Spengler v. The Queen, docket 96-1452-IT-G

Date: 19981230

Docket: 96-1452-IT-G

BETWEEN:

ARNOLD SPENGLER,

Appellant,

and

HER MAJESTY THE QUEEN,

Respondent.

Reasons for judgment

Mogan, J.T.C.C.

[1] When computing income for the taxation years 1990, 1991 and 1992, the Appellant deducted certain amounts as losses from the farm which the Appellant and his wife operate near Nanton, Alberta. When assessing tax for those three years, the Minister of National Revenue adopted two positions: (i) the Minister disallowed certain expenses claimed by the Appellant on the basis that such disallowed expenses were personal expenses and not farm expenses; and (ii) having reduced the reported loss to an amount which the Minister regarded as referable to farming, the Minister allowed as a deduction for each year the amount determined under subsection 31(1) of the Income Tax Act, the restricted farm loss. The Appellant appealed from those three assessments.

[2] The allowance of the restricted farm loss is an implicit admission by the Minister that the Appellant's farming operation was a business and not a hobby. Consistent with the recent decision of the Federal Court of Appeal in The Queen v. Donnelly, 97 DTC 5499, the issue in these appeals is chief source of income and not reasonable expectation of profit. The income reported by the Appellant and the adjustments effected by the Minister may be summarized as follows:

	1990	1991	1992
A. Employment income	$55,956	$60,000	$54,500
B. Farm Loss	33,938	45,414	17,383
C. Income Reported	22,018	14,586	37,117
D. Expenses Disallowed	7,858	7,774	3,983
E. Adjusted Farm Loss (B minus D)	26,080	37,640	13,400
F. Farm Loss Allowed per s. 31	8,750	8,750	7,950
G. Farm Loss Disallowed (E minus F)	17,330	28,890	5,450
H. Income per MNR (A minus F)	47,206	51,250	46,550

[3] The Appellant was born in Saskatchewan in 1945 but grew up near Taber, Alberta, just east of Lethbridge. In 1964, he started to work in the oil industry primarily in drilling. After he acquired some drilling experience, he lived and worked in the Middle East for about 15 years from 1966 to 1980 spending approximately 10 years in Iran. He worked his way up to the point where he could supervise a drilling crew. The Appellant and his wife have three children; a daughter born in 1970 and two sons born in 1973 and 1981, respectively. For about nine years in the 1970s, his wife and two older children lived with him in the Middle East. In 1980, the Appellant and his family returned to Canada permanently and purchased a house in Nanton, Alberta, about 45 miles south of Calgary.

[4] In 1980, the Appellant started A.C.S. Oilfield Consultants Ltd. ("ACS"), an Alberta corporation in which he intended to market his drilling skills. He owns 51% of the shares in ACS and his wife owns 49%. ACS has continued to operate from 1980 up to the hearing of these appeals. In his work for ACS, the Appellant is called out on a sporadic basis to supervise drilling operations throughout Alberta and in certain parts of Saskatchewan and British Columbia. He might have to drive as long as 15 hours to reach a drilling location. He does not have to supervise the drilling crew itself because the drilling contractor has a rig manager. The Appellant is hired as a consultant by an oil company to oversee the whole operation to ensure that things are done as efficiently and safely as possible. In the event of a conflict between the rig manager and the Appellant as representing the oil company, the Appellant will have the final say. In ordinary circumstances, the Appellant would be called out more in the winter than in the summer because there is more drilling in the winter.

[5] In 1983, the Appellant and his wife purchased a quarter section (160 acres) of ranching land to raise Limousin cattle. They decided on Limousin because, as a particular breed, Limousin were near the top in beef and had been the best beef cow for a number of years. Two advantages of the Limousin breed are that they have little trouble calving, and the calves gain weight rapidly. They decided to run a cow/calf operation with the object of building their herd by retaining the best female calves and selling all the male calves. They started in 1983 with six cows. By 1990, they had 18 cows, 17 calves, 3 heifers and 3 herd sires (bulls). In the three years under appeal, the herd grew to 21 cows, 17 calves, 11 heifers and the same three bulls. When these appeals were heard in 1997, the Appellant and his wife had 60 cows, 57 calves, 22 heifers and 3 bulls. Exhibit A-5 is a summary of the growth in their herd from 1983 to 1997.

