Graham v. The Queen, 83 DTC 5399, [1983] CTC 370 (FCTD), aff'd 85 DTC 5256, [1985] 1 CTC 380 (FCA)

Cattanach, J:—These are three appeals from three assessments made by the Minister of National Revenue of the plaintiff’s income tax for his 1977, 1978 and 1979 taxation years whereby the Minister disallowed deductions for farming losses incurred and claimed by the plaintiff in each of the three taxation years but restricted those losses to a maximum of $5,000 in each taxation year in accordance with the formula set forth in section 31 of the Income Tax Act, the Minister having made the determination that the plaintiff’s chief source of income in these respective years was neither farming nor a combination of farming and some other source of income as the Minister is required to do by subsection 31(2) as a condition precedent to an assessment under section 31.

The issue which I am obliged to determine is whether the salary received by the plaintiff from his employment with Ontario Hydro was his chief source of income and if the farming operation which the plaintiff carried on concurrently therewith was a sideline business in which event the losses incurred in the farming operation would be limited to $5,000 in each taxation year in accordance with section 31 of the Act, as the Minister concluded and is contended by him to be the case, or on the other hand whether the plaintiff looked to farming for his livelihood and that farming was his chief source of income and that he had income from his employment with Ontario Hydro which was sideline employment as is contended on behalf of the plaintiff, in which event all losses incurred by him in the years in question are properly deducted from his total income.

The issue so stated is a paraphrase of the first two of the three categories of farmers which, in the opinion of Mr. Justice Dickson as expressed by him in Moldowan v The Queen, [1977] CTC 310; 77 DTC 5213, are envisioned by the Income Tax Act.

At the outset of his reasons for judgment, Mr Justice Dickson said that central to the appeal before the Supreme Court of Canada was the construction of subsection 13(1 ) of the Income Tax Act, an awkward and intractable section and the source of much debate. It was submitted before that Court that the section is meaningless and incomprehensible and therefore should not be applied to the detriment of a taxpayer.

Mr. Justice Dickson did not accede to that submission for to do so would be in effect to write the section out of the Statute. Accordingly he made the valiant effort to make sense out of language where no sense existed.

Section 13 is now section 31 but the material language thereof is unchanged.

In construing the section he said the three classes were:

(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 carries 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 carries 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 parties agree, as do I as well, that the plaintiff is not a hobby farmer within the third category.

The defendant admits that the plaintiff is a farmer carrying on business in the Township of Sombra, County of Lambton, Ontario as alleged in paragraph 1 of the statement of facts in the statement of claim.

The substance of the salient facts is not in dispute between the parties. What is in dispute between them is the proper inference to be drawn from those facts.

The plaintiff was raised on his parents’ farm. He was the youngest son in the family and it was evident that he was the logical son to succeed to the operation of the farm.

However his father’s progressive severe illness dictated that he must sell the farm. The plaintiff was just 19 years of age and could not buy the farm. His father felt that all members of the family were entitled to the proceeds from the farm which precluded any disposition other than sale. The farm was sold in July 1960.

Accordingly, in 1962, the plaintiff obtained an offer of employment from Ontario Hydro. He moved to Toronto to undertake training as a stationary engineer. He eventually progressed through the four classes thereof in a space of eight years (the normal time being 10 years) and he ultimately became a turbine boiler operator, but his classification and salary was that of a Class IV Stationary Engineer. His duties and title differed somewhat.

Despite this diversion, dictated by necessity, the plaintiff always harboured the dream of returning to farming as his means of livelihood. He never abandoned that dream in the furtherance of which he resolved to take the first opportunity available to transfer to an Ontario Hydro generating station in a rural area.

That opportunity came to him in 1968. He applied for and received a transfer from Toronto, Ontario to a station in Lambton County of which Sarnia is the county centre.

Upon arrival he immediately bought a farm consisting of nine acres, a house and a concrete block barn.

The house was dilapidated and lacking in facilities. The plaintiff expended 2 / years in arduous labour plus a substantial outlay for materials to restore the house following upon which he embarked upon the remodelling and restoration of the barns (contained in a single building) and the installation of equipment essential to the hog farrow to finish farming operatr *s he was undertaking.

