William Morrison v. Minister of National Revenue, [1991] 1 CTC 2659, 91 DTC 622

Sarchuk, T.C.J.:—This is an appeal by William Morrison from an assessment of tax with respect to his 1988 taxation year.

In computing his income tax payable for that year the appellant elected to block average his income in accordance with the provisions of section 119 of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the"Act"). By notice of assessment the respondent denied the appellant's election. Both parties agree that the appellant's return for the 1984 taxation year was not filed as required by Part I of the Act and therefore his 1984 taxation year cannot be considered for the purposes of section 119 of the Act.

William Morrison (Morrison) was born and raised on a farm near Debolt, Alberta. He completed his high school education during the course of which, in addition to other subjects, he took courses in agriculture. In 1972, just prior to completing grade 12, he acquired a half section of land near Debolt through a homestead sale. Over the next two years he cleared the land in accordance with his homestead obligations. Some acreage was seeded in 1973 and by 1974 he had approximately 160 acres available for seeding. In 1975 Morrison purchased two further quarter sections of land near Debolt for $37,000. These sections added about 190 acres of "arable, seedable" land to his inventory. The financing for this acquisition was provided by the Alberta Development Bank. In 1980 Morrison acquired two more parcels of land near Debolt, also through a homestead sale. This land was cleared immediately in accordance with his statutory obligations. As each of the foregoing parcels of land was acquired Morrison commenced to use it in his farming operation. With some variation over the years he has been involved primarily in the growing of grain crops (wheat, rape and barley) and the production of forage seed (timothy and fescue) which was sold mostly to overseas buyers.

In addition to farming the lands he owned Morrison rented farm land during the relevant years as follows: 1985—two quarter sections; 1986—three quarter sections; 1987—three quarter sections; 1988—six quarter sections. In most instances the arrangement between Morrison and the lessor involved rental payments based on share of the grain produced.

To demonstrate the growth of his farm operation Mr. Morrison filed an analysis of his permit books from 1980 to 1989 inclusive. This document discloses a steady increase from 337 seeded acres in 1980 to 650 seeded acres in 1985 and to 10,026 acres in 1989. The low acreage seeded in 1986 (350 acres) reflected only the existence of a substantial summer fallowing project which was carried out in that year.

Since about 1979 or 1980 Morrison has also been the proprietor of W.D.M. Pumping Service. Initially the operation consisted of providing pumping services to various oil well drilling contractors, principally the pumping out of sumps at drilling sites. In 1985 he purchased a water truck and contracted with drilling contractors to haul water to drill sites. This business was principally winter related.

Since the appellant did not file his income tax return for 1984 as required by subsection 150(1) of the Act the four immediately preceding years for the purposes of section 119 of the Act are 1983, 1985, 1986 and 1987. With respect to those taxation years and the taxation year under appeal Morrison's gross income, allocated to each respective source, was as follows:

During these same taxation years Morrison's net income from each source was as follows:

The Court also heard testimony regarding gross and net income from each of these sources in 1984 and 1989. While outside of the five-year averaging period in issue, to a limited extent this evidence is relevant. The amounts were (and I ignore any reference to” other income"):

Since the pumping business operated on a fiscal year (with its year end being August 31) both parties prepared analyses for the purpose of allocating the pumping business gross and net incomes on a calendar year basis for comparison purposes (Exhibits R-1, A-7). This was done principally in an effort to support their respective positions vis-à-vis the taxpayer's involvement and financial reliance on the pumping business. These analyses add little to the other evidence before me.

Morrison testified as to his personal involvement in the two businesses. He said that many of the contracts performed by W.D.M. Pumping were done during the winter months when he was not actively engaged in grain farming. Furthermore, if either pumping or water hauling services were rendered during the farming season, Morrison's general practice was to hire a subcontractor or employee to provide such services so that his involvement in the farming business was interrupted as little as possible. It was conceded by Morrison that the continued existence of the pumping and water hauling business had been and will continue to be necessary to provide additional cash flow to permit the expansion of his farming business.

Morrison's evidence relating to his activities establishes that as contrasted to the pumping business he personally performed almost all of the work necessary on his farms. This included spring tilling and seeding; carrying out fertilization and other soil improvement programs; weed spraying; all harvesting as well as the building and maintenance of all machinery.