[6] The Appellant's wife, Trudy Spengler, testified in these appeals and gave precise details of the Limousin herd because she kept the books and records of their farming operation. Also, she was at the farm all year round, particularly when the Appellant was away on a drilling assignment. Trudy had grown up on a farm and her grandparents on both sides were farmers.

[7] By 1990, the Appellant and Trudy needed more land for their expanding herd and so they leased land from Trudy's mother and her uncle. In 1996, they purchased from Trudy's mother the quarter section they had been leasing, about 14 miles east of Nanton near Vulcan. In 1995, they had purchased another quarter section 18 miles east of Stavely which is approximately 30 miles south of Nanton. At the time of hearing, the Appellant and Trudy owned three quarter sections, the home farm at Nanton plus the quarter section near Vulcan and the quarter section east of Stavely. In the years under appeal, however, they owned only the home farm but leased two other quarter sections.

[8] Both the Appellant and Trudy described their farming operating as it proceeded through the various cycles of the year. It is a year round business. During the years under appeal, the three children were living at home and worked on the farm when not attending school. There was no "hired man". According to the Appellant, Trudy does everything that pertains to cattle and feeding and cutting hay and baling it. He stated that "she does everything that's required on the farm" (Transcript p. 37); and there is nothing that she does not do.

[9] Most calves arrive in the period January to March. This is an intense time because the cows have to be checked almost every hour. During April and May, the fields are made ready for seeding. The Appellant grows mainly alfalfa, oats, barley and hay as feed for the cattle. The seeding is done in June and late May. In June and July, they are busy irrigating because their irrigation rights end on July 31. The irrigation equipment has to be moved every eight hours. In August, they mend fences and watch the crops for an opportunity to harvest. In September and October, they are taking off their crops; baling and storing hay; and selling those calves which are not to be retained for herd purposes. From late October through the winter months, they have to feed all cattle because there is no pasture to sustain them after the frost.

[10] The Appellant and Trudy paid $350,000 for the home farm near Nanton in 1983 (Exhibit A-10). There is a creek that runs completely through the farm and so they wanted to irrigate their land. They obtained the necessary survey and then applied for an irrigation permit. In 1985, they were granted irrigation rights for only one-third of the farm and a moratorium on all irrigation in the Nanton area has prevented them from increasing their irrigation rights (Exhibit A-8).

[11] The "chief source of income" test is set out in subsection 31(1) of the Income Tax Act in the following words:

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

...

There is a wealth of jurisprudence on the "chief source of income" test. In The Queen v. Donnelly (supra), Robertson J.A. summarized the law as follows at pages 5500-5501:

A determination as to whether farming is a taxpayer's chief source of income requires a favourable comparison of that occupational endeavour with the taxpayer's other income source in terms of capital committed, time spent and profitability, actual or potential. The test is both a relative and objective one. It is not a pure quantum measurement. All three factors must be weighed with no one factor being decisive. Yet there can be no doubt that the profitability factor poses the greatest obstacle to taxpayers seeking to persuade the courts that farming is their chief source of income. This is so because the evidential burden is on taxpayers to establish that the net income that could reasonably be expected to be earned from farming is substantial in relation to their other income source: invariably, employment or professional income. Were the law otherwise there would be no basis on which the Tax Court could make a comparison between the relative amounts expected to be earned from farming and the other income source, as required by section 31 of the Act. ...

