$22,847.44

(e) the Appellant's chief source of income during the 1991 and 1992 taxation years was neither farming nor a combination of farming and some other source of income.

4 In computing income for the 1991 and 1992 taxation years, Ron Maruya (“Ron”) deducted the amounts of $52,725.78 and $30,603.76 respectively as farming losses with respect to his interest in Martwest Racing Stable. In assessing Ron for the 1991 taxation year and reassessing him for the 1992 taxation year, by Notice of Reassessment dated October 21, 1994, the Minister restricted the Appellant's farming losses in accordance with subsection 31(1) of the Act.

5 In so reassessing Ron for these taxation years, the Minister made the following assumptions of facts:

(a) at all material times the Appellant was employed full time by the Peel Board of Education as a high school teacher;

(b) the Appellant earned the following amounts from the Peel Board of Education during the 1991 and 1992 taxation years:

TAXATION YEAR	INCOME
1991	$63,889.70
1992	$70,112.92

(c) during the years under appeal, the Appellant was not a horse trainer or driver;

(d) the Appellant reported farming losses during the 1991 and 1992 taxation years from his interest in Martwest Racing Stable as follows:

Taxation Year	Gross Income	Net Loss
1991	$117,983.01	$52,725.78
1992	$ 80,359.23	$30,603.76

(e) the Appellant's chief source of income during the 1991 and 1992 taxation years was neither farming nor a combination of farming and some other source of income.

6 At the hearing, the Appellants admitted paragraphs (a) to (d) and denied paragraph (e) respectively.

7 The only issue before the Court in these appeals is whether the Appellants' chief source of income was farming or some other source of income during the 1991 and 1992 taxation years.

• (1) Business Farm Losses: losses deductible by a full-time farmer for whom farming is the chief source of income;

• (2) Restricted Farm Losses: losses deductible by a part-time farmer for whom farming, although engaged in with a reasonable expectation of profit, is not the chief source of income; and

• (3) Hobby Farm Losses: losses are not deductible by a hobby farmer for whom farming provided no reasonable expectation of profit.

9 Where a taxpayer in the business of farming incurs a farming loss, the loss is subject to the rules generally applicable to business losses. In section 31 of the Act, we find the restricted farm loss rules; these rules limit the amount of losses from a farming operation that can be deducted from other sources of income by a taxpayer who carries on a farming business with the expectation of profit, but whose chief source of income is neither farming nor a combination of farming and some other source. “Chief source of income” is not defined in the Act; however, there is well-settled case law dealing with the issue of what a taxpayer's chief source of income is for the purpose of section 31 of the Act.

10 The case of Moldowan v. R. (1977), 77 D.T.C. 5213 (S.C.C.), a Supreme Court of Canada decision, has been relied on for many years by the Courts. In this case, the taxpayer had several businesses and was also engaged in horse-racing activities; he engaged in training, boarding and racing horses on his own behalf and for others. His horse-racing activities realized a small profit in 1963 but thereafter he sustained losses every year, peaking to over$20,000 in each of 1968 and 1969. The taxpayer attempted to deduct the full amount of losses suffered in those years, but the Minister only allowed the restricted farm losses in the respective years. In dismissing the appeal, Dickson, J. stated as follows at pages 5215 and 5216:

Whether a source of income is a taxpayer's“ chief source” of income is both a relative and objective test. It is decidedly not a pure quantum measurement. A man who has farmed all of his life does not cease to have his chief source of income from farming because he unexpectedly wins a lottery. The distinguishing features of “chief source” are the taxpayer's reasonable expectation of income from his various revenue sources and his ordinary mode and habit of work. These may be tested by considering, inter alia in relation to a source of income, the time spent, the capital committed, the profitablility both actual and potential. A change in the taxpayer's mode and habit of work or reasonable expectations may signify a change in the chief source, but that is a question of fact in the circumstances.

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 interconnection between farming and the subordinate activity which provides another source of income. Section 3(f) of the Income War Tax Act of 1917, as amended, made reference to “connection” in defining the permissible deductions from income derived from the chief business, trade, profession or occupation of the taxpayer in determining his taxable income. Section 3(f) read:

(f) deficits or losses sustained in transactions entered into for profit but not connected with the chief business, trade, profession or occupation of the taxpayer shall not be deducted from income derived from the chief business, trade, profession or occupation of the taxpayer in determining his taxable income.

The word “connected” is not found in s. 13 of the present Act. As Thorson P. said, obiter, in Simpson v. Minister of National Revenue[61 D.T.C. 1117],[1961] C.T.C. 174there is no reason why there must be such a limitation. I share this view. See also Dorfman v. Minister of National Revenue, supra, at p. 154 and Bert James v. Minister of National Revenue[73 D.T.C. 5333],[1973] C.T.C. 457at p. 464.

It is clear that “combination” in section 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 carried 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 carried 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.

11 In the case of Morrissey v. R. (1988), 89 D.T.C. 5080 (Fed. C.A.), the taxpayer operated a farm and was a freighter engineer during his 1977, 1978 and 1979 taxation years. The FederalCourt of Appeal, in reversing the decision of the Trial Division which had allowed full deduction for farming losses, rejected the trial judge's views that unlikelihood of profit was only one factor to be taken into account and that the Moldowan case merely required farming to be the taxpayer's major preoccupation. Mahoney, J.A. stated as follows:

Moldowan suggests that there may be a number of factors to be considered but we are here concerned only with three: time spent, capital committed and profitability. In defining the test as relative and not one of pure quantum measurement, Moldowan teaches that all three factors are to be weighed. It does not, with respect, merely require that farming be the taxpayer's major preoccupation in terms of available time and capital.