The appellant's farm operation produced net incomes in both 1983 and 1984. He then suffered three years of losses which were followed by two years, 1988 and 1989, of substantial net income. With respect to taxation year 1985 Morrison said that the loss was the result of extremely inclement weather and early snowfall which prevented him from harvesting the majority of his crops. The bad weather and problems resulting from his attempts to harvest in 1985 left the land in poor physical condition. He concluded that his lands would be best served if they were summer fallowed, weeded and provided with nutrients in 1986 in order to increase the grain production in future years. He pointed to the results in 1987, 1988 and 1989 and particularly to the quality of his crops as proof of the wisdom of this decision. In particular he spoke of the prizes and awards won by his fescue and pedigreed seed at agricultural fairs and exhibitions in 1988 and 1989.

Mr. Morrison is convinced that his farming operation has gained momentum over the years. It is now producing substantial revenue and barring impossible weather or unforeseen circumstances will continue to do so. It is his intention for the moment to continue with the pumping business with the ultimate intention of abandoning it as the size of his farming operation increases.

Evidence was given on behalf of the respondent by Isabelle Henderson, an appeals officer with Revenue Canada. In the course of analyzing the appellant's two sources of income it was determined that W.D.M. Pumping had a fiscal year end. To permit a fair comparison to the appellant's gross farm income she used the appellant's records to recalculate his gross business income on a calendar year basis. This analysis was produced as Exhibit R-1. While no doubt unintended this recalculation had the effect of reducing the gross business income in four of the five taxation years under consideration and to some extent the exercise seems to have favoured the appellant. Ms. Henderson, utilizing a March 15 to December 15 period as the active farming period (based on statements made by the appellant) concluded from this analysis that a substantial portion of the pumping business revenue was earned during the active farm season. This analysis was put forward to demonstrate a greater involvement by Morrison in the pumping, business than admitted. It admittedly contrasts with information produced by Mr. Morrison (Exhibit A-7) which was his recalculation of volume of pumping business income during the farm season. Neither analysis is of more than limited value to the Court although I would be inclined to accept the appellant's versions as closer to the actual circumstances. I note also that the Minister's analysis inadvertently ignores the fact that most of the work done during the farming season was done by employees hired by Morrison for that purpose.

Ms. Henderson described the various factors that led to the Minister's assumption that farming was not the appellant's chief source of income during the five-year block averaging period as follows:

A. Essentially we used aggregate income over the five-year period. We determined that during the five-year period that he was requesting the block averaging provision be allowed his gross income from farming was 232,000 and his gross income from the pumping service was in excess of 355,000. We certainly don’t contest that he was in the business of farming during that period of time or that he had in fact directed his operation in a more positive nature, but we did apply pure aggregate and determine that his chief source of income—His Honour: That's a gross business income aggregate?

A. Gross for both the farm and for the pumping business, but I don’t think it changes when you use net, because again—in fact if anything, pumping services, the net income is far in excess of the pumping—of the net income for the farming operation.

Mr. Cherniawsky: So essentially a mathematical approach?

A. It was purely mathematical.

Mr. Cherniawsky: Those are all my questions.

A. I don't believe that section of the Act provides for any other application.

In examination in chief and in cross-examination Ms. Henderson quite candidly stated that nothing was done with respect to reassessing the appellant by applying the provisions of section 31 of the Act to any of the years under objection or that were included for the purposes of block averaging. She also said that she did not seriously consider any of the tests enunciated by the Courts with respect to the determination of chief source of income for the purposes of section 31 of the Act. More specifically, with respect to such factors as time, expertise, capital and centre of the work routine or occupational direction, she commented that while they were considered in the final analysis "We used a quantitative measure."

Appellant’s Position

Counsel submitted that it is not necessary that the gross/net revenue from farming be greater than the comparable revenue from the pumping business in order for farming to be Morrison's chief source of income. He argued that simply comparing net income or gross revenue from each source as a test to determine a chief source of income in a taxation year is not a valid test. All factors including the personal involvement of Morrison; the amount of capital investment; the nature and character of his businesses; his plans for the development of the farming business and the steps taken by him in connection with the implementation of those plans; the season and manner in which the majority of the gross revenue from the non-farming business was earned are more appropriate tests relevant to the determination of whether farming was Morrison's chief source of income for the block averaging period. This chief source of income test is consistent with that enunciated by the Supreme Court of Canada in Moldowan v. The Queen, [1977] C.T.C. 310; 77 D.T.C. 5213 and is as applicable to section 119 as it is to subsection 31(1) of the Act. He argued that the evidence adduced amply supported a finding that Morrison's chief source of income was farming, and that the onus on the appellant had been met.

