Yaki v. The Queen, 94 DTC 6637, [1994] 2 CTC 361 (FCTD)

This appeal from a reassessment of the Minister of National Revenue dated September 25, 1989 and confirmed by notification of confirmation by the Minister dated August 31, 1990 came on for hearing at London, Ontario on May 4, 1994. At issue in this appeal is the plaintiff's right to deduct the maximum permissible amount of farming losses incurred during the 1986, 1987 and 1988 taxation years pursuant to the provisions of subsection 31(1) of the Income Tax Act, R.S.C. 1952,

c. 148 (am. S.C. 1970-71-72, c. 63) (the "Act"). At the conclusion of argument, I allowed the appeal indicating that brief written reasons would follow.

Facts

The plaintiff was born and raised on a farm in Saskatchewan where he assisted his father with the family farm and learned about the business aspects of operating an agricultural concern. In later years, the plaintiff helped his spouse manage her farm and carried out various farming activities such as ploughing, cultivating and seeding the land. In short, the plaintiff has a personal history that is closely associated with agronomy.

When it appeared that his wife’s farm was to be appropriated, the taxpayer decided to continue with farming activities, and in August, 1978, purchased a 100 acre piece of farm property in the Township of Sombra, in the County of Lambton, Ontario, for the sum of $55,000, on which the owner took back a mortgage of approximately $45,000. By the plaintiff's own evidence, the farm was a financial disaster from the start.

Initially, the plaintiff farmed the property alone, but later entered into a share crop arrangement with Sunnyfield Farms in an attempt to improve the viability of the farming operation. The arrangement called for Mr. J. Duffy, an experienced farm operator, to pay for all crop input costs and provide all labour and equipment. In exchange, Mr. Yaki gave up his rights to two thirds of the total crop production. This agreement was subsequently modified allowing for an equal division of the crop output between the parties.

Poor drainage had a negative effect on crop production and the plaintiff caused drainage tiles to be installed during the years 1981 and 1982 at a cost of approximately $41,000. The evidence makes it clear that this was not an entirely successful remedy as the tiling had the unwanted effect of causing ponding in the fields which was eventually resolved through chisel-ploughing in 1988.

The cost of servicing the farm debt was also a significant burden on Mr. Yaki's farm operations. In the early 1980s, interest rose to about 24 per cent per year for his short term bank loans. In 1983, when he had to renew his mortgage, he was also subject to those exorbitant rates.

Finally , drought during the years 1987 and 1988 had the effect of cutting crop yields to half their usual amount. The reduced yield taken in conjunction with a decrease in commodities prices generally at the time caused an overall decline in the value of the plaintiff's profit margin on crop sales.

The taxpayer's net income from the operation of the farm for the past ten years is reproduced below. Farming income is shown on a cash basis:

As these numbers indicate, the farming business had been operating at a substantial loss for a period of at least ten years. More recently, however, there is an indication that the farm’s economic viability has greatly improved. I note that in 1992, the farm operations showed a net profit of $291.89 and $3,600.77 in 1993, supporting the taxpayer's argument that there was a reasonable expectation of profit.

The applicant also reported employment income from Sunoco Ltd. for the 1986, 1987 and 1988 taxation years as follows:

I include this as it is relevant to show that the taxpayer's chief source of income is not farming and therefore, he may not deduct the full amount of his losses from the operation of the farm.

Statutory provisions

Subsection 31(1) of the Income Tax Act reads as follows:

31(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, for the purposes of sections 3 and 111 his loss, if any, for the year from all farming businesses carried on by him shall be deemed to be the aggregate of

(a) the lesser of

(i) the amount by which the aggregate of his losses for the year, determined without reference to this section and before making any deduction under section 37 or 37.1, from all farming businesses carried on by him exceeds the aggregate of his incomes for the year, so determined from all such businesses, and

(ii) $2,500 plus the lesser of

(A) '/2 of the amount by which the amount determined under subparagraph (i) exceeds $2,500, and

(B) $2,500, and

(b) the amount, if any, by which

(i) the amount that would be determined under subparagraph (a) (i) if it were read as though the words “and before making any deduction under section 37 or 37.1” were deleted, exceeds (ii) the amount determined under subparagraph (a)(i);

and for the purpose of this Act the amount, if any, by which the amount determined under subparagraph (a)(i) exceeds the amount determined under subparagraph (a)(ii) is the taxpayer's “restricted farm loss” for the year.

Plaintiff's submissions

The plaintiff greatly simplified the proceedings by abandoning his contention that he is entitled to deduct the full amount of his farming losses which is reserved for those for whom farming is a chief source of income. Given his salary income, that would have been a very tenuous position to maintain.

