Watt v. The Queen, docket 98-1223-IT-G

Date: 19991119

Docket: 98-1223-IT-G

BETWEEN:

JAMES WATT,

Appellant,

and

HER MAJESTY THE QUEEN,

Respondent.

Reasons for Judgment

Beaubier, J.T.C.C.

[1] This appeal pursuant to the General Procedure was heard at Prince Albert, Saskatchewan on October 5 and 6, 1999. The Appellant testified. The Respondent's counsel read in portions of the examination for discovery of the Appellant.

[2] The appeal is in respect to the Appellant's 1992, 1993 and 1994 taxation years. The issues are as follows:

a) whether the Appellant's chief source of income was farming, or a combination of farming and some other source of income in each of the relevant years;

b) whether for purposes of calculating capital cost allowance and investment tax credits the cost of the John Deere 8960 tractor acquired by the Appellant is limited by ss. 13(33) of the Income Tax Act to the fair market value of the transferred property;

c) whether for purposes of calculating capital cost allowance and investment tax credits the cost of the John Deere 8970 tractor acquired by the Appellant is limited by ss. 13(33) of the Income Tax Act to the fair market value of the transferred property;

d) whether the Lease Vehicle expenses incurred in 1994 are subject to the limitation provided for in s. 67.3 of the Income Tax Act and whether expenses in excess of the amounts allowed for the Leased Vehicle were:

i) Personal in nature; or

ii) Reasonable in the circumstances.

Issue d) was settled by the parties before the hearing.

[3] The Appellant graduated in dentistry in 1965 and began practising his profession in Shellbrook, Saskatchewan, a town which is 50 km. west of Prince Albert. In 1967 he moved his dental practice to Prince Albert. In 1967 he married a girl who had been raised on a nearby farm which was then being farmed by her brother and her widowed mother. The Appellant helped on their farm and financed the breaking of 200 acres on the basis that he would be repaid from the net proceeds of the 1968, 1969 and 1970 crops and the crops thereafter until he was paid in full. The couple also worked on the farm in those years cleaning the cleared land of roots and stones.

[4] In 1970 the Appellant was ill and was unable to do any work whatsoever. In 1971 and 1972 the Appellant began to look for farm land to buy. Land was fairly cheap and grain prices were beginning to increase. The Appellant and his wife incorporated Jay Bee Farms Ltd. ("JB"). It purchased farm land and farm equipment at prices and on terms as tabulated:

	Farm Land	Farm Equipment
1973	160 acres - $24,000
	This land was farmed by his brother-in-law and was paid for by July 31, 1974 from the crop, his wife's teaching and his dental income.
1974	480 acres	tractor, pull combine, ½ ton truck with grain box, discer, augers, harrows, swather, cultivator and seeder
	$60,000 for all of the above, which was borrowed from the Bank of Montreal.
1975		John Deere 4430 tractor $22,500 borrowed from Bank of Montreal
1976		Tandem Disc $6,700. (cash) Cultivator $6,700. Grain truck $15,250. Grain dryer $13,000. (All borrowed from the Bank of Montreal)
	The grain dryer loan was paid off when Mrs. Watt cashed in her teacher's pension and paid it.
1978	160 acres $55,000 Loan from Bank of Montreal which was refinanced by Cooperative Trust Co.	Packers $3,250 (cash) Grain bins $8,000 (cash) Swather $14,580 (Federal Business Development Bank loan)
1979		Flexi Coil Harrow and packer bar $13,500 (cash)
1979	The Appellant and his wife sold their home in Prince Albert and paid off the Bank of Montreal loans. The family rented a trailer, put it on the farm land and lived in it for 3 ½ years while they built an energy efficient home on the farm, which is presently valued at approximately $350,000.
1980	160 acres $85,000 Loan from Canadian Imperial Bank of Commerce Quonset package, $24,000 (cash)
1982		TR75 Combine $85,000 loan from New Holland Finance Corp.
1983		John Deere Seeder $18,000 (cash)
1985		Versatile Tractor $109,000 loan from Versatile Finance Corporation
		50 ft. Bourgault $32,500 financed by Canadian Imperial Bank of Commerce loan
		TRNH Combine $77,000*
		Combine $100,000*
		Seeder $20,000*
		* All financed by New Holland Credit
	The Appellant cashed in his RRSP's and paid off CIBC and Versatile Finance Corp. All of the "cash" consisted of loans to JB from the Appellant's dental income.

