Marth Realties Limited v. Her Majesty the Queen, [1994] 2 CTC 2430

Garon J.T.C.C.:—These are appeals from income tax reassessments made by the Minister of National Revenue for the appellant’s 1985, 1986 and 1987 taxation years. By these reassessments, the Minister of National Revenue refused to allow in full the deduction of farm losses claimed by the appellant in the respective amounts of $76,562, $87,421 and $96,756 for the appellant's taxation years 1985, 1986 and 1987 and only permitted the deduction of $5,000 in respect of these farm losses for each of the taxation years in issue pursuant to the provisions of paragraph 31(1)(a) of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the "Act").

For the record, it should be noted that counsel for the respondent indicated at the outset of the trial that, as a result of an agreement with counsel for the appellant, the Minister of National Revenue will be reassessing the appellant for the purpose of making adjustments to the amounts of capital cost allowances to which the appellant is entitled in respect of its 1985 and 1986 taxation years. Effect must be given to this agreement.

The appellant was incorporated in 1980 as a numbered company and became Marth Realties Ltd. in 1981. The appellant's taxation year ends on April 30. The principal shareholder of the appellant is Mr. Alexander Wilson who owns 51 per cent interest in its capital stock while his wife, Mrs. Wilson, holds the remaining 49 per cent interest. Mr. Wilson and his wife were the appellant's sole directors.

Mr. Wilson was born in Windsor, Ontario, grew up as a country boy in Rosemere, Quebec, a locality near Montréal. During his school vacation, he worked on local farms and at some of the local greenhouses. After attending Loyola University in Montréal in engineering for two years, Mr. Wilson joined in 1959 as a senior estimator a corporation referred to by the name of Magi I Construction. Magi I Construction Company is one of the largest construction companies in Canada; according to Mr. Wilson, it was the largest company in Quebec. Mr. Wilson worked his way through the company and became president of Magil Construction. At first, i.e., in 1967, Mr. Wilson acquired a seven per cent interest in the capital stock of Magil Construction. At some point later, Mr. Wilson owned 40 per cent of the outstanding shares and his partner, Mr. Saul Polachek, who had voting control, held the remaining 60 per cent of the shares. Thus, Mr. Wilson and Mr. Polachek took over Magil Construction. Later on, the appellant held 40 per cent of the shares in Powil Equities, which owned all of the shares of Magil Construction, and Mr. Polachek owned the remaining 60 per cent.

Mr. Wilson testified that he preferred a more pastoral personal life and during his children's youth lived with his wife and family in St-Sauveur/Piedmont, in the area referred to as the Laurentian Mountains, some 40 miles north of Montréal. Fie subsequently moved to Baie d'Urfé on the West Island of Montréal, and some years later to Hudson, Quebec, a typical country village, where Mr. Wilson was closer to the farms where the appellant was boarding horses. Mr. Wilson and his wife moved to the farm in December 1989.

Mr. Wilson mentioned in his testimony that he had promised his wife that he would get out of the construction business by the age of 55 at the latest. In line with this objective, Mr. Wilson bought an abandoned farm in 1981, being Concession No. 2181 in Huntingdon (Elgin), Quebec. No one had been living in the building on that farm and no farming activity had been carried out for the past ten or 15 years. This property was directly across the street from the farm of his brother who was running a cow-calf operation.

The evidence also establishes that Mrs. Wilson and the two Wilson daughters enjoyed the country life and farming as well. Mrs. Wilson and the two daughters were very much interested in horses since the 1970s taking courses at various riding establishments. Mrs. Wilson has been involved in horse shows and competitions. The daughter Erin attended the Agricultural School of McGill University, at MacDonald College, where she graduated in agriculture with a major in animal sciences. She won the Quebec championship and the Eastern Canadian Champi- onship for her class in dressage. The Wilsons’ second daughter, Jennifer, attended the equestrian school of the University of West Virginia, U.S.A. and later on took a job at a thoroughbred breeding farm in Ontario. She is at present involved in a horse breeding operation in Tottenham near Toronto.

The evidence shows that the appellant was being paid consulting fees for the services provided by Mr. Wilson on various projects in which Magil Construction was involved.

