Louise Desmarais v. Minister of National Revenue, [1991] 1 CTC 2169, 91 DTC 495

Dussault, T.C.J.:—This is an appeal from new assessments by the respondent according to which the Minister of National Revenue disallowed the deduction for the 1984, 1985 and 1986 taxation years of all the farm losses claimed by the appellant for the said years. In her tax returns for the years in question, the appellant claimed deductions for farm losses of $6,606, $11,502 and $12,190, respectively. The respondent disallowed the deduction of these losses on the ground that Mrs. Desmarais did not during those years operate a farming business with a reasonable expectation of profit and that the expenses incurred therefore constituted personal or living expenses within the meaning of subsection 248(1) of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the "Act").

Summary of the Facts

In March 1984, the appellant and her husband, Serge Desmarais, jointly purchased approximately 128 acres of land located partly in the town of Chambly and partly in the town of Carignan; the two locations are separated by the Chambly Canal. The land consists of 75 acres suitable for cultivation but abandoned, five acres of ditches, 20 acres of brush, 20 acres of forest and, lastly, eight acres surrounding the residence and a few other buildings in the part located in the town of Carignan. The appellant and her husband paid $115,000 for the property and jointly borrowed $114,150, part of which was to be spent on renovating the residence, from the Bank of Montreal. The proposed renovations were to cost $39,000 and according to the deed of loan the value of the residence was to rise to $81,800 after they were completed. As for the land itself, a document prepared by an agronomist of the Bank of Montreal gave it a value of $76,000 for the purposes of the portion of the loan qualifying as a farm loan.

The appellant, who is a radiologist by profession, has not worked outside the home since 1977 because of the birth of three children. Although she has no farming experience, she says that she had always dreamed of living in the country. She owns a residential building on De Normanville Street in Montreal, and the Desmarais family lived in one of its residences before moving to the country. The appellant draws rental income from this building and wants to deduct her farm losses from that income.

Although she claims to be the sole owner of the farm business and is claiming only the losses suffered during the years in question, Mrs. Desmarais appears to be relying mainly on her husband's financial advice and actions, although his farming experience has proven to be nearly non-existent and is limited to experience related to the ownership of woodlots in the Eastern Townships.

In 1984, Serge Desmarais, the appellant's husband, transferred to her a tractor, a trailer and some other equipment, including a brush cutter, a plough, a chain saw and a wood splitter he had formerly used on a wood lot he owns at Ste-Sophie in the Eastern Townships. The appellant purchased no other equipment during the years in question.

In 1984, no, or little, work was carried out on the land, at least with respect to the portion suitable for cultivation, aside from removing rocks and fall ploughing. At that time, the Desmarais family appears to have been more concerned with renovating the house and cleaning up the adjacent land—i.e., the non-agricultural portion of the property—which is described as a former garbage dump.

In 1985, it appears that stress was again placed on cleaning up the property, which consisted of removing rocks and garbage and demolishing old buildings: a barn and a henhouse. Some vibrator tilling was carried out on the cultivable portion of the land in the spring with the help of a neighbour who owned the necessary machinery and, after he died, with his son's help. Together with those neighbours, they planted buckwheat with an agreement to share the profits from the harvest, but there was neither a profit nor even any gross income because, it appears, of a serious soil drainage problem: the water drained off poorly and the land was saturated with water, which made it impossible even to use the machinery. Later, they had fall ploughing carried out. The total cost of the work for a lump sum was $1,350. During 1985, they also had third parties carry out mechanized work to clean up 300 metres of ditches for a total cost of $750.

In 1986, a drainage plan was drawn up for $716 and drains were purchased for $105. They had mechanized work carried out to clean ditches for a total amount of $2,555.76.

The evidence also shows that no gross income was generated during the 1984, 1985 and 1986 taxation years, and that the losses for which the appellant claims a deduction were mainly due to the high cost of interest on the farm loan: $4,026.62 for 1984, $6,872.22 for 1985 and $5.978.06 for 1986.

