Cormack v. The Queen, docket 98-2531-IT-I (Informal Procedure)

Date: 19991014

Docket: 98-2531-IT-I

BETWEEN:

WILLIAM L. CORMACK,

Appellant,

and

HER MAJESTY THE QUEEN,

Respondent.

Reasons for Judgment

O'Connor, J.T.C.C.

[1] These appeals were heard at Calgary, Alberta on August 27, 1999 pursuant to the Informal Procedure of this Court.

[2] The issue in these appeals is whether the Appellant's farm losses in the years 1993, 1994 and 1995 are fully deductible or, as contended by the Minister of National Revenue ("Minister"), limited to the amounts provided for in section 31 of the Income Tax Act.

Facts

[3] I find the principal facts to be as follows:

1. During the relevant years the Appellant was employed by Nova Corporation ("Nova") as a Loss Prevention Technician (Fire-fighter/Emergency Medical Technician) at Nova's Joffre, Alberta plant which is located approximately 30 minutes from the second farm described below.

2. The Appellant acquired an original farm at the end of 1988 at a cost of $196,800. That farm comprised two quarters and the Appellant built a house thereon in 1989 at a cost of approximately $105,000. In 1993 the Appellant swapped with the Hutterite Brethren Church the said original farm for a larger farm. This second farm ("farm") comprised 320 acres. 280 acres were cultivated for grain and cash crop production, 30 acres were used for the Appellant's cow/calf operation and to graze Boer Goats, 5 acres were leased to an oil company and 5 acres were devoted to the farm buildings and 30 acres was pasture. The Appellant moved the residence that he had constructed on the original farm to the larger farm. The Appellant and his wife reside in the said residence. The farm is located near Innisfail, Alberta.

3. The Appellant, in addition to the costs mentioned above, purchased numerous items of farm equipment, improved the farm buildings and constructed a shed and installed fencing. The value at the present time of the farm assets, including land, buildings, livestock and inventory is approximately $700,000 and the outstanding debts related to the farm amount to $197,505.

4. In 1989 the operation consisted of producing wheat, barley and a variety of cash crops such as canola and field peas. In 1991 the Appellant purchased an existing cow herd and since that time has engaged in a cow/calf operation. Further, in 1994 he commenced a Boer Goat operation. To better understand the Boer Goat operation, it is useful to quote from the expert opinion of Ann Marie Hauck, filed as Exhibit A-21 which was supported and supplemented by her verbal testimony.

History

The production of Boer Goats is a relatively new phenomena, starting in Africa. In 1992, the South African Boer Goat was introduced to the New Zealand market and it was introduced into the North American market in April 1993.

In the early period, the market was quite radical due to the heavy influence of urban farmer speculators. As an example, in the spring of 1994, we saw the market for Boer Goats soar from $10,000 (US) per head to an all-time high of $250,000 (US) for a buck in the fall of 1994 ... The market fell drastically during the fall of 1995, with quality does selling for less than $4,000 per head, with lower quality does falling to near goat meat value only. This fall in the market initiated the exit of investor speculators and the market continued to slide until the fall of 1997.

The market has gained strength and stability since the fall of 1997. Due to international protocols and, to some extent, the political wisdom of Agriculture Canada, Canadian producers have a market position and reputation as being a strong source of quality Boer livestock and germ plasma. Boer Goat stud breeding farms in Canada will have sales in Canada, but will need to access international markets to obtain any kind of significant sales volumes.

...

Boer Goat Production

To properly understand the start-up period for a Boer Goat operation, it is important to understand how Boer Goat production is carried on.

As indicated above, the production of Boer Goats is relatively new to the North American market. In 1994, the price of purchasing Boer Goat bucks was so prohibitive, (very limited availability and high priced) that many breeders would begin production by purchasing South African Boer Goat embryo. The embryo is a six and one-half day old fertilized egg. The production process involves transplanting the embryo into a common domestic goat (the "'Recipient") and the offspring will be a South African purebred Boer Goat. The Recipient acts as a surrogate mother and has no genetic input into the fetus. ...

...

The purebred Boer Goat may also be bred with a domestic goat with a view of creating Canadian purebred Boer Goats. This process involves breeding a South African purebred Boer Goat with a domestic goat. The offspring will be considered a half-breed Boer Goat. If the offspring is a male, it will be kept for a period of approximately six months to one year and sold for meat value. If the offspring is a female, it will be bred back with a South African purebred Boer Goat with a view of increasing the purebred Boer Goat bloodlines over time.

This process is repeated whereby the offspring of the half-bred Boer Goat is bred with a South African purebred Boer Goat, thereby creating offspring that is three-quarter purebred Boer Goat. This process is repeated and after four years, the Boer Goat doe is considered to be a Canadian purebred Boer Goat and receives papers authenticating its status from the Canadian Boer Goat Association. After five years, a buck that is produced using this process is considered a Canadian purebred Boer buck and receives papers authenticating its status.