Mr. Wilson, in the course of his evidence, indicated that, after discussions with Mr. Polachek, they both agreed to enter into an agreement in 1984 or 1985 whereby Mr. Wilson “could be bought out of Magil", to use his expression, at some time of his own choosing, but this agreement was never signed.

In 1985, Magil Construction, in his search for new executives, hired three engineers. The significance of this decision is explained by Mr. Wilson in these terms:

Well, in 1985 we hired three engineers, two of which were in contention for a senior position in the company. It was Joseph Gutstadt, Yehuda Weinberg and Chanak Freidel, all of them with the same qualifications, except for Mr. Gutstadt who had more managerial experience in the construction and development field.

Now, these three people were employed because of the anticipated expansion of the company through the years of 1986, 1987 and 1988.

One of these three engineers, Mr. Gutstadt, acquired in 1987, 15 per cent of the stock of Magil Construction and was appointed Executive Vice-President of Magil. He eventually took over as President of Magil. At the present time, Mr. Gutstadt is the Chief Operating Officer and President of Magil. Mr. Wilson agreed not to leave Magil in 1985 on account, among other considerations, of his long association with the latter firm and Mr. Polachek, and the fact that Place Victoria project was taking increasing amounts of Mr. Polachek’s time. Mr. Wilson also agreed to be involved in a condominium project on Nuns’ Island known as Verrières sur le Fleuve. It was originally contemplated that this would be a one phase project. Mr. Wilson acquired a ten percent interest in Verrières sur le Fleuve. This project was extremely successful and the appellant acted as a construction consultant for the first five of six phases of construction of this project. The total project involved 650 apartments. The appellant ended his construction activities in this project in late 1989.

The appellant also became involved in three other major projects in Montréal, one was the Coopérants office tower on Maisonneuve street, and Place de la Cathédrale shopping centre. This project was viewed by Mr. Wilson as one project although it consisted of the construction of two separate buildings, one of such buildings was erected as a part of a shopping centre underneath a church on Ste- Catherine Street. A second project involved Cadillac Fairview as the owner and was referred to as Place Montréal Trust. Magil Construction was awarded the contract for the construction management as long as Mr. Wilson was personally involved. Mr. Wilson was then asked by Mr. Polachek to stay with Magil Construction to take over the supervision and management of this Cadillac Fairview project. It was a $200,000,000 undertaking which took three years to complete. The third project was the Eaton Place project which had to do with the reconstruction of Les Terrasses into a viable shopping centre. During this period, the appellant was also active in two other projects in the Montréal region known as "Eaton Place” and as "He Paton". In addition, the appellant through Mr. Wilson, played a role in the construction of the Hilton Hotel in Toronto.

The important involvement of the appellant and Mr. Wilson in the construction activities of Magil Construction did not preclude them from looking after their farming operations.

On January 2, 1984, Mr. Wilson transferred to the appellant the Farm Concession No. 2181, equipment and livestock, the whole having a fair market value of $202,000. This transfer was within the framework of the rollover provisions of section 85 of the Income Tax Act. As part of the transfer of certain assets described in Schedule "B" to the agreement of January 2, 1984, the appellant acquired from Mr. Wilson three horses and six yearling Gelway calves.

Mr. Wilson testified that he devoted during the relevant years about 40 per cent of his time to farming related activities. The appellant could also count on the full time services of one Mr. Lécuyer. Part-time help was also supplied by individuals such as Messrs. Gilles Maurice, Roger Tanner, Campbell Calder and Ben Lecus. The restoration of the house on the Farm Concession No. 2181 and the regeneration of the fields on this property were proceeded with, the appellant paying out not less than $85,000 during the three years in issue with respect to hired help. Also, Mrs. Wilson and Miss Erin Wilson were each spending four to five hours a day with the horses.

Mr. Wilson also gave explanations about the work that was done by the appellant in regenerating the fields of Farm Concession No. 2181. Mr. Wilson said this:

All these fields were plowed and then we had purchased rock pickers and rock grates which are basically machines that you drag behind a tractor which grate the rocks into piles, continuous piles, and the rock picker goes along and scoops these pickers, these rocks up and toss them into a wagon dragged along behind it to transport them somewhere else.

