LeBlanc v. MNR, 93 DTC 1564, [1993] 2 CTC 3054 (TCC)

Brulé, T.C.C.J.:—These appeals are in respect of the deduction of farm losses incurred by the appellant, Dr. Alphonse E. Leblanc, during his 1983, 1984 and 1985 taxation years in the respective amounts of $22,136.65, $121,320.39 and $125,321.48. The Minister of National Revenue (the"Minister") disallowed the appellant's claim by restricting his losses in accordance with 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").

Facts

At the material times the appellant was a medical doctor specializing in the practice of psychiatry. He had been practising in this field since 1953 until 1989 when he became too ill to continue his medical practice.

The appellant, through his wife, Monique Leblanc, testified that following the death of their son, Marc, they reconsidered their priorities and decided to plan their retirement in a way that would provide them with a source of income. As a result, in the early 1980s, the appellant planned to phase out his medical practice and operate a vineyard as his principal occupation. The appellant, together with his son Pierre Leblanc, sought professional advice on the purchase and operation of such a business. He eventually purchased, in October 1983, a 109-acre of property near Harrow, Ontario for the sum of $160,000 (the "vineyard"). The purchase price was paid for as follows: $10,000 from the appellant's savings and the estate of his son Marc Leblanc, $60,000 loan secured by a mortgage on his Windsor home and a $90,000 loan from Woodsley Credit Union.

After consulting with an expert from Agriculture Canada, Mr. Roberto Michelutti, the appellant decided to plant the vineyard in incremental annual plantings of 5 to 10 acres. In addition, the appellant was advised by the same expert to tile every row of vines to compensate for the heavy clay soil on the vineyard. Both pieces of advice were followed by the appellant.

The appellant and his son Pierre also consulted experts on which varieties of grape vines would be best suited to their vineyard. They also contacted a local wine maker, Colio Wines of Canada ("Colio") to determine which varieties of grapes they preferred. In choosing the site of the vineyard, the appellant was influenced by the closeness of his vineyard to the Colio winery. His intention was to sell grapes to this winery.

Eventually 24 acres were planted, three of Pinot Blanc and five of Riesling in 1984; in 1985, he planted six acres of Seyval and Vidal grapes; and in each of 1986 and 1987, he planted five acres of Vidal grapes. A significant number of the vines planted in 1987 had to be replanted following a drought in 1988 and a serious flood in 1989. The rest of the 109 acres which were not used by the appellant was leased to Green Giant for an annual rental of $6,800.

At the outset, the appellant hired a local-based company, Heuriger Corporation ("Heuriger") to plough, cultivate and plant eight acres of the vineyard in 1984. In the subsequent years, due to the high costs charged by Heuriger, these tasks were assumed by Pierre who was employed full-time in the early years until the hiring of Robert Remko as manager of the vineyard.

The family of the appellant including his wife, Monique, and his daughter- in-law, Lyse contributed to the establishment and maintenance of the vineyard. In fact, after renovations were made to the farmhouse on the vineyard in 1984, the latter, her husband and children moved there to oversee the operations. In addition, Lyse who has a better affinity to details is now the wine-maker of the Leblanc Estate Winery.

The appellant's physical contribution was limited to weekends and Wednesday afternoons and, in 1987, he moved his residence to a lot approximately 500 metres from the vineyard. However, Pierre Leblanc testified that his father was at all times kept abreast of the operations carried out on the vineyard. He also testified that his father had to maintain long hours in his medical practice in order to finance the vineyard which was very cash-intensive.

To date, the appellant's business is a full-blown winery. In 1992, Pierre and Lyse Leblanc obtained permission from the Liquor Control Board of Ontario to ferment grapes. In March, 1993, they obtained a licence to manufacture wine and in June, 1993, they obtained a licence to sell wine on the premises. The winery is now producing ice-wine as well as wine from Pinot Blanc, Riesling and Vidal grapes.

Appellant's position

The appellant submits that during the taxation years in question, he was engaged in a business the end result of which was the production of wine. Therefore, he argues that subsection 31(1) of the Act is not applicable.

In the alternative that if the Court finds that the appellant was in the farming business, he maintains that his expectation of profit from the vineyard was realistic since it takes four or five years before a vineyard yields grapes. In addition, the appellant submits that the Court has to consider the fact that experts advise planting such vineyards in incremental acreage.