The appellant and her husband, both of whom testified, reported that more extensive work was carried out during subsequent taxation years in order to correct the soil drainage problem with more suitable surface drainage, to weed it and, lastly, to fertilize it adequately for more profitable crops. The appellant claims to have incurred total expenses of some $24,000 for this purpose between 1984 and 1989 and to have received subsidies from the Ministère de l'Agriculture totalling some $4,800.

In 1987, buckwheat was planted once again before they passed to two crops in 1988: a crop of spring wheat was harvested in August 1988 while a crop of winter wheat was harvested in 1989. Nothing was planted in 1989. During those years, the appellant's farm income consisted of proceeds from sales, compensation payments from crop insurance and stabilization insurance programs, and subsidies. Only the 1989 taxation year showed a profit: it was the year during which no crop was planted and the winter wheat planted in 1988 was harvested. While the 1988 harvest appears to have been severely affected by drought, that of 1989 was ruined extensively by frost.

Following two meetings with the appellant in April and September 1987, Ghislaine Lavoie, an officer of the Department of National Revenue, notified Mrs. Desmarais in a letter dated October 22, 1987, that she intended to disallow the deduction of farm losses claimed for 1984, 1985 and 1986 because, after having considered all factors and circumstances surrounding the farming activity, she felt that it did not offer a reasonable expectation of profit. According to Mrs. Lavoie's testimony, this conclusion was also justified by the lack of a development plan or even of specific plans as to the type of crop to be planted in 1987 (meeting of April 1987) or even in 1988 (meeting of September 1987) along with the appellant's minimal activities on her land. Similarly, the appellant's claims concerning the possible sale of her 1987 buckwheat crop to the Mouvement pour l’agriculture biologique appeared to be unrealistic in the light of the certification required and the need for the crop to be tracked by an inspector, which, moreover, proved subsequently not to have been done. Mrs. Lavoie's conclusions appear to have be confirmed by the mention, in an insurance policy on the property, that the farm was not operated in 1984 and 1985.

We should mention that it was not until 1988 that an agronomist—Mr. Laflamme, who also testified—carried out a soil analysis and made his recommendations. Prior to that intervention, which occurred at Mrs. Desmarais' request, Albert Laflamme said that he had had contacts with Mr. Desmarais, the appellant's husband, whom he then described as a "farmer by circumstance", which means in substance a person who owns land that he attends to only occasionally without much consultation and for whom the important aspect is more the fact of living in the country.

Analysis

The appellant's farming activities seem to have become more extensive beginning in 1988 (following the audit carried out by Ghislaine Lavoie of the Department of National Revenue). I will repeat that the taxation years in question here are 1984, 1985 and 1986, however. The appellant must prove, by a preponderance as is necessary, that during those years she operated a farm business with a reasonable expectation of profit. That evidence is necessary in order to prove whether the losses she suffered during the years in question are deductible or, on the contrary, must be considered to have been personal or living expenses.

Many decisions have been rendered on this question since the classic judgment of the Supreme Court of Canada in Moldowan v. The Queen, [1978] 1 S.C.R. 480; [1977] C.T.C. 310; 77 D.T.C. 5213 which laid down the principles of analysis.

Rip, T.C.J. presented a very good summary of the state of the law on the question in Taillefer v. M.N.R., [1987] 2 C.T.C. 2137; 87 D.T.C. 418. In this respect, I will now refer to an extract from the judgment, in which the following is written on pages 2140-42 (D.T.C. 420-21) under the heading "Reasonable Expectation of Profit”:

The important ingredient distinguishing one class of farmer from another is the source of his income. If the chief source is farming or farming combined with something else, then the taxpayer is a class (1) farmer; if farming is only a secondary source of income the taxpayer is a class (2) farmer; if farming is not a source of income, the taxpayer is a class (3) farmer.

The Supreme Court of Canada confirmed that because subsection 13(1) comes into play only when a taxpayer's farming activities have incurred a loss for a taxation year, one must place emphasis on the words “source of income” to determine the meaning of the subsection. The Court acknowledged that" in order to have a 'source of income’ the taxpayer must have a profit or a reasonable expectation of profit" (Moldowan, op cit, page 313; D.T.C. 5215).