Respondent's Position

Counsel for the Minister did not disagree that with respect to the Court's determination whether farming is this taxpayer's chief source of income for the purposes of section 119 of the Act, it is proper to consider the interpretation given to that phrase by the Supreme Court of Canada in Moldowan v. The Queen, supra. However counsel qualified his comments by submitting that the approach to be taken to the evidence is perforce different when section 119 is in issue. He argued that it is inappropriate to view the whole period, that is the year of averaging and the four immediately preceding years, as defined by section 119, to determine whether for that period overall the chief source of income was farming. He says that it is necessary to look at each of the preceding years and to determine with respect to that year whether farming was the taxpayer's chief source of income in that year. In his argument he did not go so far as to say that each year must be determined without any reference whatsoever to the other years but he seems, by inference at least, to suggest that in approaching the task of determining whether a taxpayer's chief source of income was farming for the purposes of section 31 of the Act an approach has been taken by the courts, inadvertently perhaps, which blurred the lines between the individual taxation years and failed adequately to take into account that a taxpayer's chief source of income in a particular year might not yet be his chief source of income or might no longer be his chief source of income as a result of changed or changing circumstances.

He argued that viewing the year of averaging and the four preceding years in the manner suggested by counsel for the appellant is tantamount to viewing the five-year period as one very long taxation period, which in counsel's view is not what the provisions of section 119 of the Act require.

Counsel for the respondent disagreed with submissions made on behalf of the taxpayer that the respondent's assessment was made almost exclusively on the basis of the gross and net income figures. He argued that consideration was given to other factors including the allocation of time and resources to the two sources of income, the allocation of capital to those two sources of income and to the fact that in an economic sense the farm business was always subordinate to the pumping business. He submitted that the appellant had failed to satisfy the onus or to demonstrate error in the respondent's assessment.

Conclusions

Two issues arise in this appeal. The first is the proper interpretation of the phrase "chief source of income" within the context of section 119 of the Act. The second is whether this appellant's farming business was his chief source of income in the year of averaging and in the four preceding years within the meaning of that section.

The relevant portions of the enactment read as follows:

119.(1) Where an individual's chief source of income has been farming or fishing for a taxation year (in this section referred to as the "year of averaging”) and the 4 immediately preceding years for which he has filed returns of income as required by this Part (in this section referred to as the "preceding years"), if the individual, on or before the day on or before which he was required to file a return of his income for the year of averaging, or on or before the day on or before which he would have been required to file such a return if any tax had been payable by him for the year of averaging, files with the Minister an election in prescribed form, the tax payable under this Part for the year of averaging is an amount determined by the following rules: . . .

The Act does not define "chief source of income". This concept, however, has been extensively considered in connection with the restricted farm loss provisions found in section 31 of the Act. The opening words of that section read:

31.(1) Where a taxpayer's chief source of income for a taxation year is neither farming nor a combination of farming and some other source of income, for the purposes of sections 3 and 111 his loss, if any, for the year from all farming businesses carried on by him shall be deemed to be the aggregate of. . .

The reported section 119 cases have not been particularly consistent with regard to how a taxpayer's chief source of income for the averaging period should be determined. The earliest decisions, Lawrence v. M.N.R. (1954), 10 Tax A.B.C. 140; 54 D.T.C. 138; Stringam v. M.N.R. (1954), 9 Tax A.B.C. 407; 54 D.T.C. 45, Bekkerus v. M.N.R. (1954), 10 Tax A.B.C. 166; 54 D.T.C. 146 and Holt v. M.N.R. (1954), 10 Tax A.B.C. 170; 54 D.T.C. 150 appear to have been decided on the basis of an arithmetical approach or on a comparative analysis of net and gross incomes from each source.

In two subsequent decisions, Blake v. M.N.R. (1961), 28 Tax A.B.C. 156; 61 D.T.C. 704 and Hood v. M.N.R. (1963), 34 Tax A.B.C. 41; 63 D.T.C. 968 the Tax Appeal Board not only continued the mathematical formula approach but further to hold that to interpret income" as "gross income" was inappropriate and that for the purposes of the relevant section income for a taxation year is the profit therefrom from the year and that was the primary criterion for the determination of whether a taxpayer would be entitled to average his farm income or not.