The appellant also argues the fact that commercial production and profit are delayed by the nature of grape growing and a wine-making operation, and does not prevent the appellant from deducting start-up costs and losses incurred until profit is obtained.

In addition, the appellant claims that his occupational direction shifted from medicine to farming at the time when the first expenditures in relation with the development of the vineyard were made.

Finally, he argues that his chief source of income for the 1983, 1984 and 1985 taxation years was a combination of farming and his medical practice.

Respondent's position

The respondent maintains that the activities carried on by the appellant from the purchase of the farm through the relevant years until the winemaking activity was actually licensed were exclusively farming as defined in the Act. The respondent argues that the evidence shows that the appellant had the intention at the beginning to grow the fruit and to sell grape juice, and not to start the winery right away.

On the second issue, the respondent contends that the income from the medical profession is the taxpayer's chief source of income and farming is the subordinate or sideline interest. The respondent submits that there was no change of occupational direction in 1983, 1984 and 1985. He claims that there is no evidence that would support a finding that the appellant shifted from his medical practice as his chief source of income.

Issues

1. The first question is whether the appellant, during the taxation years in question, was engaged in a farming activity or a manufacturing activity. If this Court finds that he was involved in the production of wine and therefore a manufacturing activity, section 31 of the Act does not apply.

2. However, if this Court finds that the appellant was in fact engaged in the farming business, the second issue is to determine whether the Minister has properly assessed the appellant in limiting his losses under subsection 31(1) of the Act.

This issue contains two parts:

(a) the first part is to ascertain whether there is a source of income, that is whether the appellant was carrying his farming activity with a reasonable expectation of profit; and

(b) the second part is whether the appellant's chief source of income was farming or a combination of farming and some other source of income during the 1983, 1984 and 1985 taxation years.

Analysis

On the first issue the appellant argues that subsection 31(1) of the Act is not applicable since he was engaged in the business of manufacturing wine rather than farming.

In order to decide this issue it is important to look at the definition of "farming" in the statute and in dictionaries.

The term “farming” is defined at subsection 248(1) of the Act as follows:

"farming" includes tillage of the soil [translated in french as "culture du sol"], 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;

[Emphasis added.]

The Oxford English Dictionary, 2nd ed. defines "tillage" as:

The act, operation, or art of tilling or cultivating land so as to fit it for raising crops; cultivation, agriculture, husbandry.

Le Petit Robert 1 defines culture” as follows:

Action de cultiver la terre; ensemble des opérations propres à tirer du sol les végétaux utiles à l'homme et aux animaux domestiques.

In my opinion, irrespective of how the taxpayer describes his/her activity, the determination of whether an activity constitutes farming or manufacturing is a question of law for the Court to decide. Therefore, the Court has to decide whether the activities carried on by the appellant fall within the "four corners" of the definition of "farming" in subsection 248(1) of the Act.

During the taxation years in question, the activities carried out in the vineyard consisted of preparation of the soil, the planting of the vines, the growing of the grapes, and their ultimate harvest. The activities described constitute fruit growing. They can also be broadly defined as tillage of the soil because the appellant was in effect cultivating the land to prepare it for agricultural purposes. If we consider these activities, I believe that it is farfetched to conclude that the appellant is not at all involved in the farming business. Activities carried out before the wine-making process started fall within the categories of fruit growing or tillage of the soil. It appears that there are two businesses, a farming business and a wine-making business.

In addition, the evidence shows that at the outset, the appellant's intention as reflected by his wife's testimony was to sell grapes and grape juice. This conclusion is reinforced by the fact that one of the determinent factors in the choice of the site of the vineyard was its proximity to the Colio winery and by the fact that at the outset, the appellant contacted the local winery to decide which variety of grapes they would prefer.

It is also my opinion that the broad definition given to the term "farming" by Sarchuk, T.C.C.J., in De Cloet Ltd. v. M.N.R., [1989] 1 C.T.C. 2308, 89 D.T.C. 207 at page 2315 (D.T.C. 212) to the effect that “Agricultural farming involves the whole aspect of commercial production of any crop" does not imply that winemaking constitutes farming. In the case at bar, the activities involved in grape growing and wine-making are too different to classify both as various aspects of a single commercial production compared to, for example, packaging of mushrooms. In wine-making the end product is totally different from the raw materials. One could compare growing grapes and producing wine to growing tomatoes and making tomato sauce and paste. In both scenarios, the first activity falls under the broad definition of farming whereas the latter does not.