After this point in time, a Canadian Boer buck may be bred with a Canadian Boer doe and their offspring are considered Full Canadian Boers.

...

Boer Goat/Goat Meat Production and/or Industry Facts

The goat meat industry is characterized as follows:

·          goat meat is consumed 7 times more in the world than beef

·          90% of the countries in the world are net importers

·          New Zealand and Australia are the only two continuous net goat meat export countries

·         

...

Boer Goat Operations in Canada - Western Canada/Start Up

A typical Boer goat breeding stock production farm in Western Canada requires three principal items:

1.         A strong business plan;

2.         $100,000 capital investment;

3.         Close attention to marketing and the economics of production.

To develop a successful stud-breeding farm in Canada, a producer will need to address international market access in their business plan. They will require a capital investment of approximately $100,000 for basic seedstock and some fortitude to stay with their plan until they have developed not only the product for the market but also the market access and a reputation.

Once the basic stud herd has been developed and the initial market channels have been established, provided the producer pays attention to its production and provides a quality product with some after sales support and integrity, a reasonable level of profitability can be expected. This level of profitability is directly related to production and marketing abilities.

William Cormack has demonstrated both strong production and marketing abilities as seen in his client base and the export sales he has completed and given his reputation in the marketplace.

On average, a South African purebred Boer Goat operation can start showing significant profits after three to five years, but it is expected that you will require five years to develop a significant quality Boer Goat livestock inventory. The time difference here being directly related to the breeding program (embryo transfer compared to natural breeding programs or a combination thereof). In addition, to develop a Canadian Boer Goat operation, it will take, on average, five years using breed-up programs before significant profits can be expected from a Canadian Boer Goat operation.

Mr. Cormack faced and survived the major price corrections the industry experienced in 1994 through to 1996. A party entering the industry in 1994, with knowledge of the expected prices received or expected to be received at that time would have likely been significantly profitable in one year. The rapid decline of Boer Goat prices likely extended this period before significant profits can be expected to five years, assuming a 1994 startup year.

[4] The Appellant has derived income from both farming and his Nova employment as follows:

YEAR	EMPLOYMENT INCOME	GROSS FARM INCOME	EXPENSES	CCA CLAIMED*	NET FARM INC. (LOSS)
1989	$65771	$27275	43157	$ 7359	$(15882)
1990	67421	26178	81963	0	(55785)
1991	63553	89930	108585	16080	(19655)
1992	68250	69611	113546	17661	(43935)
1993	66256	79315	90949	16998	(11634)
1994	70084	148199**	176350	15627	(28151)
1995	68612	152000***	179544	13965	(27544)
1996	69146	137380****	223916	10899	(86536)
1997	72198	130279*****	166412	20779	(35362)

* CCA claimed is also included in net farm income(loss)

** includes mandatory inventory adjustment of $73040.00

*** includes mandatory and optional inventory adjustments of $78576.22

**** includes mandatory inventory adjustment of $24000

***** includes mandatory inventory adjustment of $10601

The above figures have been taken from the Notice of Appeal and the Reply. They, in some cases, vary from the Appellant's returns but the differences are insignifcant.

[5] The Appellant's hours of work at Nova are based on a five week cycle:

week 1 4 – 12 hour nights

week 2 3 – 12 hour days, plus 2 – 12 hour nights

week 3 3 – 12 hour days plus 1 – 12 hour night

week 4 off, except for 1 – 12 hour day

week 5 4 – 8 hour training days but the Appellant only had one

training day and was off 6 days

The Appellant also coordinated his annual vacation to coincide with busy periods on the farm and was able to rotate shifts and take other time off to attend to farm tasks.

[6] The Appellant devotes over 40 hours per week attending to farm work in addition to his time working for Nova. During his off weeks he estimates the time devoted to farming is closer to 60 hours per week. He spent more hours on farm work than at Nova.

[7] The Appellant grew up on a farm in Saskatchewan helping his father with both grain and cattle production. From his early teens until the age of 18, he would spend several hours each day farming. He worked for neighbouring farms as a teenager, and essentially managed a neighbour's grain farm when he was 18 years old. The Appellant eventually left the farm to join the Navy. Since leaving the service, he has worked primarily as a firefighter.

[8] The Appellant financed much of the expenses he incurred in acquiring the farm, improving same and purchasing livestock, feed and equipment by means of bank loans. As appears from Exhibit A-9 the bank loans totalled $227,424 and had been paid down by $29,918 for a balance of $197,505 as of August, 1999.

