Prosser v. The Queen, docket 2000-290(IT)G

Date: 20020910

Docket: 2000-290-IT-G

BETWEEN:

SHIRLEY PROSSER,

Appellant,

and

HER MAJESTY THE QUEEN,

Respondent.

Reasonsfor Judgment

Mogan J.

[1]            The Appellant describes herself as a horse farmer. In her income tax returns for the taxation years 1995, 1996 and 1997, the Appellant reported farm losses in the respective amounts of $192,963, $169,926 and $80,692. The Appellant deducted the full amount of such farm losses against income from other sources leaving her with net income for each year. When assessing tax for those three years, the Minister of National Revenue disallowed the deduction of the farm losses described above and permitted the deduction of only $8,750 in each year under the provisions of section 31 of the Income Tax Act. The amount of $8,750 is referred to as the "restricted farm loss". The Appellant has appealed from those three assessments claiming that her chief source of income for each year was horse farming or a combination of horse farming and some other source of income. The only years under appeal are 1995, 1996 and 1997.

[2]            In Moldowan v. The Queen, [1978] 1 S.C.R. 480, the Supreme Court of Canada considered section 31 of the Income Tax Act (section 13 in the prior legislation). Dickson J. (as he then was) writing for a unanimous Court described three classes of farmers at pages 487-488. The hobby farmer in class 3 may not deduct any amount with respect to farm losses. The person who carries on farming as a sideline business in class 2 may deduct only the restricted farm loss. The Minister views the Appellant as a person for whom farming is only a sideline business. The class 1 farmer may deduct all farming losses without any limitations imposed by section 31. By permitting the Appellant to deduct the restricted farm loss of $8,750 in each year, the Minister has acknowledged that the Appellant's farming is a business and not a hobby. The only issue in this case is the question frequently referred to as "chief source of income". The Appellant claims that farming is her chief source of income.

The Facts

[3]            The Appellant has been associated with horses all her life. She started riding when she was three years old. In 1951, when she was only 15, she was the first woman to represent Canada at international jumping competitions. From 1951 to 1954, she was ranked among the top three female riders in the world. As a result of her accomplishments in riding and jumping competitions at international horse shows, the Appellant was nominated Canada's female athlete of the year in 1953 when she was only 17 years old. She was fortunate in the sense that her father owned and operated a successful business; he owned horses; and he wanted her to have the experience of riding and jumping horses in competition.

[4]            The family farm which was owned by the Appellant's father occupied more than 300 acres near Westport, Ontario, about 100 kilometers (60 miles) west of Ottawa in the Rideau Lakes. After her riding career, the Appellant operated a marina at Alexandria Bay for her father. When he sold the marina, she went to work for her parents at the family farm breeding, racing and selling horses. The Appellant's father died in 1984. At the time of his death, the farm was owned by Thomas Supply & Equipment Co. Ltd. ("the Company"), the corporation which had operated the father's business. The executors of the father's estate decided to separate the farm from the Company. The farm assets, excluding land and buildings, were sold to the Appellant's mother on July 1, 1985 at fair market value. The Bill of Sale is Exhibit A-17 and lists the assets in three categories as follows:

Schedule A	Vehicles & Trailers	$55,000
Schedule B	Tractors, Wagons, Equipment, etc.	36,000
Schedule C	62 named horses	1,131,000

[5]            When the Appellant's father was alive, the farm was operated under the name "Box Arrow Farm". The Appellant's mother continued that operation and the Appellant still operates the same farm under the same name. When the mother purchased the farm assets on July 1, 1985, she signed a lease on the same date (Exhibit A-18) under which the Company leased the farm lands and buildings to her for life at a monthly rent of $2,200. When the Appellant's mother could no longer manage the farm, she gifted it to the Appellant effective January 1, 1991. All of the assets listed in the Bill of Sale (Exhibit A-17) were transferred by way of gift from the mother to the Appellant; and the mother executed a formal assignment of lease (Exhibit A-19) to the Appellant with respect to the farm lands and buildings. Since January 1, 1991, the Appellant has owned and operated Box Arrow Farm as her own.