As mentioned above the second issue contains two parts. The first is whether there is a source of income which would mean that the appellant was operating his farming activity with a reasonable expectation of profit, while the second part concerns the appellant's chief source of income.

Dealing with the first part, expectation of profit, it is now settled in law that in ascertaining whether there is an expectation of profit, consideration should be given to a reasonable start-up period. What is reasonable should be judged in light of the circumstances of each case, therefore the specific nature of the venture should be taken into account. See Demers v. M.N.R., [1990] 1 C.T.C. 317, 90 D.T.C. 6216 (F.C.T.D.); The Queen v. Gorjup, [1987] 2 C.T.C. 129, 87 D.T.C. 5348 (F.C.T.D.), and The Queen v. Matthews, [1974] C.T.C. 230, 74 D.T.C. 6193 (F.C.T.D.).

This latter case is important because it involved the growing of trees in a farming operation and the Court held that while there might not be a source of income for many years the defendant Matthews carried on a business with a reasonable expectation of profit.

In the case of Hover v. M.N.R., [1993] 1 C.T.C. 2585 , 93 D.T.C. 98 (T.C.C.), Bowman, T.C.C.J., held that the Court can reach a finding that a farming business exists by the very fact that the Minister applied section 31 to limit the deduction of farm losses. Such is the situation here.

In his judgment Bowman, T.C.C.J., had this to say at page 2596 (D.T.C. 106):

The relevance of the expression in the context of section 31 is that to obtain even the limited deduction granted by section 31 the taxpayer must have a business. Without a reasonable expectation of profit no business exists. [. . .] Once it is conceded, either by the very fact of applying section 31 or otherwise, that a business exists, the taxpayer's reasonable expectation of profit ceases to be a factor in determining whether he is to be subject to the restrictions of section 31. It is true that the concession implicit in the fact that the Minister applied section 31 is not necessarily binding on the court if the facts clearly establish that there was no hope of ever making a profit.

As to the second part, the appellant's chief source of income, a guideline was set out in Moldowan v. The Queen, [1978] 1 S.C.R. 480, [1977] C.T.C. 310, 77 D.T.C. 5213 wherein Dickson, J. (as he then was), said at page 486 (C.T.C. 314, D.T.C. 5215):

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 profitability 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.

The criteria set out by the Supreme Court of Canada can be said to include in relation to a source of income:

(i) time spent;

(ii) capital committed;

(iii) the profitability both actual and potential.

In accordance with the Federal Court of Appeal decision in The Queen v. Morrissey, [1989] 1 C.T.C. 235, 89 D.T.C. 5080, these factors should be assessed collectively and not disjunctively. This would indicate that the Court felt that all factors should be considered as a group and no one factor should determine the existence of a source of income.

In order to qualify as a chief source of income the taxpayer's reasonable expectation of income from his various revenue sources and his ordinary mode and habit of work are essential as was stated in Moldowan, supra.

In the case at bar, the thrust of the argument of the Minister’s counsel is that the Court should compare the time, capital and profit factors in each of the two income sources of the appellant. The Minister’s counsel set out a statement of Bonner, T.C.C.J., in Timpson v. M.N.R., [1985] 2 C.T.C. 2114, 85 D.T.C. 446 at page 2117 (D.T.C. 448) to the effect that:

It seems plain from that description that if farming is to be regarded as part of a combined chief source it must be a source or operation capable of generating relatively significant amounts of income, either immediately or after what, having regard to the nature of the operation, is a reasonable start-up period.

As to a summary of the legal position this has been well expressed by Strayer, J., in Mohl v. M.N.R., [1989] 1 C.T.C. 425, 89 D.T.C. 5236 (F.C.T.D.). He said at page 428 (D.T.C. 5238-39):

It now appears clear from the Supreme Court decision in Moldowan as recently interpreted by the Federal Court of Appeal in Morrissey that, for a person to claim that farming is a chief source of income, he must show not only a substantial commitment to it in terms of the time he spends and the capital invested, but also must demonstrate that there is a reasonable expectation of it being significantly profitable. I use the term “significantly profitable" because it appears from the Morrissey decision that the quantum of expected profit cannot be ignored and I take this to mean that one must have regard to the relative amounts expected to be earned from farming and from other sources. Unless the amount reasonably expected to be earned from farming is substantial in relation to other sources of income then farming will at best be regarded as a "sideline business" . . .