One must look first at the taxpayer's farm activities to find whether he has a reasonable expectation of profit from farming and thus carries on the business of farming. Both class (1) and class (2) farmers carry on the business of farming.

To determine whether a taxpayer has a reasonable expectation of profit is an objective determination to be based on all the surrounding facts. Mr. Justice Dickson suggested the following criteria as a guideline, but stated that the list is not exhaustive and factors would differ with the nature and extent of the undertaking: profit and loss experience in past years, the taxpayer's training, that taxpayer's intended course of action, and the capability of the venture as capitalized to snow a profit after deducting capital cost allowance (Moldowan, op cit, page 314; D.T.C. 5215). One of these criteria may predominate over the others and the weight to be given to any criterion will depend on all the circumstances of an individual case: Hadley v. The Queen,[1985] 1 C.T.C. 62 at 68; 85 D.T.C. 5058 at 5063.

Where the farming activities have never shown a profit the Court must decide whether the undertaking is susceptible of profit, if the losses were reasonable in view of the income produced and whether the taxpayer did what would be necessary to show a profit. A profit in a future year from activities identical to those undertaken in the years under appeal is relevant in determining its profitability.

Also relevant in determining whether a taxpayer has a reasonable expectation of profit is the activity itself: a farmer who purchases a productive going operation will in all likelihood achieve profit before a man who begins the business of growing trees on raw land: The Queen v. Matthews, [1974] C.T.C. 230; 74 D.T.C. 6193, cited in Moldowan, op cit, at page 314 (D.T.C. 5215). A profit may never be achieved where the undertaking is not suitable to a particular area, or the undertaking is on an insufficient level of operations, or the taxpayer is without competence to carry on the undertaking.

The dedication the taxpayer has to making the farm profitable must also be considered. His physical labour in working the farm is almost always put into evidence and is important: The Queen v. Graham, [1985] 1 C.T.C. 380; 85 D.T.C. 5256 (F.C.A.); affg [1983] C.T.C. 370; 83 D.T.C. 5399 (F.C.T.D.). The potential for profitability frequently depends on the amount of capital the taxpayer has invested, and if the amount of capital invested cannot reasonably yield any profit, the taxpayer has no reasonable expectation of profit. The farm must have sufficient capitalization from which one may reasonably expect a profit. Where the taxpayer does not have money available to invest and must borrow, the interest rate on the money borrowed is an additional factor to consider whether there is a reasonable expectation of profit.

A taxpayer who has farmed profitably over the years will ordinarily retain farming as a source of income even if he subsequently suffers losses; however a taxpayer starting out to farm must consider the economic conditions and forecasts at the time he enters that activity.

The fact [that] a taxpayer enjoys farming does not turn what is a farm business where he can reasonably expect to earn a profit into a hobby. Also, a farming business ought not to be distinguished from any other business, and simply because the taxpayer may or may not reside on the farm property, does not perform physical labour, or hires people to work the farm should not affect the business nature of the farm. For example, see Hadley v. The Queen, op cit.

When determining if a taxpayer has a “ reasonable expectation of profit” one must place some emphasis on the word reasonable”. Reasonable” is defined by the Shorter Oxford English Dictionary on Historical Principles as:

. . . 4. Not going beyond the limit assigned by reason; not extravagant or excessive; moderate . . .

The term “reasonable expectation of profit” in the french language is "espoir raisonnable de tirer un profit”. The word “raisonnable” is the equivalent of the word reasonable”. Raisonnable” is defined by Le Petit Robert as:

. . . v. Naturel, normal . . . Qui consent des conditions honnêtes et modérées (commerçant, homme d’affaires, etc.), oppose à exigeant . . . 3. Qui correspond à la mesure normale . . . prix raisonnable.