On a proper application of the test propounded in Moldowan, when, as here, it is found that profitability is improbable notwithstanding all the time and capital the taxpayer is able and willing to devote to farming, the conclusion based on the civil burden of proof must be that farming is not a chief source of that taxpayer's income. To be income in the context of the Income Tax Act that which is received must be money or money's worth. Absent actual or potential profitability, farming cannot be a chief source of his income even though the admission that he was farming with a reasonable expectation of profit is tantamount to an admission which itself may not be borne out by the evidence, namely, that it is at least a source of income.

12 In R. v. Poirier (1992), 92 D.T.C. 6335 (Fed. C.A.), the taxpayer devoted approximately equal amounts of time to farming and his employment occupation. In overturning the lower Court decision which had allowed the taxpayer to deduct the full amount of his farming losses in computing taxable income, MacGuigan, J.A. speaking for the Federal Court of appeal stated as follows at page 6336:

The learned Judge here seems to suggest that farming income can be combined with, in the sense of supplemented by, another source of income in order to constitute a chief source of income. It is clear from Moldowan v. The Queen (1977), 77 D.T.C. 5213 at 5216 (S.C.C.)that the word ‘combination’ in s. 31(1) is not to be read in that sense. It is also now clear that what is required for a determination that farming is a chief source of income is a favourable comparison of farming with the other source of income as to such matters as the time spent, the capital committed, and the profitability, both actual and potential: Queen v. Connell (1988), 88 D.T.C. 6166(Strayer, J.), approved on that point by this Court in A-341-88 (decided January 16, 1992).

Applying the present view of the law to the facts in the case at bar, it is patent to us that farming was in a subordinate position to the respondent's employment occupation. Farming comes closest to a rough equality on the time factor, but it lags far behind on the capital and income tests.

The respondent argued that for these tests what should be taken into account is his respective contributions to each in cash rather than in capital, his prospective gross income rather than net income, and his projected net farming income in relation to his actual employment income. There is no warrant in the case law for any of these considerations....

It must be remembered that it is the cumulative impact of the various factors for determination that governs, not any one factor taken distinctively: Morrissey v. The Queen[89 D.T.C. 5080],[1989] 2 F.C. 418 (F.C.A.)and Connell, supra (F.C.A.)

13 In the case of Timpson v. Minister of National Revenue (1993), 93 D.T.C. 5281 (Fed. C.A.), the taxpayer was a practising physician who also carried on a purebred cattle operation. In overturning the lower Court decision, MacGuigan, J.A. stated at page 5282 as follows:

At the time the Trial Judge decided this case in 1987, the implications of the Moldowan test had not been so fully spelled out by this Court as they have been since in The Queen v. Morrissey (1988), 89 D.T.C. 5080, Gordon v. The Queen (1989), 89 D.T.C. 5481, The Queen v. Roney (1991), 91 D.T.C. 5148, Connell v. The Queen (1992), 92 D.T.C. 6134, The Queen v. Poirier (1992), 92 D.T.C. 6335.

The Trial Judge limited his examination solely to the question of the taxpayer's reasonable expectation of profit (Appeal Book at 147):

I am satisfied on the evidence here that the plaintiff had a “reasonable expectation of profit”. Most assuredly this profit did not arise as soon as the plaintiff predicted but the market, the high interest rates and the time required to gain credibility all conspired to delay what he had every right to expect - a profit.

But this consideration gets, at best, only to a finding that farming is “a source of income”, not that it is “a chief source of income”, as required by s. 31(1) of the Income Tax Act.

We find this case to be on all fours with Poirie r, where we said (at 6336):

It is ... now clear that what is required for a determination that farming is a chief source of income is a favourable comparison of farming with the other source of income as to such matters as the time spent, the capital committed, and the profitability, both actual and potential...

Applying the present view of the law to the facts in the case at bar, it is patent to us that farming was in a subordinate position to the respondent's employment occupation. Farming comes closest to a rough equality on the time factor, but it lags far behind on the capital and income tests.

In our view, the Trail Judge would have come to the same conclusion in the case at bar if he had applied the correct legal test.

14 The two Appellants gave evidence at the hearing in a clear, open and honest fashion, clearly demonstrating their love of horses and harness racing. They worked approximately 40 hours per week during the school year for the Peel Board of Education for a total of approximately $105,000 in 1991 and $117,000 in 1992. At the same time they devoted their energy and interest in their horse racing operation under the name of Martwest Racing Stable. Evenings, weekends and school holidays of approximately 21/2months per year were spent learning about the business, buying and selling horses and trying to interest family and friends in joining their business venture.

15 Martwest Racing Stable was operated as a sideline in 1990 but in 1991, when Ron's father died, there was a change in focus. Ron's father had participated as a partner prior to his death and had been the chief source of funding. In 1991 and 1992, the business had five to seven horses and outside trainers were hired to train the horses that boarded out at various locations. Ron had 60% interest in the unincorporated company and Lori had 40%. The gross income of Martwest for 1991 was approximately $117,000 and $80,000 in 1992, with net losses of $52,000 in each year, divided on a 60-40 basis between the two Appellants; expenses were also allocated on the same basis. They estimated that they spent almost the same amount of time looking after Martwest as they did with their full-time teaching jobs. Prior to 1990, they had no experience in horse racing so they had to devote a lot of time to learning how to deal with the trainers and others involved in the care of their horses.

16 The Appellants had the onus of establishing on a balance of probabilities that the Minister's reassessments restricting their farming losses in accordance with subsection 31(1) of the Act were ill-founded in fact and in law. Taking into consideration all of the circumstances in the light of the case law before me, I am satisfied that the Appellants have failed in this onus. In my view, they did not succeed in establishing that their “chief source of income” was from farming or a combination of farming and some other source of income.

17 Accordingly, the appeals are dismissed.