The plaintiff did all the work himself. A witness described him as “a jack of all trades and the master of all”. If he was not the master at the outset he became one. In addition to his labour a great part of his savings from the prior years as well as the proceeds of the sale of his former home in Port Hope, Ontario, went into this enterprise — a total of $16,000 of which $13,000 was his own and the small balance borrowed from a credit union.

In 1973 the plaintiff purchased a further five acres abutting his original nine acres which had come on the market.

From 1970 to 1974-75 the plaintiff went into a cattle operation on a very limited scale.

From 1975-76 he began the pig farming operation he had planned. This operation grew from nothing.

On January 1, 1973 the plaintiff had two sows.

On January 1, 1974 he had four sows.

On January 1, 1975 he had nine sows.

In 1976 he had nine sows, two boars and five feeder pigs.

On January 1, 1977, the beginning of the first taxation year of the three under review, he had 13 sows, one boar, 48 feeder pigs and 16 weanlings.

On January 1,1978 he had 18 sows, 2 boars, 95 feeders and 84 weanlings.

On January 1, 1979 he had 28 sows, 2 boars, 148 feeders and 73 weanlings.

In 1977 he sold 70 pigs, in 1978, 128 and in 1979, he sold 210. In the next year, 1980, he sold 340 pigs. These figures are indicative of the growth.

Throughout he was employed by Ontario Hydro and continues to be so employed as at this date.

The plaintiff had a very accommodating employer.

The plaintiff was on a 28-day, 8-hour shift cycle. In every 28 working days he gets 7 days off.

The busy farm times are in the spring and fall, that is, seeding in May and June and harvesting in October and November. He arranged for his holidays at those times. He also got time off without pay and he arranged exchanges of time with fellow employees.

Out of the 24 hours in a day the plaintiff slept five hours, worked eight hours at Ontario Hydro and spent the remaining 11 hours on the farm with minimal time off for breakfast, supper and personal needs.

Mrs Graham, the plaintiff’s wife, with the help of their sixteen-year-old son was quite capable of handling matters which might arise during the plaintiff’s absence at work with Ontario Hydro but in the event of an emergency arising beyond her competence the plaintiff was available, with the concurrence of his employer, upon being summoned by telephone. Those occasions were rare.

Mr DeMars, who is the deputy reeve of the County and is engaged in the same type of farming operation as is the plaintiff, testified that the plaintiff is a compulsive worker.

In 1980 he and the plaintiff entered into an arrangement whereby they shared and operated major equipment to their mutual advantage. Mr DeMars had reservations at the outset as to the feasibility of the arrangement because he knew of the plaintiff's employment at Ontario Hydro. He foresaw the likelihood of himself doing the bulk of the work. That reservation was dispelled very early in the implementation of the arrangement. The plaintiff was always at the work site and ready to go in advance of the agreed starting time.

Further Mr DeMars testified that the plaintiff was a dedicated, efficient and progressive farmer. The plaintiff has a good breeding line in his hog operation and he was the first to introduce the use of artificial insemination in the area with excellent results. He also gave Mr DeMars advice whereby he raised his average index to 104.9, two tenths above that of the plaintiff. They are both among the top 10 in the area.

The plaintiff cultivated and grew crops on 116 acres in 1976 of which he owned seven acres and rented 109.

In 1977 he cultivated and seeded 133 acres of which he owned 61 and rented 72. That was the year he purchased 54 more acres 1 /2 miles from his home place.

In 1978 he planted 109 acres of which he owned 61 acres and rented 48.

In 1979 he planted 75 acres of which he owned 61 acres and rented 14.

In 1978, 1979 and 1980 the acreage decreased because of a change of ownership in the rented land. In these years the plaintiff spent money on better equipment rather than on buying land.

In 1981 and 1982 his ownership remained constant and the rented land increased to 69 acres and 185 acres.

In 1982 his home farm was expropriated by the municipality as well as the 54 acres he had bought.

With the advance proceeds of the expropriation of his home place (he has not as yet been compensated for the expropriation of the 54 acres) and a loan from the Ontario Farm Loan Board he bought a new farm consisting of 120 acres 25 /2 miles from the generating station at which he works. The plaintiff estimates that there is a 64 sow capacity and it is his objective to reach that capacity when he can do so.

The capacity of the land owned by the plaintiff in the taxation years under review, that is 1977, 1978 and 1979 was 40 sows. In those years he had not reached that capacity. The maximum number he has reached at this time is 39.