[6]            At all relevant times, the Appellant has resided at the farm year round. The only excepting was a trip to Florida for a month each winter with the Appellant's mother who would be 100 years old in 2001. The Appellant still resides at the farm. She occupies a self-contained apartment over the arena which is a building that permits indoor training of horses in bad weather. In the years under appeal, the principal farming business was breeding and raising horses, some for sale and others for racing. There was also significant revenue from boarding horses for other owners. From 1991 until 2000, the Appellant also raised some cows at the Box Arrow Farm. The Appellant attempts to grow all her own hay but she does not grow grain because, in her experience, the grain grown in western Canada is better for horses.

[7]            When the Appellant began to operate the farm as her own enterprise in January 1991, she realized that the horses were very overpriced as inventory and the financial records of the farm were in a mess (her own words!). Her father (up to 1984) and her mother (from January 1985 to 1990) had never written down the book value of horses as they aged, even brood mares. She wanted Box Arrow Farm to be profitable and so she made some changes. She sold many horses at prices lower than their book value and absorbed the loss as if it had occurred during her ownership. She reduced her staff. She tried to grow more of the feed for both horses and cattle. She hired a bookkeeper to maintain better financial records at the farm. Notwithstanding her efforts, Box Arrow Farm continued to show losses from 1991 through to 1999.

[8]            The Appellant was asked to describe a typical day at her farm. She would get up at 5:00 a.m. to feed the animals. She fed them herself before her staff (two men) came to turn them out. She would then work with the men to turn the animals out of the barn. They would then get a tractor and manure spreader and bring it into the barn. Up until 1999 (when the Appellant was 63 years old) she used to work with the men cleaning 20, 30 or 40 stalls depending on how many horses she had at a particular time. The cleaning involved taking a manure bucket and fork into the stall; lifting the manure into the manure bucket; lifting the manure bucket into the spreader, and then towing the spreader out of the barn when it had a full load. After the stalls were cleaned, they would rake fresh straw for the next night.

[9]            Feeding the animals, cleaning the stalls and the barn, and spreading the manure would consume most of the morning. In the afternoon, she would spend some time on her pedigree books because she was breeding and raising thoroughbred horses for sale, and she had to keep up current knowledge on the different pedigrees. She would also work on tack or on horses' legs or on the farm financial records. Tack is the equipment that the horses wear: bridles, reins, saddles, blankets, etc. Working on horses' legs is a special task. The Appellant and the two men who work on her farm go over the horses every day to find out if there is any heat in the legs. If a horse is running a temperature, she and her staff use a coffee grinder to grind up pills so that they can be fed to the horse. In haying season, they would watch for the right weather; cut the hay; wait for it to dry; bale it and bring it in the barn.

[10]          At the end of the afternoon, the horses have to be collected and brought back into the barn - a task which could take up to an hour, depending on how many horses are under her care on a particular day. In summer, when she has mares and foals, if the mosquitoes are not bad, the Appellant will go out to the barn around 10:30 in the evening and put the mares and foals out so that they will be outside for the whole night. In winter, when the mares are foaling, she has closed circuit television in her bedroom with three cameras and three screens so that she can monitor the mares. Each mare in foal has an "alarm" attached. The Appellant herself participates in the delivery of every foal.

[11]          The Appellant runs the tractor pulling the mower in haying season. She cuts up to eight acres per day. She sometimes runs the tractor pulling the manure spreader. And she often drives the truck pulling a trailer to transport horses. She stated that there was no equipment on the farm that she could not operate. When a yearling gets to a certain age, she has to start conditioning it for market: bringing it into the barn; cleaning and grooming it; walking it; getting it in shape; and delivering it to an agent in Toronto about three weeks before the sale date. The agent who is a woman works on the yearling and makes it available for any potential customer to see.

[12]          The Appellant does most of the horse transporting herself by driving her van and towing a horse trailer. She has transported horses as far as Kentucky and Florida mainly for breeding purposes.

[13]          The Appellant is a "hands-on" farmer who resides at the Box Arrow Farm year round. She has no regular vacation herself except for one month in winter when she takes her elderly mother to Florida. She is in attendance at the farm seven days a week unless she is shipping horses in her van/trailer to market or for breeding. In the years under appeal (1995, 1996 and 1997), she actively participated in the feeding and care of the horses, cleaning the stalls and delivering foals. The Appellant has only Grade 10 education probably because she was so involved in competitive riding and jumping when she was a teenager. She stated in evidence that her principal occupation is farming because it is what she knows and what she does best (Transcript page 119).