In Wilfley v. The Queen, [1974] C.T.C. 510; 74 D.T.C. 6422 (F.C.T.D.) Collier, J. questioned the arithmetical approach in the following words: “In my opinion, the net dollar and cents position, when viewed through five years of hindsightis not the only, or conclusive criteria, to be considered in determining the question of fact: 'Has the chief source of income been farming?"'

Collier, J. considered all of the surrounding facts and circumstances including the gross receipts and expenditures related to the various sources, the capital invested by the taxpayer and the direction of his activities over the five- year period. On the basis of these factors, although farming had resulted in a net loss of $16,131 while the other sources had produced net incomes of $69,415 during the averaging period, farming was found to be the taxpayer's chief source of income.

The arithmetical basis of comparison was also rejected in Brown v. The Queen, [1975] C.T.C. 611; 75 D.T.C. 5433 (F.C.T.D.). In that case the Court took into consideration the future capacity of the farming operation to earn income, cash flow, personal involvement, net income and capital investment.

Notwithstanding Wilfley and Brown, supra, the mathematical formula continued to be used and was applied in Van Moorlehem v. M.N.R., [1978] C.T.C. 2786; 78 D.T.C. 1559. However in Israel v. The Queen, [1979] C.T.C. 468; 79 D.T.C. 5418, Cattanach, J. accepted the comments made by Ryan, J. in Mold- owan v. The Queen, [1975] C.T.C. 323; 75 D.T.C. 5216 (F.C.A.) to the effect that a source may be a source of income in a particular taxation year even though the taxpayer receives no income or suffers a loss. He concluded that being so, the simple mathematical test of computing the net income from two sources is not a conclusive test for determining which of the two sources may be the chief source. To so determine resort may be had to other criteria.

Several decisions have been given with respect to section 119 since Mold- owan but the issue of "chief source" does not appear to have been addressed or argued.

I am satisfied that the current view is that although there are minor distinctions between section 119 and subsection 31(1) of the Act the appropriate test of chief source of income to be applied for the purposes of section 119 is that set out by the Supreme Court of Canada in Moldowan v. The Queen, supra, at page 314 (D.T.C. 5215) in which Dickson, J. (as he then was) said with respect to subsection 31(1) of the Act:

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.

On the other hand what is clear from virtually all of the foregoing cases is that the determination of chief source is to be made on the basis of the averaging year and the preceding years taken together. This approach was first enunciated by Chairman Fisher in Stringam v. M.N.R. at pages 410-11 (D.T.C. 47-48):

In dealing with this section, one has to keep in mind the intention of Parliament, which obviously was aware of the hazardous nature of farming or fishing operations and the fact that, due to the effect of business conditions as well as weather conditions, farmers and fishermen are frequently experiencing profitable years followed by years of losses. The legislation was enacted, therefore, in an endeavour to equalize the tax which a farmer or fisherman would have to pay, depending on his average income over a number of years. If the contention of the Minister’s officials is to be accepted, under which in any year in which a taxpayer suffers a loss on his farming operations and nevertheless has some income from his investments he will be denied the privilege of averaging because it will be held that in the year in question his chief source of income was from investments and that he had no income from his farming operations, then the whole purpose of the legislation is completely nullified. If that were the interpretation to be given to the legislation, it would mean that any person in the business of farming, if he desires to average his farm income for the purposes of the Income Tax Act, must never save any of his money, or at least must never invest it so as to receive investment income, since, if he does and suffers a loss on his farming operations in any year, he will be denied the right to average his income however small the amount of his investment income may be in the year of loss. Indeed the interpretation also envisages that a taxpayer must have an income from his farming operations in each year of the averaging period, as, if he suffers a loss in any one year, it will be stated that he did not have a source of income from farming in that year, irrespective of whether he has income from any other source or not.

it is my opinion that this interpretation of the section would make it almost meaningless and would completely nullify the intention of Parliament when it enacted the averaging provisions. . . .

and later he said:

There is, however, another interpretation which can be given to the opening part of subsection (1) of Section 39, which is, that you may look at the full five-year period (or, in the case of the year 1949, the four-year period) in respect of which the averaging is to apply, and if, over the whole of that period, it is found that the taxpayer's chief source of income has been farming or fishing, then the provisions of the section apply. This interpretation overcomes the situation where a taxpayer may make a loss on his actual farming operations in any one year and yet have some income by way of investments in the year of loss. By looking at the whole period of averaging, one obtains a truer perspective and a clearer picture of what a taxpayer's chief source of income was in that particular period. In the case of this individual taxpayer, it would appear from the figures given by him on his Election to Average that there cannot be any doubt that his chief source of income for the period 1946 to 1949, both inclusive, was farming.