He also pursued in these terms:

Basically, an excavation job and a levelling and grating job which I think I was qualified to do, it required resloping and to carry off the surface water ditching and digging always deep holes to (inaudible) all the rocks that existed on the field.

The regeneration of this Farm Concession No. 2181 was being done ”. . . during 1985, 1986, and going into 1987 because the. . .once the rocks were picked and the field levelled and graded, it required applications of fertilizer and it required redisking for the purpose of applying seed to the, the mix of seed that we were using, to provide either pastures or hay fields.”

The evidence suggests that the appellant had intended that the fields of Concession No. 2181 would provide feed for its cow-calf plans. But the rock problem caused a setback to its cow-calf operation. In answer to the following question, Mr. Wilson testified thus:

Q. How do you feed the cattle? Would you buy feed or would you grow it yourself?

A. Grow it ourselves, purchasing unless you purchase in a market that exists, as it exists today, you cannot afford it because of the pounds your animals gain are too costly and you price yourself right out of the market. We, the main reason we bought the additional farms on the Fourth Concession was because we not cultivate proper feed or grain on the First Concession.

With respect to Farm Concession No. 2181, Mr. Wilson finally came to the conclusion, that "Further, agricultural planting and so on, on these farms, these fields, would be totally wrong, totally inefficient simply because of the rocks. It is a rock farm basically and every spring we go around and lift the rocks that have been pushed out by the frost. So we decided that this would be, the horse operation would be centered here".

With respect to the horse operation, it is of interest to take cognizance of the “equine inventory from 1976 to present", which was filed in evidence. A list of 20 horses is shown in this inventory. Most of these horses were kept in St-Lazare, a municipality about 50 kilometres west of Montréal. Some of these horses were retained for breeding purposes. Many of these horses participated in competitions or were show-horses. The evidence also discloses that, at the material time, this component of appellant's activities would consist of a stable where horses would be boarded together with an arena where they could exercise in winter time or rainy days. The arena and stables were built in two phases between 1988 and 1991. The arena was first erected and the appellant started construction of the stable two years later. The construction of the stables was postponed "because the economy was in a downturn”, asserted Mr. Wilson. He went on to say that he was not sure if the stable operation was financially viable. The appellant was charging $200 per month per horse to attract boarders. Mr. Wilson observed that in the first full year of horse boarding operation in 1993 the appellant derived gross revenue of $13,712 and net income of $5,566 from such operations. It is projected by Mr. Wilson that with an increased rental to $250 a month, and larger stables, the revenues from this operation could increase to $35,000 per annum in 1994.

Mr. Wilson explained in his terms why no market surveys were done by the appellant on horse breeding or cow breeding:

We did not do a normal study, I went by the experience of my brother and my next door neighbors whom I'm very close to, I was very close to. And from the horse point of view, my daughters and my wife are, I consider them experts, so they thought we could. . .we could make it successful.

Because of the poor prospects in terms of productivity of the Farm Concession No. 2181, the appellant proceeded to acquire two additional farms in the area. The first one, Concession No. 1297, the size of which was about 325 acres, was bought on February 26, 1988, and the second one, Concession No. 1147, containing 138 acres, on April 11, 1989. The total area of the three farms amounts to 630 acres.

The first farm, Concession No. 1297, had laid fallow for eight or nine years. The second farm at the time of its acquisition in February 1988, had been operated as a dairy farm. Some time during 1988, the year in which the appellant purchased Concession No. 1297, a herd of 26 cows was acquired by the appellant. The appellant also purchased from Mr. Wilson's brother an additional 15 Glenway cows. It was also mentioned by Mr. Wilson that the two farms acquired in 1988 and 1989, contained excellent bush for a maple syrup operation. The appellant decided to get into the production of maple syrup, as the maple syrup was selling at favourable prices at that time. The appellant, in carrying on the maple syrup operation, proceeded to make significant investment in the form of a building and equipment, including bottling and purification equipment. Unfortunately, the prices of maple syrup declined rapidly after the making of such investment from $42 to $32 per gallon.