That number and those he owned previously did not support the standard of living that the plaintiff wished to provide for his family. To reach that standard he considered it expedient to continue in his employment at Ontario Hydro, having reached the capacity of 40 sows on the home place expropriated in 1982 and to achieve the objective of 64 sows on the new farm.

Incidentally the plaintiff was aware from his experience of the policy of the Ontario Farm Loan Board not to lend money to part-time farmers but the Board was not reluctant to advance to the plaintiff moneys to purchase his new farm. This was after the taxation years in question.

Mr DeMars, who testified, had been employed full time with a canning company. In 1975 he decided to devote his energies to full-time farming. He gave up his employment and borrowed extensively to acquire land, equipment and livestock. The burden of the increased rate of interest compelled him to liquidate a substantial portion of his assets to reduce the loan and interest burden.

He now owns 307 acres which supports a 65-sow operation.

Mr DeMars described the plaintiff as having adopted a plan different to his own. Whereas he had borrowed heavily, the plaintiff had not done so. Rather the plaintiff continued in his employment with Ontario Hydro and put his income from that source together with his savings and limited borrowing and income from cash crops all into the farming operation. His farm holdings and equipment have gradually increased without the necessity of retrenchment. He is getting out of debt and his credit rating has increased accordingly.

The plaintiff continues to expand his farming operations.

Thus the plaintiff has been committed to his farming venture since 1968 and from that time onward he has committed everything he has and earns to the farm. Everything he has is in the farm.

I fully appreciate that some of this evidence is subsequent to the taxation years in question but that evidence is properly admissible as illustrative and confirmatory of the plaintiff’s course of conduct and intention in those antecedent years.

While the plaintiff's farming activity was directed primarily to the hog raising operation nevertheless he also engaged in the production of cash cereal crops. He grew winter wheat, soya bean and corn. The corn was grown as feed for the swine but the surplus was sold. It was for this purpose that the plaintiff rented land additional to that which he owned.

The plaintiff's income from his employment and farming in the years 1975 to 1979 is as shown in the following schedule:

In limiting the farm losses of the plaintiff to $5,000 in each of the 1977, 1978 and 1979 taxation years as he did the Minister did so on the assumptions that:

(1) the plaintiff was employed by Ontario Hydro on a full time basis;

(2) the plaintiff farmed during his spare time, and

(3) the plaintiff’s chief source of income was neither farming nor a combination of farming and some other source of income as is reflected in the quantum of income from farming and his employment set forth in tabular form in the above schedule.

(1 have paraphrased the assumptions as they appear in the statement of claim.)

The first two assumptions are, in actuality, predicated upon semantics.

Of course the plaintiff is employed full time at Ontario Hydro. He works an 8-hour shift in a cyclical 28 days. That 28 days is reduced by seven days to 21 days for time allowed off. Therefore in a cycle he works 168 hours.

The second assumption is that the plaintiff works the farm during his spare time.

That too is so. But in a 28-day cycle that spare time represents 11 hours per day for 21 days for 231 hours plus 19 hours per day for seven days which equals 133 hours for a total of 364 hours spare time. The plaintiff testified he slept but five hours in 24.

Therefore the spare time is more than double the time spent in his employment and would be still greater in a calendar year when account must be taken of the plaintiff’s spring and fall holidays, time off without pay, exchanges of time and overtime.

If need be I would say that those two assumptions have been rebutted.

The matter turns on the third assumption.

The initial words of subsection 31(1) [13(1) of old Act] of the Income Tax Act are:

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

It is now authoritatively established in Moldowan v The Queen, (supra), that in order to have a “source of income” the taxpayer must have a profit or a reasonable expectation of profit. Source of income, thus, is an equivalent term to business. Farming is a business but unlike other businesses it is the only business in which losses incurred in the conduct thereof are not deductible in their entirety but are subjected to limitation in instances which might fall within section 31. That, however, is a matter of policy and as such is not of judicial concern except as it might affect the interpretation of the language of the section.

It is equally now well established in the Moldowan case that whether a taxpayer has a reasonable expectation of profit is an objective determination to be made from all the facts. It is a finding of fact to be made from all the facts. It is a finding of fact to be made taking into consideration the criteria mentioned in the Moldowan case but the criteria mentioned were not intended to be exhaustive.