He argues, however, that his farming operation amounts to a sideline business operating on a for profit basis for which he may deduct its losses up to the maximum permitted under section 31. Notwithstanding the fact that losses were incurred on a continuous basis, the plaintiff points to the long-term plan put into effect at the start up of his farm operations, the large sum of money invested in the farm and the present profitability of the farm to support his contention that he is not simply a weekend hobby farmer. As a result, he contends he should not have been excluded from making the deductions allowable under the restrictive farm loss provision for the taxation years at issue.

Defendant's submissions

Counsel for the defendant argues that in light of the fact that the plaintiff incurred losses on the farm property for virtually every year since it was purchased, that it could not constitute a business carried on for profit or with a reasonable expectation of profit.

The Minister also submits that the evidence fails to establish that the taxpayer had any reasonable basis for believing that operating a farm would provide him with a profit to supplement his income. To support this assertion, the defendant points to the fact that the taxpayer's purchase of the farm was made without the use of a conventional business plan, nor with making realistic projections about profitability.

Analysis

The leading case on the application of subsection 31(1) of the Income Tax Act remains Moldowan v. The Queen, [1978] S.C.R. 480, [1977] C.T.C. 310, 77 D.T.C. 5213, in which the Supreme Court of Canada comprehensively analyzed the issues relevant to the resolution of this case. The Court concluded that the Act was designed to encompass three classes of farmers:

1. Taxpayers for whom farming could reasonably be expected to provide the bulk of their income or the core of their work routine. Such taxpayers are not confined by subsection 31(1) and may deduct the full amount of their farm losses from their other income.

2. Taxpayers for whom farming can be regarded as a sideline business, providing only a less than significant portion of their income. These taxpayers’ allowable farm losses are restricted by the formula set out in subsection 31(1) which limits losses deductible to a maximum of $5,000. ( This amount has now been increased to a maximum of $8,750, S.C. 1988, c. 55, subsection 16(1)).

3. Taxpayers for whom farming is simply a diversion or hobby, but whose activities fall short of being capable of characterization as a career. These individuals are prohibited under the Act from deducting any of their farming losses from their income. These are considered non-business losses and are treated as personal living expenses subject to paragraph 18(1) (h) of the Act.

The important distinction between each class of farmer for the purpose of proper application of the Act is the source of that person's income. If the chief source is farming or farming combined with something else, then the taxpayer is a class (1) farmer; if farming is only a secondary source of income, the taxpayer will be deemed to be a class (2) farmer; if farming is not in fact a source of income, the taxpayer is a class (3) farmer.

Where the farming activities from the outset have never shown a profit, the Court must determine whether the undertaking is apt to profit and if the losses were reasonable in view of the income produced and finally, did the taxpayer take appropriate steps to show a profit. A profit earned in future years may be relevant in assisting the trier of fact in concluding that the taxpayer entered into farming with a view to profit, but this is by no means conclusive. In Timpson v. The Queen, [1987] 1 C.T.C. 389, 87 D.T.C. 5266, wherein the Court referred to the statements by my colleague Joyal J. in Hadley v. The Queen, [1985] 1 C.T.C. 62, 85 D.T.C. 5058 at page 63 (D.T.C. 5060), the problem was outlined as follows:

Section 31 creates no problem for the full-time farmer whose money, time and efforts are exclusively devoted to his farming operations and who has no other source of income. Treatment of farming losses for such a taxpayer is substantially in accordance with the general tax rules. Neither does the section create much of a problem when dealing with a taxpayer who makes no pretence of being a farmer but, nevertheless, owns a country place with sufficient acreage to keep a couple of horses, who spends weekends and holidays there and has a neighbouring handyman look after his stock during the weekdays. The public is not in the mood to subsidize the losses which might be experienced by such a taxpayer. Such losses are not businesses losses. They are merely the costs of maintaining a lifestyle.

Whether a taxpayer has a reasonable expectation of profit is an objective and factual determination. Indeed, this farm showed a profit in 1992 and I assume would have continued to do so had it not been for the severe drainage problems. The taxpayer's investment in excess of $40,000 to rehabilitate the land for agricultural use where the purchase price of the land itself was only marginally higher is more than symbolic. It is the act of an individual who has a long-term commitment.

Conclusion

Accordingly, on May 4, 1994, I allowed the appeal and returned the matter to the Minister for reassessment on the basis that the plaintiff is entitled to deduct losses in the amount of $5,000 for the years in issue. Costs to the plaintiff.

Appeal allowed.