[5] On November 15, 1985 the Appellant purchased all of the farm machinery and 160 acres of farmland ("SE18") from JB. Thereafter JB's land was leased to the Appellant. The Appellant owned the equipment and had $400,000 of debt. He then became the operator. This has remained the arrangement to the present. The Appellant raises wheat, peas, canola, barley and alfalfa seed. He also breeds and sells leaf cutter bees which are used to pollinate alfalfa.

[6] Thus, on November 15, 1985 the Appellant personally assumed the debts previously incurred against land consisting of what then remained of the total sum of $200,000. The remainder of his farm debt of $400,000 had been incurred on account of equipment. He took over the going operation which he had previously managed for JB. JB was left with the remaining farmland and was free of all debt. Because of the Appellant's previous experience in managing JB and the fact that he took over a going operation, the Appellant was long past any start-up period by 1992.

[7] Paragraph 23 of the Notice of Appeal describes wheat and barley prices from 1985 through to July 31, 1994. It reads:

23. Unfortunately grain prices began to falter at this time and continued downward until 1995.

Wheat	Metric Tonne	Deductions	Per Bushel
1985-86	$146.00	27.00	3.24
1986-87	110.00	27.00	2.26
1987-88	105.00	27.00	2.13
1988-89	187.00	27.00	4.36
1989-90	161.00	27.00	3.65
1990-91	117.00	27.00	2.45
1991-92	123.00	27.00	2.62
1992-93	145.00	27.00	3.22
1993-94	143.00	41.00	2.78
1994-95	180.00	41.00	3.79

These prices must be compared with the 6.00 a bushel price when the first land was purchased.

Barley	Metric Tonne	Deductions	Per Bushel
1985-86	$110.00	26.50	1.82
1986-87	80.00	26.50	1.17
1987-88	69.00	26.50	.93
1988-89	124.00	26.50	2.12
1989-90	112.00	26.50	1.86
1990-91	90.00	26.50	1.38
1991-92	107.00	26.50	1.75
1992-93	102.00	26.50	1.64
1993-94	119.00	40.50	2.02
1994-95	101.00	26.50	1.62

These prices must be compared with the 3.30 a bushel price when the first land was purchased.

[8] Paragraph 25 of the Notice of Appeal describes the interest charges from 1986 through 1995. It reads:

25. The interest paid by the Appellant in each year divided between long term debt (mainly capital acquisitions) and short term or current debt (mainly operating expenses) were as follows:

1986 Long Term 39,533

1987 Long Term 34,248

1988 Long Term 28,642

Current 8,365

37,017

1989 Long Term 34,616

Current 6,618

41,234

1990 Long Term 41,354

Current 4,612

45,966

1991 Long Term 25,182

Current 5,468

30,570

1992 Long Term 19,646

Current 4,954

24,500

1993 Long Term 16,281

Current 3,247

19,528

1994 Long Term 21,583

1995 Long Term 26,113

[9] In 1990 JB and the Appellant resumed purchasing farmland and farm equipment as tabulated:

	Farm Land	Farm Equipment
1990		TR80 New Holland Combine $25,000 (cash) Fertilizer Bin $6,700 (cash) (Cash from dental practice loans)
1991	252 acres Purchased from mother-in-law and purchased from Farm Credit Corp) Price $130,000 140 acres Purchased from mother-in-law by the Appellant and his wife Price $50,000 (assumed loan)
1992	JB sold 98 acres Price $40,000	John Deere 8960 tractor $178,355 (for $67,000 cash and Versatile 936 trade-in and a New Holland swather) Miscellaneous Equipment for total price of $19,288
1993		John Deere 8970 Tractor $188,800 (traded in 8960 Tractor purchased in 1992 for credit of $160,250) Versatile Sprayer $5,000 Air Seeder $27,250 John Deere Sweeper $561.00

[10] In 1994 and 1995 the Appellant purchased miscellaneous equipment. In 1995 he commenced building a seed cleaning plant and grain dryer, but stopped when these reassessments began. In 1996 he purchased an adjoining 192 acres for $130,000 which he financed. In 1999 he purchased a further 120 acres from the same neighbour.