These are the general principles and it is necessary to apply these to the present case.

In the case at bar, the appellant's contribution in terms of time spent was limited to weekends and Wednesday afternoons. He was also contacted at his medical practice for major decisions. The evidence shows that when the appellant bought the farm, he intended to reduce the number of hours worked in his medical practice. However, the phasing out of his practice had to be delayed to finance the vineyard which is very cash-intensive. Although there was no corroborative evidence per se on this point, Pierre Leblanc testified that if his father had not been putting in the hours he did, the farm would not have been in the position it is in today.

The evidence shows that the capital invested in his medical practice amounted to $78,000. Evidence was adduced to indicate that over $900,000 was invested in the farm by the appellant and his wife. Their capital contribution consists of buying for example, three tractors, a small crawler bulldozer, a truck, a manure spreader, a sprayer, discs, a triple k.

The importance of the appellant’s contribution is a strong indication of his commitment to farming. As mentioned by Joyal, J. in Hadley v. The Queen, [1985] 1 C.T.C. 62, 85 D.T.C. 5058, at page 68 (D.T.C. 5063):

One such factor which might predominate over the others is the amount of capital the plaintiff committed to his farming venture. If the plaintiff argues new direction, new orientation, or new commitments to bring himself within the first category defined in the Moldowan case, the quantum element alone of his capital investment provides the plaintiff with pretty good credibility. It gives force to the several arguments advanced by the plaintiffs counsel and overcomes the incredulity which an ex post facto analysis of actual performance attracts to the case.

Therefore, it can be said that the important amount of capital committed by the appellant reflects his commitment to reduce his hours spent practising medicine and to devote most of his time to the operation of the vineyard and the winery.

It is essentially at this point that the conclusion in Timpson, supra, is applicable. This case stands for the proposition that for farming to be a chief source of income, it must be capable of generating relatively significant amounts of income. On one hand, the Minister argues that the Court should compare the income generated by the farm after a reasonable start-up period and the professional income from the appellant's medical practice during the taxation years in question, that is 1983, 1984 and 1985. On the other hand, the appellant submits that it is more reasonable to compare the income from the farm after the start-up period with the professional income obtained in the year that commercial production begins.

In essence, the Minister is purporting to compare farm income received after a reasonable start-up period, representing income from an operation that is yielding income for the first time, and professional income during the taxation years in issue, that is income from a settled practice which can be said to have reached peak level. In my opinion, such a comparison does not reflect the real commitment of a taxpayer to shift occupational direction.

Therefore, to my mind, the Court should emphasize the reasoning adopted by Bowman, T.C.C.J., in Hover, supra, where the fact situation is very similar— in both cases, the appellant's professional income was the major source of financing of the farm. Using the words of Bowman, T.C.C.J., if we consider the amount of income the medical practice contributed to the vineyard, it cannot be said to be subordinate. The professional income was an essential adjunct and complement to the farming operation and without it the vineyard would not have existed. As such, a strict comparison between the two sources of income is not appropriate if we consider the particular facts of the case at bar.

Following the analysis of Sarchuk, T.C.C.J., in Manaigre v. M.N.R., [1991] 1 C.T.C. 2376, 91 D.T.C. 443 it appears from the testimony of Lyse Leblanc that profitability from the vineyard, however small in the first year of commercial production, does exist. There is also evidence that over the years the potential profit from the vineyard is more than one would expect from a sideline business. Such evidence was borne out by the figures submitted to the Court.

To my mind, the application of the three above tests points towards the conclusion that farming does not constitute a sideline business to the appellant. Adopting the terminology used by Bowman, T.C.C.]., in Hover, supra, at page 2599 (D.T.C. 107), Dr. Leblanc was not ”. . . merely testing the water. He had plunged fully and without reservation into the water.” Therefore, the appellant should be allowed to deduct full losses in the 1983, 1984 and 1985 taxation years.

The appeals are allowed, with costs to the appellant and the matter is returned to the Minister for reconsideration and reassessment.

Appeals allowed.