[14]          Exhibit A-20 is a table showing the Appellant's sources of income for the period 1987 to 1999 but I am concerned primarily with the years under appeal. Exhibit A-21 contains extracts from the financial statements of Box Arrow Farm for the years 1991 to 2000. In the table below, I have summarized the relevant amounts from Exhibits A-20 and A-21 for the years 1994 to 1999 being the three years under appeal (1995, 1996 and 1997) plus the immediate preceding year (1994) and the two following years. The table shows that, in each year, the Appellant's aggregate income from all sources exceeds her loss from horse farming. She explained in evidence that she did not borrow money to finance the farm losses but injected fresh capital into Box Arrow Farm from her investment income. She received substantial investments from her father (or his estate) and so she has a generous flow of investment income in the form of dividends and interest. She has very little personal knowledge of financial matters and therefore leaves all her investments in the hands of professional financial advisors.

	1994	1995	1996	1997	1998	1999
T4 earnings	$58,493	$57,673	$27,580	--	--	--
Other income	--	10,046	15,156	360	1,210	12,250
RRSP	--	--	2,000	--	--	--
Dividends	37,579	48,302	52,472	53,084	37,293	54,975
Interest	118,987	114,520	111,717	116,127	145,508	128,459
Taxable Capital Gains	13,290	2,129	5,996	17,724	29,453	32,602
Non-Farm Income	228,349	232,670	214,921	187,295	213,464	228,286
BOX ARROW FARM
Sales	246,270	310,461	354,589	263,311	250,231	281,006
Gross Margin	88,422	94,229	107,804	146,659	178,711	214,123
Other Revenue
Boarding	22,434	17,436	16,746	25,632	37,993	31,277
Stud Fees	16,455	2,298	--	853	6,066	11,535
Winnings	132,304	106,477	18,676	3,500	4,716	23,043
Interest, etc.	5,718	742	458	1,478	1,018	1,995
Total Revenue	265,333	221,182	143,684	178,122	228,504	281,973
Operating expenses	338,721	414,263	338,849	268,968	282,539	296,783
Profit/(Loss)	(73,388)	(193,081)	(195,165)	(90,846)	(54,035)	(14,810)

Analysis

[15]          The only issue in this appeal is whether the Appellant may deduct, in computing income, the full amount of the losses incurred by Box Arrow Farm. The Respondent does not dispute the amount of the losses and does not dispute the fact that Box Arrow Farm is a business. The issue arises under section 31 of the Income Tax Act.

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 the taxpayer's loss, if any, for the year from all farming businesses carried on by the taxpayer shall be deemed to be the total of

(a)            ...

Paragraphs (a) and (b) of subsection 31(1) establish a formula which determines the maximum amount of the deemed farm loss (the "restricted farm loss") when the condition in subsection 31(1) is satisfied. It is not necessary to set out the terms of paragraphs (a) and (b) because the parties are in agreement that the deemed farm loss for the Appellant in each year is $8,750 if the condition in subsection 31(1) is satisfied. The farm loss reported by the Appellant in each year under appeal and the farm loss accepted by the Minister are as follows:

	1995	1996	1997
Farm loss per Appellant	$193,081	$195,165	$90,846
Farm loss per Respondent	8,750	8,750	8,750

[16]          The Appellant claims that her chief source of income for the years under appeal was farming or a combination of farming and some other source of income. If she is successful in her claim, then the restricted farm loss established by the formula in subsection 31(1) will not apply to her and she will be permitted to deduct the full amount of her farm losses as reported by her. The "chief source of income" issue under section 31 has been litigated many times and, over the last 15 years, the Federal Court of Appeal has issued a series of judgments which are important in the interpretation and application of section 31.

[17]          In The Queen v. Morrissey, 89 DTC 5080, Mahoney J.A. writing for the majority stated at page 5084:

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.

In Morrissey, the Federal Court of Appeal through a majority decision concluded that the three factors of (i) time spent; (ii) capital committed; and (iii) profitability should be considered conjunctively and not disjunctively. Subsequent decisions of the Federal Court of Appeal in The Queen v. Roney, 91 DTC 5148; The Queen v. Poirier, 92 DTC 6335; The Queen v. Timpson, 93 DTC 5281; and The Queen v. Donnelly, 97 DTC 5499 have the effect explicitly or implicitly of confirming the conclusion in Morrissey.