[11] The Appellant has always lost money on the farming operation after interest and capital cost allowance were deducted from his farm income. He intends to carry on the farm operation just as he always has. During the years in question he spent about 2,000 hours per year on the farm operation and about 1,500 hours per year on his dental practice. He then farmed 1298 acres and now farms 1790 acres. In 1992-94 the amount of land he farmed was almost 20% larger than average in Saskatchewan.

[12] In cross-examination the Appellant admitted that Schedule "B" to the Reply to the Notice of Appeal was correct. It reads:

Schedule "B"

Farming Income vs Other Income

Taxation Year	Gross Revenue Dentistry	Net Income Dentistry	Gross Revenue Farming	Net Income (Loss) Farming	Other Income
1987	$271,371	$118,269	$97,757	$(91,985)	$9,857
1988	293,502	119,482	89,403	(62,404)	3,107
1989	319,191	131,968	98,280	(53,409)	1,401
1990	323,690	120,339	99,686	(65,353)	4,043
1991	336,510	150,707	129,680	(47,047)	19,810
1992	338,699	135,736	92,196	(72,935)	26,379
1993	379,216	147,673	153,064	(42,345)	12,555
1994	396,488	145,252	146,306	(86,561)	13,989

[13] In The Queen v. Andrew Donnelly, 97 DTC 5499, at 5501, the Federal Court of Appeal stated that in a Section 31 case the Appellant must provide sufficient evidence to enable an estimate quantitatively of what his profit might have been had his year turned out as he planned. The Appellant gave evidence of his estimated profit from farming during the years in question on a calendar year (his tax year) basis. These estimates did not include his leaf cutter bee breeding and sales operation or his alfalfa seed sales operation. Nor did they allow for the deduction of interest charges or capital cost allowance.

[14] The figures are:

	1992	1993	1994
		(low	projections)
Planned income	$168,000.	$96,000	$175,000
Planned expenses	96,800	73,000	108,500
Planned profit	$71,000	$23,000	$66,500
Planned profit on high projections		$28,500	$321,000
Actual profit or (loss)	($31,000)	$51,860	($27,000)

In the same years his net reported income from bees and alfalfa seed was:

	1992	1993	1994
Bees	Nil	$4,425
Alfalfa seed	Nil	(400)
"Other commodities" (gross)	Nil		$9,360
Low Projection Totals	($31,000)	$55,885	($17,640)

[15] From these low projection totals, interest and capital cost allowance must be deducted on the basis that the Appellant did during these years. (The Appellant deducted "real estate" interest in some years which is shown).

	1992	1993	1994
Low Projection Totals	($31,000)	$55,885	($17,640)
Less:
Interest - Real Estate	(19,646)	(16,281)
- Other	(4,954)	(3,247)	(21,583)
Capital Cost Allowance	(40,966)	(46,062)	(39,499)

Income or (Losses) Based on projections	($96,566)	$9,705	($78,622)
Farming losses admitted to in Schedule "B"	($72,935)	($42,345)	($86,561)
Reported after adjustment	($72,935)	($36,994)	($76,589)

[16] The causes of failure which the Appellant testified to respecting each year were set out in the following paragraphs of his Notice of Appeal:

1992

40. In 1992 the region in which the Appellant's lands are situate experienced very little precipitation leading to below average growth. On August 21^st frost hit the area causing severe crop damage arising from reduced yields and poor grades. The Appellant, in planning his 1992 operation, using average yields and grades as well as current prices look forward to achieving a profit of $68,000.00, however, the Acts of God turned all the farms of the area into a loss position in this year.

1993

41. In 1993 the Appellant removed 500 acres from production in order to cope with couch grass and thistle problems in lands purchased by him. Since the Appellant had been cropping 1000 to 1100 acres in prior years the removal of 500 acres from production cut his operation in half. The acres removed from production were summerfallowed after spraying with Roundup in the spring. The land was again sprayed with Roundup in the fall. Removal from production for the year was dictated by conditions which would only have become much worse if not dealt with and the summerfallowing rested the land for the 1994 crop.