With respect to the appellant's investment in farming operation, it is to be noted that Mr. Wilson testified that before the transfer was effected to the appellant on January 2, 1984, Magil Construction had not been in the practice of declaring dividends. However, this policy was changed, according to Mr. Wilson, to accommodate his desire to invest additional funds in farming activities through the appellant. In fact, the appellant received dividends in the amount of $1,144,000 from Powil Equities, the parent company of Magil, in the years running from 1984 to 1987 inclusive. These dividends were used to expand the appellant's farming operation. The appellant also received in 1984 a dividend in the amount of $200,000 from M.A.P. Properties Ltd. of which the principal asset was an undivided interest in Place Victoria, a major high-rise in Montréal. After receipt of this dividend, the appellant disposed of its common shares in M.A.P. Properties Ltd. With respect to the appellant's investment in farming operations a chart was produced as Exhibit A-4, tab 10. This chart is hereafter reproduced:

MARTH REATIES LTD.

CAPITAL EXPENDED TOWARDS FARMING V. DEVELOPMENT/CONSTRUCTION ENTITIES

FARM INVESTMENT IN SHARES OF DEVELOPMENT/

CONSTRUCTION CORPORATIONS

1985

Livestock	$53,260
Fixed Assets	235,609
Farming Loss	76,562
Claimed ('85)	$365,431
LESS:
Mortgage	$13,182
Balance of Price	48,000	61,282
		$304,149	$142,140
1986
Livestock	$55,260
Fixed Assets	258,237
Farming Loss
Claimed ('85, '86)	163,983	$477,480
LESS:
Mortgage	12,626	12,626
		$464,854	$142,140
1987
Livestock	$62,260
Fixed Assets	303,758
Farming Loss
Claimed ('85, ‘86, '87)	260,739	$626,757
LESS:
Mortgage	12,028	12,028
		$614,729	$142,140

The total moneys devoted by the appellant to the farming operations as at April 30, 1991 are described as follows at page 27 of the appellant's notes and authorities:

The capital assets relating to the three concessions is $1,704,692

(see financial statement, April 30, 1991), less $182,597, the amount

invested in rental properties (see page 63, lines 7-10), or	$1,522,095
Inventory at April 30, 1991 (see balance sheet)	225,050
The total of appellant’s loss have been
1985-87 (see Tab 10)	$ 260,739
1988-91 (see 2.55)	1,130,321
	$1,391,060
Less: Depreciation taken
(see financial statement
April 30, 1991)	367,910
	1,023,150
THE WHOLE FORMING A TOTAL OF	$2,770,295

Finally, it is worth taking stock of the appellant’s revenues from 1984 to 1991 from the various sources of income, as set out at page 6 of the respondent's notes and authorities (Exhibit R-1):

Also, the results of the appellant’s farming activities during the years 1984 to 1992, in terms of gross income and farm losses, were as follows:

Analysis

The question in issue is whether or not the appellant's chief source of income during the three years in question was farming, either alone or in combination with some other source, within the purview of section 31 of the Income Tax Act. If the answer to this question is in the affirmative, all the appellant's farm losses are deductible.

As mentioned at the beginning of these reasons, the Minister of National Revenue has allowed a restrictive farm loss of $5,000 per year during each of the years in issue. In so doing, the Minister of National Revenue has acknowledged that the appellant was carrying on a farming business during the same years.

The leading decision in interpreting section 31 of the Income Tax Act is that 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. Many passages of this decision have been referred to in virtually every farm loss case since 1977, as mentioned by Judge Bowman of this Court in the case Hover v. M.N.R., (1992), [1993] 1 C.T.C. 2585, 93 D.T.C. 98 (T.C.C.). I find it particularly helpful to quote the following excerpt from the Moldowan decision at C.T.C. page 314 (D.T.C. 5215):

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

Exhibit R-1

reasonable expectations may signify a change in the chief source, but that is a question of fact in the circumstances.