[18]          In Donnelly, Robertson J.A. writing for the Court referred to taxpayers "who earn their income in the city and lose it in the country". Justice Robertson was referring to taxpayers who reside in a city where they carry on a business or profession and who own a farm outside the city. The Appellant in this appeal has never resided in any city or urban community at any relevant time. For all practical purposes, she has always resided at the Box Arrow Farm; and she has been the sole owner of that farming operation (excluding land and buildings) since January 1, 1991. Robertson J.A. stated at page 5500 of Donnelly:

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. ...

In the above passage, the phrase "that occupational endeavour" refers to farming. In most decisions from the Federal Court of Appeal concerning chief source of income under section 31, the taxpayer had a second occupational endeavour different from farming. In Donnelly, for example, the taxpayer was a medical doctor. In this appeal, however, the Appellant has no occupational endeavour other than horse farming. I propose to consider conjunctively the three factors which the Federal Court of Appeal has endorsed many times as the important factors in "chief source of income" cases: time spent, capital committed and profitability.

[19]          The Appellant spends all of her time at Box Arrow Farm. She did not work at any other occupation in the period 1991 to 2000. The T4 earnings which appear in Exhibit A-20 were amounts paid to her by the Company after her father's death in 1984, partly as fees for her status as a director and partly as some kind of income equalization within her family. Those T4 earnings ceased in 1996 when the Company ceased its business operations. In any event, the Appellant did not provide any personal services with respect to those T4 earnings. She is in every sense a full-time farmer. She feeds the horses. She helped clean the stalls until 1998 when she was 62 years old. She transports the horses for breeding and sale purposes. She administers medication when the horses are sick. And she participates as a midwife when the foals are born, monitoring the mares in foal with closed circuit television.

[20]          In terms of "time spent", the Appellant has no other occupation or hobby which competes with the time she spends on the business of Box Arrow Farm. On this factor, the Appellant is easily distinguished from the taxpayer in Morrissey (the chief engineer on a ship working the Great Lakes for 6 or 7 months each year) or Roney (the president and sole shareholder of a large security firm with more than 400 full-time and part-time employees) or Donnelly (a medical doctor). The Appellant's dedication to her horse farm (breeding, raising, training and either selling or racing) is proven by her conduct. She monitors mares in foal with three closed circuit television cameras in the stalls and screens in her bedroom. She is the midwife to each mare. She still feeds the horses and transports them for breeding and sale purposes. The factor of time spent indicates that farming is the Appellant's chief source of income.

[21]          In terms of "capital committed", it is apparent that the Appellant has invested a significant amount of capital in Box Arrow Farm to cover, at least in part, the losses which the farm has incurred. The Appellant also owns significant investments inherited from her father. Exhibit A-20 shows that her investment income in the form of dividends and interest in each of the three years under appeal was never less than $162,000. For whatever reason, there is no evidence which permits me to compare, in the years under appeal, the value of the capital which the Appellant owned in the form of dividend-paying shares and interest-paying debt instruments with the value of the capital which she had invested in Box Arrow Farm.

[22]          By examining the financial statements of Box Arrow Farm for the years 1992 to 1997 (Exhibits A-6 to A-11), I can determined from the "Statement of Capital" the amounts of capital introduced and drawn in each year and arrive at a net amount. Those financial statements disclose the following respective amounts as "capital introduced" and "drawings" but the "net capital invested" is my own determination:

	1992	1993	1994	1995	1996	1997
Capital introduced	$178,000	$284,000	$294,000	$240,000	$169,000	$63,000
Capital drawings	18,000	68,000	23,000	133,000	46,000	58,000
Net capital invested	160,000	216,000	271,000	107,000	123,000	5,000

The above table shows that the Appellant introduced net capital of $882,000 to Box Arrow Farm in the period 1992 to 1997. This amount is not surprising given the fact that the farm incurred aggregate losses of $758,000 in the same six-year period, according to Exhibits A-6 to A-11. The factor of capital committed indicates that farming could be the Appellant's chief source of income.