42. The taking of the acres out of production was, of course, a planned action, however, in 1993 problems not foreseen occurred. The Appellant seeded 300 acres to peas. Unfortunately harvest, due to weather, was late and the peas when swathed were required to lay in the swath for an unduly long period to get to the stage where they could be combined and geese were attracted to the crop. The Appellant borrowed and maintained 5 goose canons (propane timed explosives) and operated same for weeks. The Appellant realized $11,553.00 from Ducks Unlimited as 35% of the damage suffered but had to bear the balance of the damage approximating $30,000.00. The Appellant seeded 285 acres to barley and had the good fortune that on 200 acres the crop went to 100 bushels per acre and was accepted for malt. There was no call for malt barley until May of 1994 so there was no revenue therefrom in 1993.

1994

43. In 1994 the Appellant had 500 acres of summerfallowed land to seed and seeded it to canola. There was an abundance of early season rain resulting in good growth, however, the plants not needing to send down deep roots had only surface roots and when hot dry weather arrived in August at the head filling stage, the seed fried resulting in small kernels and a crop about one-half of average. Instead of 40 to 45 bushels to the acre the harvest realized below 20 bushels. The 1994 barley crop realized 50 to 55 bushels per acre. The barley was again of malt quality, however, because Bonanza and Robust barleys were mixed the barley had to be sold for feed. The Appellant had looked for 18,000 bushels of canola at $8.00 per bushel, 200 acres of malt barley at 90 bushels to the acre and $3.50 a bushel, and 350 acres of peas at 50 bushels to the acre and $6.00 per bushel price, all of which would have realized a $321,000.00 crop and such would have been achieved with timely August rain.

[17] Respecting these reasons for failure, by year, the Court finds:

1992 A frost in late August in Saskatchewan is not unusual and will happen from time to time.

1993 The couch grass problem was foreseeable, and the expenses incurred were for long term income. The goose problem, or something like it, will occur from time to time over the years, since the land is adjacent to the North Saskatchewan River. It resulted in a $30,000 loss.

1994 The canola problem was due to the happenstance of farming. The barley problem was an accident in that year which is unlikely to happen again.

[18] Thus, the 1992 problem was a normal occurrence from time to time. The 1993 loss was quantified at $30,000. The 1994 occurrences might or might not have happened; however the Appellant's high forecast of $322,000 was wildly optimistic. The result is that the Appellant's explanations describe variations which can occur from time to time in farming in northern Saskatchewan. If the $30,000 loss is removed from 1993, the Appellant still suffered a loss of $12,345.

[19] More important is the fact that the losses have continued from 1986 to date with no change in the operation or in the Appellant's farming practises. Rather, the Appellant has enlarged the operation and, correspondingly, the losses. In cross-examination the Appellant admitted that he expected his dental income to pay the interest on his farm loans. He also admitted that, except for his optimism for 1994, he expected that the bulk of his income during these years would be from dentistry.

[20] The quantitative estimates of Dr. Watt for 1992, 1993 and 1994, taken at their realistic levels, would have yielded a loss of $96,566, income of $9,705 and a loss of $78,622 respectively. In fact, every year resulted in a reported loss in excess of $40,000. Moreover, Dr. Watt admitted in cross-examination that he relied on his dental income to pay the interest charges he incurred in his farming operations. Finally, these interest charges were planned for deduction from his dental income as a policy when he took over all of the farm debt in 1985. Until 1992 the Minister of National Revenue allowed this to occur.

[21] The single profit projected for 1993 of $9,705 is insignificant in relation to the Appellant's investment in farming and in relation to constant large farming losses and a constant six figure dental income. Moreover, the Appellant admitted that due to crop year sales and calendar year projections, the projected figures by calendar year were not realistic from a practical point of view. His factual losses bear out this admission. On the evidence, farming was not the Appellant's chief source of income in 1992, 1993 or 1994. Nor was his chief source of income a combination of the two. Quantitatively, the Appellant could not expect a profit from farming during the years in question. In part this was because of his constant capital expenditures with resulting interest expenses. These capital expenditures occurred because the Appellant kept on buying equipment and increasing the size of his farming operation in the face of a history of constant gigantic losses. That is not the practice of a reasonable businessman.