I will now refer to the facts which are in my view significant in this case. Mr. Wilson after having transferred in 1984 substantial farming assets to the appellant, took steps to phase himself out of Magil Construction and to cause the appellant to begin the process of divesting itself of its construction related activities. To this end, Mr. Wilson persuaded Mr. Polachek, the controlling shareholder of Powil Equities, the holding Company of Magil Construction, to effect substantial payments of dividends, so as to enable the appellant to devote more funds to its farming operations. During its 1984 to 1987 taxation years, the appellant received dividends from Powil Equities, as mentioned earlier, in the amount of $1,144,000. A large portion of these moneys was directed to the appellant’s farming operations. The appellant's President, Mr. Wilson, was replaced as President of Magil Construction in 1989. The appellant’s equity in Magil Construction was redeemed in 1991. From October 1991, the appellant completely removed itself from any construction activities and earned no income from real estate or construction activities. It is true that Mr. Wilson’s departure from Magil Construction was delayed for a few years. One could have easily expected that the change of activities on the part of both the appellant and Mr. Wilson could have been achieved more quickly. However, my assessment of all the circumstances, and I accept the evidence of Mr. Wilson, who appeared to me to be a credible witness, persuades me that the appellant and Mr. Wilson did not waver in their determination and resolution to get out of the construction business and to redirect their activities to farming operations. It is only because of special circumstances involving a close business associate and the pressure inherent in these circumstances that the appellant pursued contemporaneously its construction activities for a few years. It can be easily realized that it was incumbent upon Mr. Wilson to leave Magil Construction in an orderly fashion.

With respect to the time spent by the appellant on farming operation, I find that Mr. Wilson, Mrs. Wilson and their two children spent substantial amount of time on such farming activities in the years in issue. Hired help was also employed in a significant manner in farming operations during the relevant period. In considering this factor, it would be wrong in my view to take into account solely the time spent by Mr. Wilson himself, given the fact among other considerations, that these appeals involved a corporate appellant. Counsel for the respondent stressed in argument that the appellant did not carry much activity on Farm Concession No. 2181 in the three years under appeal. While this is true to some extent, it should not be overlooked that this tract of land had not been cultivated for many years and that a period of regeneration was required. Also some preliminary work had been done. I am referring in particular to the rock-picking operation.

Turning now to the capital invested in farming operation, I find that the appellant's commitment was considerable commencing in 1984 and continuing in the ensuing years. Huge sums of money were invested in farming activities. In fact, by April 30, 1985, the appellant had advanced capital toward the farming operation to the extent of $304,149. The total appellant's investment had doubled by April 30, 1987, the last year under appeal in the present litigation and finally by the end of 1991, the appellant had committed over $2,700,000 to the farming operation, as I have mentioned earlier. To a substantial extent, financing for the farming activities was provided by the appellant's consulting income.

The matter of potential profitability must also be looked at. The facts disclose that the appellant's revenues from farming have increased in a significant fashion, particularly in the past few years. It is true that over a number of years during the period considered, farming losses have also been considerable. Counsel for the appellant has claimed that a small profit was realized by the appellant in 1993. The existence of this profit was contested with vigor by counsel for the respond ent. Reference was made in particular to the fact that audited financial statements in respect of the appellant's 1993 taxation year were not tendered in evidence establishing this profit. The significant factor however, in my view, is that the revenues from the farming operation are on an upward trend, and there is no question that the profitability of the appellant's farming operation, has either been achieved or is about to be achieved. In the overall appreciation of all the circumstances of this case, I attach some significance to the fact that as from October 1991, the appellant’s only source of earned income, so to speak, would be from farming. The source of consulting income had dried up by design. To adopt the terminology of Justice Dikson, as he then was, in the Moldowan case, farming has become for the appellant the only centre of its work routine. For some time now, the appellant has in effect removed itself totally from its prior construction related activities to take up farming on a full time basis. I see a definite and clear link between the situation in existence since 1991 and the sequence of events which unfolded beginning in 1984.

There was some debate about the chief sources of income during the years in issue. Counsel for the respondent urged the Court that dividend and interest income were chief sources of income along with consulting income. Counsel for the appellant, on the other hand, pointed out that in the context of section 31 a source of income cannot connote an unexpected source of income but must be taken to refer to an ongoing recurring source of light of the Moldowan decision. The short term placing of funds or the dividend income would not qualify as chief source of income, according to counsel for the appellant.

In view of the above evidence, given the appellant's commitment in terms of time and capital and the profitability of appellant's farming operation, I find that farming was in combination with construction related activities or consulting services a chief source of income in the years in issue within the purview of section 31 of the Income Tax Act. Having in mind all the circumstances of the present case, I see no reason why the appellant should be disentitled to deduct the full impact of the start-up costs of its farming business.

Appeal allowed.