[23]          Profitability is the factor which seems to trouble the courts most because the taxation years under appear are invariably years in which the farm in question has suffered losses. The emphasis therefore is on potential. In the passage from Donnelly quoted in paragraph 18 above, Robertson J.A. used phrases like "not a pure quantum measurement" and "no one factor being decisive". Those phrases induce me to conclude that each court performs a balancing act with respect to the three factors. Immediately after the passage from Donnelly quoted in paragraph 18 above, Robertson J.A. continued with the following comment on profitability at pages 5500-5501:

... 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. ...

The words "invariably employment or professional income" indicate to me that the Federal Court of Appeal was thinking of a taxpayer who had a competing occupational endeavour. This indication is reinforced by the following words from page 5501 of Donnelly:

... 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. ...

[24]          If the taxpayer does not have a competing occupational endeavour, potential farm income can be compared with only investment income or some other income that is not derived from an occupational endeavour. In this appeal, the Appellant is fortunate to have substantial investment income and her only occupation is horse farming. She described the books and records of the farm as being in a mess when the farm assets were given to her in January 1991. In particular, the inventory of horses had never been written down (to the lower of cost or market) from their original cost. The Appellant stated that her prime purpose was to earn a profit from Box Arrow Farm and, toward that purpose, she disposed of all the horses which she received by way of gift and replaced them with better stock. According to Exhibit A-6, the comparable "Statement of Income" for 1991 shows that she purchased horses (and perhaps some cattle) at an aggregate cost of $498,340 in 1991.

[25]          The Appellant is a very credible witness, and I believe that her prime purpose is to earn a profit from Box Arrow Farm. The table in paragraph 14 above shows that the farm losses from 1997 (the most recent year under appeal) to 1999 declined respectively from $90,846 to $54,035 to $14,810. According to Exhibit A-21 (extracts from the financial statements of Box Arrow Farm for the years 1991 to 2000), the farm did in fact earn a profit of $64,691 in the year 2000 on gross sales of $309,176. Those gross sales are consistent with the preceding five years. In other words, without a material change in gross sales from 1995 to 2000, the farm losses declined progressively from 1996 to 1999 and the farm earned a profit in 2000.

[26]          The Appellant is a full-time horse farmer. She has no other occupation with which farming has to compete. Her investment income is passive because she has no experience with securities and she leaves her investments in the hands of professional financial advisors. No one could say that she uses her generous investment income to pass her time in idleness. The profitability of Box Arrow Farm may have been only potential in 1995 and 1996 when the losses were in the range of $194,000 but, from 1997 to 2000 when the losses steadily declined for three years and became a profit in the fourth year, potential profit became real profit. The factor of profitability indicates that farming was the Appellant's chief source of income in 1995, 1996 and 1997. The appeals are allowed, with costs.

Signed at Ottawa, Canada, this 10th day of September, 2002.

"M.A. Mogan"

J.T.C.C.

COURT FILE NO.:                                                 2000-290(IT)G

STYLE OF CAUSE:                                               Shirley Prosser and Her Majesty the Queen

PLACE OF HEARING:                                         Ottawa, Ontario

DATE OF HEARING:                                           March 22, 2001

REASONS FOR JUDGMENT BY:      The Honourable Judge M.A. Mogan

DATE OF JUDGMENT:                                       September 10, 2002

APPEARANCES:

Counsel for the Appellant: J. Alden Christian

Counsel for the Respondent:              Roger Leclaire and Carole Benoit

COUNSEL OF RECORD:

For the Appellant:                

Name:                                J. Alden Christian

Firm:                  Doucet McBride

For the Respondent:                             Morris Rosenberg

                                                                                Deputy Attorney General of Canada

                                                                                                Ottawa, Canada

2000-290(IT)G

BETWEEN:

SHIRLEY PROSSER,

Appellant,

and

HER MAJESTY THE QUEEN,

Respondent.

Appeals heard on March 22, 2001, at Ottawa, Ontario, by

the Honourable Judge M.A. Mogan

Appearances

Counsel for the Appellant:                  J. Alden Christian

Counsel for the Respondent:                              Roger Leclaire and Carole Benoit

JUDGMENT

                The appeals from assessments of tax made under the Income Tax Act for the 1995, 1996 and 1997 taxation years are allowed, with costs, and the assessments are referred back to the Minister of National Revenue for reconsideration and reassessment on the basis that the Appellant's chief source of income in the years under appeal was farming or a combination of farming and some other source of income.

Signed at Ottawa, Canada, this 10th day of September, 2002.

"M.A. Mogan"

J.T.C.C.