The expectation of profit, therefore, is not a mere hopeful or wishful expectation; it is what a person having a basic knowledge of the undertaking would normally expect having regard to the various factors involved in the undertaking. If the undertaking is susceptible to the vagaries of weather (e.g. drought), disease, economics (e.g. fluctuating prices and costs) or other adversities beyond the taxpayer's control, that potential adversity must be taken into account in appreciating the meaning of "reasonable". Many of the adversities, beyond the control of the taxpayer, may be expected and are normal risks of farming but others are unusual and exceptional occurrences; the taxpayer ought to allow for the former in determining his expectation of profit. The term" reasonable expectation” is not analogous to "expectation under ideal conditions”.

If a taxpayer starts his farming operations with a reasonable expectation of profit but incurs losses year after year the expectation of profit, for whatever reason, at a given time may cease to be reasonable and the taxpayer has to consider cutting his losses to minimize the continuing erosion of his personal net worth: Hadley v. The Queen, op cit, at page 68 (D.T.C. 5063).

I will take the liberty of adding that the lack of a well-defined or systematic development plan or program and of financial forecasts from the beginning of the operations, or at least at any subsequent time [1] , has on several occasions been adopted as one of the major criteria for establishing that there was no reasonable expectation of profit.

Similarly, the question whether there was a reasonable expectation of profit has often been raised when taxpayers have claimed that "start-up" costs were in large part the main cause of the losses incurred over the first few years. In this respect, it is important to note the distinction made in several judgments between such costs incurred in operating a farm business in accordance with a well-defined program and improvement expenses of a capital nature preliminary to the operation of the business itself. [2] On this point, I will take the liberty of quoting Taylor, T.C.J., who said the following in McClure v. M.N.R., [1988] 2 C.T.C. 2140; 88 D.T.C. 1504 at 2155 (D.T.C. 1514):

The term “start-up costs" in my view, does not represent all outlays and expenses incurred to start a business, it does signify the accumulation of such outlays and expenses from the start of the business up to the point of profit. A" business” is an economically viable operation from which it can be determined at that point in time that there is a“ reasonable expectation of profit”. Reasonable" is a term encompassing both objective and subjective considerations; "expectation", means something more than mere "hope",—perhaps it is closer to "anticipation"; and "profit", is a calculation taking into account the Act and G.A.A.P., with little need for subjectivity in my view.

Conclusion

In the present case, I find that the appellant, Louise Desmarais, has not proven that she operated a farm business in 1984, 1985 and 1986 with a reasonable expectation of profit. The expenses incurred during those years must therefore be regarded as personal or living expenses within the meaning of subsection 248(1) of the Income Tax Act.

These findings are based on several facts. The appellant and her husband, who appears to be directly involved, had no training or experience in agriculture or, more specifically, in growing cereal crops.

The appellant and her husband purchased an unproductive and abandoned piece of land with extensive drainage problems that they only appear to have discovered after unsuccessful attempts at cultivation made without either expertise or real consultation. Capital invested in the business, and not in purchasing the land itself or the residence, was minimal during the years in question. No specific plan for farming the land or documents setting out financial forecasts or other information for the years in question have been adduced in evidence. An evaluation document by an agronomist of the Bank of Montreal does refer to income projections, which were apparently supplied for purposes of obtaining the loan in 1984, but that information was never submitted to the Court. The appellant and her husband expended minimal time and effort, which was mainly aimed at fixing up the residence and the adjacent lot, on the land during the years in question. Nor was the work by third parties for lump sum payments extensive. All things considered, these activities generated neither profits nor even gross income during the three years in question. Finally, the obtaining of a drainage plan and carrying out of mechanized work on some 300 metres of ditches in 1986 was more a case of improving the land before farming took place on a genuinely serious basis than of start-up costs in the context of operating a farm business with a reasonable expectation of profit.

The appellants consultation with an expert during the 1988 taxation year following the audit by Revenue Canada, Taxation, in 1987 along with the subsequent drainage, fertilization and cultivation work does not make it possible for me to find that a farm business was operated during the 1984, 1985 and 1986 taxation years with a reasonable expectation of profit.

For these reasons, the appeal from the new assessments issued for 1984, 1985 and 1986 is dismissed.

Appeal dismissed.