Submissions

[9] Counsel for the Appellant submits that during the relevant years the Appellant's primary source of income was farming or a combination of farming and some other source, namely his employment income which was used to acquire farm assets and pay down loans. Therefore the Appellant's losses should not be restricted. He points to the three basic factors of capital employed, time spent, and profitability, both actual and potential.

[10] The Respondent points to the continued losses since inception and concludes that the farming operation is not the chief source of income considered alone or in combination and that the Appellant should be restricted to the loss limits provided for in section 31 of the Act.

Analysis and Decision

[11] The leading case on the questions raised in these appeals is the Supreme Court decision in Moldowan v. The Queen, 77 DTC 5213. It is useful to quote Dickson J. at page 5215 et seq in commenting on subsection 13(1) (now section 31):

The next thing to observe with respect to s. 13(1) is that it comes into play only when the taxpayer has had a farming loss for the year. That being so, it may seem strange that the section should speak of farming as the taxpayer's chief source of income for the taxation year; if in a taxation year the taxpayer suffers a loss on his farming operations it is manifest that farming would not make any contribution to the taxpayer's income in that year. On a literal reading of the section, no taxpayer could ever claim more than the maximum $5,000 deduction which the section contemplates; the only way in which the section can have meaning is to place emphasis on the words 'source of income'.

Although originally disputed, it is now accepted 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: Dorfman v. M.N.R. [72 DTC 6131], [1972] C.T.C. 151. ...

There is a vast case literature on what reasonable expectation of profit means and it is by no means entirely consistent. In my view, whether a taxpayer has a reasonable expectation of profit is an objective determination to be made from all of the facts. The following criteria should be considered: the profit and loss experience in past years, the taxpayer's training, the taxpayer's intended course of action, the capability of the venture as capitalized to show a profit after charging capital cost allowance. The list is not intended to be exhaustive. The factors will differ with the nature and extent of the undertaking: The Queen v. Matthews (1974), 28 DTC 6193. ...

Whether a source of income is a taxpayer's `chief source' of income is both a relative and objective test. It is decidedly not a pure quantum measurement. A man who has farmed all of his life does not cease to have his chief source of income from farming because he unexpectedly wins a lottery. The distinguishing features of `chief source' are the taxpayer's reasonable expectation of income from his various revenue sources and his ordinary mode and habit of work. These may be tested by considering, inter alia in relation to a source of income, the time spent, the capital committed, the profitability both actual and potential. A change in the taxpayer's mode and habit of work or reasonable expectations may signify a change in the chief source, but that is a question of fact in the circumstances.

...

In my opinion, the Income Tax Act as a whole envisages three classes of farmers:

(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 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.

(3) the taxpayer who does not look to farming, or to farming and some subordinate source of income, for his livelihood and who carried 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 reference in s. 13(1) to a taxpayer whose source of income is a combination of farming and some other source of income is a 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 section provides that these subsidiary interests will not replace the taxpayer in class (2) and thereby limit the deductibility of any loss which may be suffered to $5,000. 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. A man who has farmed all of his life does not become disentitled to class (1) classification simply because he comes into an inheritance. On the other hand, 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.

[12] The principal criteria set out by the Supreme Court in Moldowan in relation to a chief source of income are therefore:

(i) time spent;

(ii) capital committed;

(iii) the profitability both actual and potential.

These, as noted, are not the only criteria, because the Supreme Court clearly indicated that they are "inter alia". Before analyzing these criteria I must say that I accept absolutely the credibility of the Appellant and the expert witness.

Time Spent

I have little difficulty in concluding that the Appellant satisfied this criterion. The evidence reveals that he spent considerable time in the farm operations and that his rotation work schedule at Nova facilitated this. Moreover, he lived with his wife in the residence on the farm.

Capital Committed

Once again I have little difficulty in concluding that the Appellant meets this criteria. Extensive amounts of money were invested in the acquisition of the farm, the construction of the house, fences and other farm structures and the acquisition of equipment and livestock. Farming was clearly not a hobby.

[13] I adopt, with approval, the analysis of Joyal, J. in Hadley v. The Queen, 85 DTC 5058 at pages 5063-4:

I also find in the considerations and factors outlined in the Moldowan case that they do not need all to be of equal value. Their individual importance depends on all the circumstances of an individual case. One such factor which might predominate over the others is the amount of capital the Plaintiff committed to his farming venture. If the Plaintiff argues new direction, new orientation, or new commitments to bring himself within the first category defined in the Moldowan case, the quantum element alone of his capital investment provides the Plaintiff with pretty good credibility. It gives force to the several arguments advanced by the Plaintiff's Counsel and overcomes the incredulity which an ex post facto analysis of actual performance attracts to the case.