Reverting to the initial words of subsection 31(1) the reference is to the taxpayer’s chief source of income for the year is “neither farming nor a combination of farming and some other source of income”. The language is negative but there is no impediment to expressing it positively that a “chief source of income”, for the purposes of the section can be “farming or a combination of farming and some other source of income”.

At the time Moldowan v The Queen, (supra), was decided by the Federal Court, Appeal Division, [1975] CTC 323; 75 DTC 5216, there was a divergence of opinion as to whether the word “combination” in the subsection required a connection between farming and the other source of income.

After that decision but before the decision of the Supreme Court of Canada, it was said by way of obiter in C D Brown v The Queen, [1975] CTC 611 ; 75 DTC 5433, that it was implicit from the plain meaning of the words of subsection 13(1) (new subsection 31(1)) that when there are but two sources of income consisting of farming and another source of income that is a “combination” forming the chief source of income and that it was “irrelevant” that those two sources were not “connected”.

Mr Justice Dickson resolved the divergence of opinion that there must be a connection between farming and another source of income to constitute a combination by concurring in the view expressed by Thorson, P. in Simpson v MNR, [1961] CTC 174; 61 DTC 1117, that there is no reason why there must be such a limitation.

However he concluded that the word “combination” as used in the section of the Income Tax Act:

.. . 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 that subsection 13(1) can be properly so construed. Such constructions 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.

With these considerations in mind it is expedient to again reproduce the first two of the three classes of farmers whom Mr Justice Dickson said the Income Tax envisioned and his comment thereon.

The first class he described as follows:

(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.

In explanation of this first category he said:

The reference in s. 13(1) to a taxpayer whose source of income is a combination of farming and some other source of income isa 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 second category of farmer Mr Justice Dickson described as follows:

(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.

(This limits the losses deductible to $5,000)

In continuation of his explanatory remarks but with more particular reference to this second category Mr Justice Dickson said:

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.

Thus it is clear that if the “major preoccupation” of the plaintiff is farming but he has “income from a sideline employment” then he is within class (1 ).

Likewise if the plaintiff’s employment is a sideline employment then this subsidiary interest(s) will not place the taxpayer in class (2)”.

The issue resolves itself into this: is the plaintiff’s “major preoccupation” farming and his employment is “sideline” thereto. If this be so then is the plaintiff entitled to deduct his farming losses in their entirety from the combination of these two sources of income.

Conversely if the plaintiff's employment is not “sideline” but his “major preoccupation” and farming is his “subsidiary” interest then the deduction he may claim from his combined sources of income for farming losses is as limited by section 31.

This, in turn, may be expressed in the question more consonant with the initial language of subsection 31(1) which of farming or employment is the plaintiff’s “chief source of income”.

It has been held in many instances that a source may be a source of income in a particular taxation year even though in that year the taxpayer suffers a loss. That being so, the simple mathematical test of comparing the net incomes from two sources, while a relevant factor, is not a conclusive test for determining which of two sources of income is the chief source.

Mr Justice Ryan in his reasons for judgment in the decisions of the Appeal Division in Moldowan v The Queen, (Supra), said at 333:

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 though 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 (see for example, Wilfely v The Queen [1974] CTC 510; 74 DTC 6422) 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.

Mr Justice Dickson was confirmatory of those remarks by Mr Justice Ryan when he said:

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.

Mr Justice Ryan in his remarks quoted stated that, “the relative importance as sources of income” would be “in most part a function of their capacity to produce gain” and that to do so “significant attention” should be given “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 activities, in implementation of his plans, is the chief source of his income in the sense of its usual or its foreseeable profitability or both”.

In seeking an answer in looking at both of a taxpayer’s sources as to capacity for both future and present profit he made specific mention of (1) gross income, (2) net income, (3) capital investment, (4) cash flow, (5) personal involvement and as indicative of that list not being exhaustive he added, (6) other factors.

The principal emphasis of counsel’s contention on behalf of the defendant was predicated on the remark made by Mr Justice Dickson on the first class of farmers: he saw the Act as contemporary when he there said that, a taxpayer for whom farming may be reasonably expected to provide the bulk of income, “who looks to farming for his livelihood” is free of the limitation of losses.