[12] I propose to consider in order capital committed, time spent and profitability, actual or potential. There is no doubt that the Appellant and Trudy have more capital committed to their farming operation than to the Appellant's ACS business as a drilling consultant. The home farm near Nanton cost $350,000. They have expended at least $40,000 on irrigation equipment. They built a barn and had it wired so that the insulated room for calving could be heated. The barn cost $25,000. According to Exhibit A-6, the value of the herd of cattle in 1992 was approximately $46,000. And then in 1995 and 1996, the Appellant and Trudy purchased two additional quarter sections of land. They also have a tractor, a haying machine, a baler and a trailer to transport the hay. Even if the cost of the home farm ($350,000) is allocated between family dwelling and farm land, the investment in the farm is significant.

[13] The Appellant's consulting business in ACS does not require much capital because the drilling contractor provides the equipment while the Appellant provides his knowledge and experience. The 1990 balance sheet of ACS (Exhibit R-11) shows fixed assets at a depreciated value of $130,935. Note 2 to the balance sheet indicates that automobile and computer equipment had an original cost of $282,000 but have accumulated depreciation of $156,000, leaving a depreciated balance of approximately $126,000.

[14] It is important to observe that ACS actually carries on two businesses. In addition to the Appellant's consulting business as a drilling supervisor, ACS owns four gravel trucks and hires drivers in the non-winter months (April to October) to operate a haulage business. The Appellant said that, on occasion, when one of his four drivers was absent, he would drive one of the gravel trucks himself but that was not a frequent occurrence. Comparing the Appellant's three commercial activities, two of which are carried on within ACS, there is no doubt that the Appellant has much more capital committed to farming than to his consulting business or haulage business.

[15] There is unequivocal evidence that the Appellant spends more time at farming than any other activity. The Appellant entered into evidence Exhibits A-1, A-2 and A-3 which were the invoices of ACS showing the number of days when ACS billed its oil company clients for services in 1990, 1991 and 1992, respectively. The maximum number of days covered by those invoices was:

1990 176 days

1991 81 days

1992 80 days

When Trudy Spengler testified, she said that the invoices of ACS were not necessarily an accurate record of the days which the Appellant spent away from the farm. She kept her own records of the days when he was away and, according to Trudy, the ACS consulting business took the Appellant away from the farm for the following days in the three years under appeal:

1990 155 days

1991 87 days

1992 103 days

[16] The above evidence of time spent by the Appellant at the ACS consulting business was not challenged by the Respondent. Whether I accept the Appellant's evidence of 337 total days in three years or Trudy's evidence of 345 total days is not material. In 1990, the Appellant spent a little more time at farming than at drilling but, in 1991 and 1992, the Appellant spent three days farming for each day at the consulting business. Everyone knows that farming is not a 40-hour week like so much of urban society. For a cattle herd like the Appellant's, the cows have to be fed every day through the winter months; and in summer, the feed crops have to be harvested when the weather permits. In time spent, the main thrust of the Appellant's life was farming.

[17] The third factor is profitability. In Donnelly (supra), Robertson J.A. stated at page 5501:

Any doubt as to whether the taxpayer's chief source of income is farming is resolved once consideration is given to the element of profitability. There is a difference between the type of evidence the taxpayer must adduce concerning profitability under section 31 of the Act, as opposed to that relevant to the reasonable expectation of profit test. In the latter case the taxpayer need only show that there is or was an expectation of profit, be it $1 or $1 million. It is well recognized in tax law that a "reasonable expectation of profit" is not synonymous with an "expectation of reasonable profits". With respect to the section 31 profitability factor, however, quantum is relevant because it provides a basis on which to compare potential farm income with that actually received by the taxpayer from the competing occupation. In other words, we are looking for evidence to support a finding of reasonable expectation of "substantial" profits from farming.