The findings I have made with respect to the Plaintiff's farming operations must be viewed within the framework of intentions and expectations. While it is true that the operations, as financially unsuccessful as they were, might indicate prima facie that the Plaintiff should come within the second category of `sideline' operators as articulated by Dickson, J. in the Moldowan case, the Plaintiff's intentions and expectations are, in my view, material to the conclusions I have drawn. To a great extent, in reviewing past history, a trier of facts must adopt something akin to an armchair approach as that expression is used in the interpretation of testamentary instruments. The intentions and expectations must be analyzed in the light of the taxpayer's activities and of the economic situation relating to beef farming which existed at that time.

...

Furthermore, as I have found earlier in these reasons, the Plaintiff is not the type of person who would gladly risk a million dollars in an operation on the simple expectation that in the event of losses, half of them would be absorbed by deductions from his other income.

...

It is my view therefore that the conclusion I have reached is on the basis of a factual situation which has unique and distinguishing features. Numerous precedents cited to me by Counsel on both sides might be relevant or persuasive but I would doubt that any one of them would be conclusive. I prefer to be guided by the principles enunciated in the Moldowan decision. I think that my conclusion is in conformity with these principles and in keeping with the legislative intent of section 31.

Inter AliaCriteria

[14] The farm is large and the Appellant has attempted to improve the profitability picture by starting up the cow/calf operation in 1991 and the Boer Goat operation in 1994. The Appellant has a farming background. He researched and consulted others. He formulated a plan.

Profitability - Actual or Potential

[15] The farm has never shown a profit. The question becomes therefore, was there a reasonable expectation of profit? There is ample authority to the effect that in assessing pursuant to section 31 of the Act, the Respondent is tacitly admitting that the Appellant was operating a business and not indulging in a mere hobby but the question remains, was there a reasonable expectation of profit? Sales, i.e., gross income, have improved. Although losses are continuing, according to the expert's report of the Boer Goat operation, after a reasonable start-up period it should be profitable.

Start-up costs

[16] Concerning the start-up costs, it was held in Moldowan, supra, that the permissible amount to be deducted depends on the class the taxpayer finds himself in. Dickson, J. stated referring to the class (1) farmer at p. 5216:

On the other hand, 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.

Start-up costs are considered over an extended period of time if evidence is accepted that the farm operation eventually will provide the Appellant with the bulk of his income, that is, the commitment of time and capital, the expectation of profit and the change in business direction are such that a favourable comparison over time can be made to the other source of income (Hover, supra and The Queen v. Poirier, 92 DTC 6335).

Combinations of Income as a Chief Source of Income

[17] Bowman, J. in Hover, supra, (pp. 107-108) commented on sources of income as follows:

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.

Given the amount of income that the dental practice produced and the amount of cash it contributed to the farming operation it cannot be described as either subordinate to farming, in terms of the revenue that it produced, or a sideline business. It was an essential adjunct and complement to the farming operation. Without it the farming operation could not have been commenced nor could the substantial capital expenditures and start-up costs have been incurred. In this sense it formed an integral part of the combination. While I am of course bound to follow the principles enunciated by Dickson, J., I must attempt to apply them to the facts before me and I must conclude, if I am to give effect to the word "combination", that by "subordinate" he intended to include a source of income that although substantial is integral to the very existence of the farming operation.

And at page 110:

I have therefore concluded on the evidence that the appellant's chief source of income was a combination of farming and dentistry and that section 31 does not apply to the determination of his income for the 1984, 1985 and 1986 taxation years.

In so deciding, Bowman, J. held that an interrelation existed between the two sources that permitted the combination. The interrelation was a provision of financing from dentistry to farming in the sense that the other business formed an integral part of the combination. I have come to the same conclusion in this case.

[18] One of the cases referred to by counsel for the Respondent was Young v. R., a 1999 decision of Mogan, T.C.C.J. 1999 Carswell Nat. 12. In that decision the Court gave little weight to the investment of capital on the basis that an employee does not as such invest capital in his employment position and consequently the comparison between capital invested in the two sources of income was not important. I do not agree with that analysis. I see nothing in the Moldowan decision or in Hover or the other relevant cases that leads to the conclusion that a comparison is required as to where the capital is invested. I believe one should simply look at the capital invested in the farm operation as one of the elements to determine the intention of the taxpayer as to the farming operation and as to the possibility of making a profit therefrom. The fact situation in these appeals differs from the common situation where considerable capital is invested in race horses but the owner has very little involvement in the horse operation.

[19] In conclusion, in my opinion, the criteria to establish a chief source of income as being farming or a combination of farming and another source of income have been met. Section 31 was not applicable to the Appellant and the Appellant is entitled to the total of the farming losses claimed for the three years in question. Thus, the appeals are allowed, with costs, and the matter is referred back to the Minister for reconsideration and reassessment on the foregoing basis.

Signed at Ottawa, Canada this 14th day of October 1999

"T.P. O'Connor"

J.T.C.C.