In Bekkerus, Fisher added at pages 168-69 (D.T.C. 148):

In my opinion the interpretation to be given to the opening provisions of subsection (1) of Section 39 of The 1948 Income Tax Act is that the whole five-year period is to be looked at, and if over that five-year period it is shown that the taxpayer's chief source of income has been either farming or fishing, then he is entitled to take advantage of the averaging provisions contained in the said section.

It seems fair to say that in Wilfley v. The Queen, supra, and in Brown v. The Queen, supra, both Federal Court-Trial Division decisions, the global approach with respect to the years in issue was taken. Indeed counsel for the Minister in Wilfley urged the Court to look at the whole of the financial picture for the five years to determine whether the farming operations warranted the finding that they were the chief source of income.

The only support for the position advanced by counsel for the respondent is found in what appears to be an obiter comment by Chairman Weldon in Hood v. M.N.R., supra, at page 47 (D.T.C. 971); with respect to subsection 42(1) (now section 119):

As a matter of fact, in my opinion, the burden was on the appellant in this matter of establishing that his chief source of income was farming firstly in 1960, and thereafter successively in 1959, 1958, 1957 and 1956. Thus, it was really only necessary to examine the situation in 1960 in this appeal to conclude that the appellant was not entitled to the benefit of Section 42(1).

No other decisions that I have reviewed appear to support such an approach. Moorlehem and Israel, supra, may on first blush suggest it but upon careful reading I am satisfied that neither case supports the proposition advanced on behalf of the Minister in this appeal.

I find no valid basis upon which to depart from the principle that the determination of chief source must be made on the basis of a review of the years in issue contextually and not successively in the manner suggested by Hood v. M.N.R., supra. Therefore in order for Mr. Morrison to benefit from the provisions of section 119 he must adduce evidence to demonstrate that farming was his chief source of income for a five-year period, which in this case includes the taxation years 1984, 1985, 1986, 1987 and 1988. I have concluded that he has satisfied the onus and that farming was his chief source of income. I take into account the farm's levels of profitability in those years and its foreseeable profitability. I have considered the gross income, the net income, the capital investment, the cash flow and the personal involvement of the taxpayer. It is clear that Mr. Morrison has a substantial commitment to farming and that his commitment in terms of capital increased during the five-year block averaging period before me, evidence of which is found to some extent in the increased seeded acreage during the five-year period.

In terms of capital committed I take note of the fact that during the years in question Morrison owned six parcels of land, all of which were used in the farming business. Although the capital cost was low, that was due largely, as his counsel noted, to his energy and enthusiasm since four of the six parcels represented homestead land which he obtained from the Province of Alberta at a very low cost but which in exchange required tremendous personal effort on his part to clear the land. Clearly the labour cost is not reflected, as counsel noted, if one looks only at the historical and financial cost of the land. He has during this same period of time made a substantial investment in farm machinery and a substantial investment in farm buildings. The capital invested in the pumping business pales in comparison.

With respect to Mr. Morrison's pumping business, it was clear from his testimony that it was, in terms of his time, managed in such a fashion so as not to interfere with the farm operation. During the busy farm periods any conflict was resolved by the hiring of help to perform the water hauling or water pumping contracts.

There is absolutely no doubt in my mind that insofar as his occupational direction is concerned it is farming. It is noteworthy that Mr. Morrison's operations have yielded crops which won awards on a number of occasions including first prize and grand champion for Red Fescue Canadian Western Agribition (Edmonton) and fourth prize in the Royal Agricultural Winter Fair (Toronto), both in 1988 and first prize and grand champion for Edmonton Northlands Western Pedigreed Seed Show in 1989.

The appeal is allowed with costs.

Appeal allowed.