In the circumstances of these appeals I do not accept the premise predicated upon the evidence that the plaintiff might not reasonably expect his farming operations to “provide the bulk of income” and it most certainly is “the centre of work routine”. I do not think that the clause “who looks to farming for his livelihood” can be extracted from the context in which it appears and examined in isolation. It must be read in conjunction with the other language in class (1) and with class (2) by which these categories were characterized by Mr Justice Dickson.

The substance of the evidence given in this respect by the plaintiff was that the acreage and facilities he owned in the taxation years was capable of supporting 34 sows (the maximum he achieved there was 28) and that 40 sows would provide a reasonable standard of living. But it was my understanding that the plaintiff was not satisfied with that standard and that his ultimate objective on increased holdings was 60 sows. Meanwhile the salary from his employment was utilized to supplement the plaintiff’s standard of living and to achieve his ultimate objective.

I am satisfied that subjectively the plaintiff is a dedicated farmer and that farming is his all consuming-interest.

He was precluded from becoming a farmer in his youth by adverse circumstances and was diverted to employment with Ontario Hydro where by application and dedication he achieved a position of responsibility but his ambition to farm was never forsaken.

In the Moldowan case Dickson, J. said that:

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.

In my view the plaintiff changed his occupational direction when he applied for transfer to and was transferred to a rural area in his employment. He did that with the ultimate objective of farming in view in 1968.

In that year he invested all his available capital in farm land, buildings and residence.

By prodigious labour, without outside help, he restored a dilapidated house in two and a half years and in a further two years readied barns for a pig rearing operation by installing the necessary equipment at expense and effort.

The schedule of gross revenue in the taxation years in question is relevant.

In the three taxation years under review the plaintiff’s gross farming revenue exceeded his employment income.

In 1977 the farm receipts exceeded the plaintiff’s employment by about $500, in 1978 by about $10,900 and in 1979 by not quite $10,000.

While this is so the expenses were consistently high, and substantially higher than the plaintiff’s farming income. In his 1977, 1978 and 1979 taxation years he suffered farming losses of $10,725, $10,017 and 12,702 respectively and all of which exceed $5,000.

In the light of Mr Justice Dickson’s remark that a farmer, “is not disentitled to deduct the full impact of start-up costs”, it must be borne in mind that the plaintiff started his farming operation from scratch in 1968. From that time he expended his physical labour to restoring a house and barns and it was not until 1975-1976 that he was able to embark upon the pig farming operation he had planned to the extent he had envisioned.

Notoriously the initial expenses of such a farming operation will be extraordinarily high but that does not detract from the validity and necessity of these expenditures to reach the ultimate objective.

Thus to consider the criteria mentioned by Mr Justice Ryan as quoted above, the plaintiff’s gross income from farming exceeded his income from his employment.

His net income did not but that is explainable by the high expenses incidental to starting up a farming operation on the scale which the plaintiff planned.

The plaintiff’s every resource was invested and devoted to his farming operation. That includes all of his savings, his income from his employment and his labour.

The farming operation did generate a substantial cash flow from cereal crops and the pig farming operation but while the cash flow was substantial it was taken in the main by the start-up expenses for machinery, equipment and the acquisition of the land upon which to farm.

There is no question that his personal involvement was dedicated to farming to the maximum.

I can see no real difference in the object sought to be achieved by the plaintiff and his neighbour, Mr DeMars.

Both had been employed in occupations other than farming.

Mr DeMars, when he undertook to farm, gave up his employment and the income therefrom. He borrowed heavily to begin and sustain his operation subject to the necessity of retrenchment at one point.

On the other hand the plaintiff did not give up his employment and begin farming on borrowed capital but rather devoted his employment income to the same end that Mr DeMars devoted borrowed capital.

From the cumulative effect of the foregoing circumstances I am satisfied that the main preoccupation of the plaintiff is farming but he has income from a sideline employment.

That being so it follows that the appeals of the assessments for the plaintiff’s 1977, 1978 and 1979 taxation years are allowed and the assessments are referred back to the Minister for reassessment on the basis that the farming losses claimed by the plaintiff in the taxation years are properly deductible in their entirety.

The plaintiff shall be entitled to his taxable costs but on the basis of a single appeal since all appeals were included in a single statement of claim and the issue was identical in each appeal.