[22] While the Appellant testified that he personally spent more time farming than practising dentistry during the years in question, the fact is that his dental practice's gross income increased constantly during 1992, 1993 and 1994. The evidence indicates that he continued his occupational patterns in the same way as in the past and that dentistry predominated as his occupation. Moreover, the evidence does not indicate that in 1992, 1993 and 1994 he could anticipate an income from farming. In spite of this his personal capital investment in the farming operation (excluding his home) was about $1.3 million or 13 times his investment in his dental practice, and it continued to grow after 1994. The farming operation was subordinate to his dental practice. He relied on his dental income to support his family, to pay the interest on his farm debt and to make capital purchases for the farm. Moreover, dentistry remained the central focus of his occupational life; it provided him with his income, he expanded his practice and diverged it into preventative dentistry where the market was going, and he was active in his dental professional organization. In contrast, he continued to operate the grain farm without major change and to enlarge his investment in it despite continuing losses. There is no evidence that he was active in farm organizations.

[23] Thus the appeal is dismissed in respect to issue (a). In 1992, 1993 and 1994 the Appellant's chief source of income was neither farming nor a combination of farming and some other source of income.

[24] With respect to issues (b) and (c), subsection 13(33) of the Income Tax Act reads:

For greater certainty, where a person acquires a depreciable property for consideration that can reasonably be considered to include a transfer of property, the portion of the cost to the person of the depreciable property attributable to the transfer shall not exceed the fair market value of the transferred property.

This subsection applies after November, 1992. Thus, the trade-ins described in assumptions 18(k) and (n) are the subject matters of these issues. Assumptions 18(i) to (n) inclusive read:

i) On December 28, 1992 the Appellant paid $67,000.00 and transferred a 1985 Versatile tractor 936 serial number 227132 to acquire a John Deere 8960 tractor serial number 004325 from Long Tractor Inc.;

j) The Appellant and Long Tractor Inc. signed a written contract for the transaction described in subparagraph i) above that specified a list price and total cash price of $178,355.00 for the John Deere 8960 tractor and a total allowance for the 1985 Versatile tractor 936 of $111,355.00;

k) The fair market value of the 1985 Versatile tractor 936 transferred as and when described in subparagraph i) above was $60,459.00;

l) On October 15, 1993 the Appellant paid $25,000.00 and transferred a John Deere 8960 tractor serial number 004325 to acquire a John Deere 8970 tractor serial number 002026 from Long Tractor Inc.;

m) The Appellant and Long Tractor Inc. signed a written contract for the transaction described in subparagraph l) above that specified a list price and total cash price of $188,800.00 for the John Deere 8970 tractor and a total allowance for the John Deere 8960 tractor of $175,300.00;

n) The fair market value of the John Deere 8960 tractor transferred as and when described in subparagraph l) above was $111,176.00;

[25] The Appellant did not call expert evidence respecting the trade-ins. Rather he relied on his own testimony and the fact that he dealt with a licensed farm implement dealer on the purchases and trades. It is well known that a sale and trade-in for that sale may not reflect fair market value. Often the cash difference is the only indicator of any relative value. But in these times of financing and leases, even that may not reflect fair market value.

[26] Without the testimony of a qualified expert as to the value of the trade-ins, the assumptions of the Minister are not refuted. Therefore, the appeals respecting issues (b) and (c) are dismissed.

[27] At the conclusion of his oral argument, Appellant's counsel raised an alternate ground that the deduction of the portions of the Appellant's farm losses claimed relating to interest and capital cost allowance may nonetheless be deducted from the Appellant's dental income on the basis that Sections 18 and 20 of the Income Tax Act do not require that these items be tied to a source. This ground of argument is rejected on the basis of the maxim expressio unius est exclusio alterius for two reasons:

(1) Section 31 is a particular section with particular application in the Income Tax Act.

(2) In support of (1) above, subsection 9(2) of the Income Tax Act provides for the calculation of business or property losses "subject to Section 31."

[28] The appeal is dismissed in its entirety. The Respondent is awarded party and party costs.

Signed at Ottawa, Canada this 19^th day of November 1999

"D.W. Beaubier"

J.T.C.C.