In the passage from Donnelly quoted in paragraph 11 above, Robertson J.A. used the words "profitability, actual or potential". In these appeals, the Appellant's income tax return for 1996 (Exhibit A-4) shows that he did report a modest profit of $303.14 from farming for that year. Much more important than the modest 1996 farming profit is Trudy Spengler's evidence of how they could increase their herd to 200. Both the Appellant and Trudy stated that the farm would be profitable when it reached 200 head of cattle. At that time, they should have about 200 calves each year. If they sold all the male calves at six months plus those female calves not required for replacement stock, they would have enough revenue from farming to be profitable. From 1983 to 1996, their herd had grown tenfold from six cows to 60 cows.

[18] Trudy estimated that in four or five years, they could grow from 60 cows to 200 cows. They will need more land because the three quarter sections they owned in 1996 would support only about 120 head, the land being allocated to both feed crops and pasture. Their plan is to sell the big home they have occupied on the Nanton farm (on a surveyed lot of 10 acres); move to a smaller house (now rented) on one of the quarter sections which they own; and use the proceeds of sale to acquire another quarter section. The plan sounds reasonable and there is no evidence to indicate that it is not.

[19] The Appellant is not one of those individuals "who earn their income in the city and lose it in the country", adopting some words from Donnelly. The Appellant was born in Saskatchewan and raised in rural Alberta. The Appellant's wife was raised on a farm as were both her parents. The Appellant and his wife are hands-on farmers. The Appellant spends all of his time at farming (seven days a week) except for those days when he is required to supervise drilling for oil companies. Trudy Spengler spends all of her time at farming with no exceptions. It is a fact that the Appellant has been able to pay himself a salary out of ACS in the range of $60,000 per year while his farm was losing money. The table in paragraph 2 above shows that the disallowed farm loss (line G) is not significant in proportion to the employment income (line A).

[20] In Hover v. M.N.R., 93 DTC 98, a dentist in Lethbridge, Alberta, was permitted by the Minister of National Revenue to deduct the restricted farm loss but not allowed to deduct his full farming loss for the years 1984, 1985 and 1986. The dentist appealed. When allowing the taxpayer's appeal in Hover, Bowman J. of this Court stated at pages 107 and 108:

The Act does not specifically require that the other source of income be either subordinate or sideline. It would seem that if farming can be combined with another source of income, connected or unconnected, it can as readily be combined with a substantial employment or business as with a sideline employment or business. Indeed, if the other source were merely subordinate or sideline it would not prevent farming alone from being itself the taxpayer's chief source of income without combining it with some other unrelated subordinate source.

...

In this case the appellant's dedication to farming, the time that he spent, although possibly less than that which he was obliged to spend in his dental practice, and his commitment of capital all lead to the conclusion that farming was not a sideline business but rather the central focus of his life. To achieve that end the practice of dentistry was an essential adjunct but one which while not subordinate in terms of the generation of cash was nonetheless subordinated to Dr. Hover's overall objective. ...

In my view, the Appellant is in a much stronger position that the taxpayer in Hover because the Appellant and his wife live on their farm all the time. It is their only dwelling. They are both actively involved in farming all the time except for those days when the Appellant is called away to supervise drilling for the oil company clients of ACS, no more than one-third of the time. Farming is the central focus of the Appellant's life.

[21] The passage from Donnelly quoted in paragraph 11 above states that the test of capital committed, time spent and profitability is both relative and objective; not a pure quantum measurement; and all three factors must be weighed with no one factor being decisive. Capital committed and time spent strongly support the Appellant. With respect to profitability, the farm has lost money but the object of section 31 is to permit the deduction of farm losses in certain circumstances. Having regard to the Appellant's pattern of living and the three factors comprising the test, I find that the Appellant's chief source of income for 1990, 1991 and 1992 was farming or a combination of farming and some other source of income. To hold otherwise would permit profitability to dominate capital committed and time spent. The appeals are allowed with costs. In accordance with the statements by both counsel at the commencement of the hearing, the appeals of the Appellant's wife for the same three years (on an unrelated issue) are to follow the result of the Appellant's appeals.

Signed at Ottawa, Canada, this 30th day of December, 1998.

"M.A. Mogan"

J.T.C.C.