Conray-Dymond Truck Line Limited v. Her Majesty the Queen, [1994] 1 CTC 199, 94 DTC 6166

Jerome, A.C.J.:—This appeal from a decision of the Tax Court of Canada, [1992] 1 C.T.C. 2148, 92 D.T.C. 1099, dated August 1, 1991 came on for hearing at London, Ontario on June 15, 1993. At issue in this appeal is the plaintiff's right to deduct the full amount of farming losses incurred during the 1980, 1981 and 1982 taxation years. At the conclusion of argument, I took the matter under reserve. For the reasons that follow, the plaintiff should succeed in this action and is not subject to the restrictive provisions of subsection 31(1) of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the "Act")

Background

The plaintiff was incorporated under the laws of Ontario in 1976. During its first years of operation, the corporation limited its activities to trucking in the New Liskeard area. In 1980 however, a farming division was established and as is common with this type of venture, incurred losses in its first years of operation. The plaintiff deducted the full amount of these losses in determining its taxable income. The Minister of National Revenue reassessed the plaintiff for the 1980, 1981 and 1982 taxation years and restricted the losses to $5,000 in each year, pursuant to subsection 31(1) of the Income Tax Act. These proceedings were launched following the confirmation of the reassessments and the subsequent unsuccessful appeal by the taxpayer to the Tax Court of Canada.

Facts

The plaintiff corporation's president and principal shareholder, Conrad Desjardins, moved to the New Liskeard area from Québec as a young boy in 1939. Mr. Desjardins worked on various dairy farms from then until his marriage in 1951. From 1951 until 1968, he worked for a local trucking company doing various tasks ranging from driving a truck to looking after horses on the company's farms. In 1968, ne purchased his first truck and began hauling under a lease for the Rexwood Company in New Liskeard. The business quickly expanded to a maximum of six trucks and drivers in the mid 19705.

In 1974, Mr. Desjardins sustained a serious back injury which prevented him from returning to trucking and his son Denis came to his assistance by taking a more active role in the running of the company. The plaintiff, incorporated in 1976 to take over all of Mr. Desjardins’ trucking business, has two principal shareholders, Conrad Desjardins and his wife Raymonde. Their son Denis is a minority shareholder.

Because of Mr. Desjardins’ doubts about the survival of his trucking business, he and his family began to discuss the possibility of opening up a farming division. Mr. Desjardins testified that they chose farming, and specifically a cow/calf operation for at least three reasons. First, farming had always been an integral part of Mr. Desjardins’ life and was therefore a comfortable challenge. Second, Mr. Desjardins’ back problems would not impede him from working on a farm as the demands of this occupation are different from those in trucking. Third, he felt he could make money from it. He had seen many farmers make a good living with a modest size herd and knew he could do as well or better. The initial plan was to acquire the money for the farming operation by disposing of the truck assets, most likely to their son Denis, although Mr. Desjardins acknowledged that this step had never been taken because of the huge amount of capital involved in maintaining the trucking operation. Nevertheless, it was always their belief that within a reasonable time the farm would pay its own way and had a reasonable chance of producing a significant portion of the plaintiff's income.

In 1980, the plaintiff’s farming division was opened with the purchase of a 100 acre farm for $51,189.05. A second farm of 160 acres was purchased in 1981 for $82,000 plus the balance of an unpaid tile draining loan. In addition, a total of $85,297.78 was spent on additions to capital during the first three years of the farming operation. These capital expenditures ranged from such things as the repair and construction of barns, sheds and fences, to the purchase of various equipment and machinery needed to run the farm.

Mr. and Mrs. Desjardins were the only employees of the farming operation, but they devoted virtually all of their time to it, from sunlight to sunset, seven days a week, for a great part of the year.

In order to achieve a higher level of productivity, Mr. Desjardins participated in training programs offered by the local community college as well as a red meat program offered by the provincial government The farming division seems to have profited from this training as the size of the herd quickly grew to a level where it could become revenue generating in 1982.

I have reproduced the taxpayer's net income derived from both its farming and trucking operations over the last 13 years. Farming income is shown on a cash and accrual method:

As these numbers indicate, the farming division turned the corner (on an accrual basis) in its fourth year of operation and generated a profit of $5,814.80. In that same year, the trucking division's major client, Rexwood, was hit with a long strike, resulting in the loss of just over $15,000.

Statutory provisions

Subsection 31(1) of the Income Tax Act reads as follows:

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

(a) the lesser of

(i) the amount by which the aggregate of his losses for the year, determined without reference to this section and before making any deduction under section 37 or 37.1, from all farming businesses carried on by him exceeds the aggregate of his incomes for the year, so determined from all such businesses, and

(ii) $2,500 plus the lesser of

(A) 1/2 of the amount by which the amount determined under subparagraph (i) exceeds $2,500, and

(B) $2,500, and

(b) the amount, if any, by which

(i) the amount that would be determined under subparagraph (a)(i) if it were read as though the words “and before making any deduction under section 37 or 37.1” were deleted,

exceeds

(ii) the amount determined under subparagraph (a)(i);

and for the purposes of this Act the amount, if any, by which the amount determined under subparagraph (a)(i) exceeds the amount determined under subparagraph (a)(ii) is the taxpayer's "restricted farm loss” for the year.

Plaintiff's submissions

The taxpayer argues that a careful examination of the data for each division with respect to time spent, capital committed, potential and actual profitability verifies that farming combined with trucking to constitute the taxpayer's chief source of income.

The taxpayer also points to the fact that the farming operations quickly achieved profitability and on several occasions even out-performed the trucking operations. It is, therefore, argued that the case at bar should be distinguished from the “traditional” restrictive farm loss cases where the farm operation incurs heavy losses over an indefinite period of time, never achieving, and likely never to achieve profitability.

Defendant’s submissions

Counsel for the defendant argues that a comparison of the taxpayer's farming and trucking operations, in particular the time spent, the capital committed and the potential and actual profitability indicated that farming would only ever be, at best, a sideline business for the taxpayer.

The defendant also submits that the evidence fails to establish that the taxpayer had any reasonable basis for its belief that farming would provide it with the bulk of its income or the centre of its work routine in the near future, particularly in light of the fact that the decision to move into farming was made without the trappings of conventional business practices, such as business plans and profit projections.

Analysis

In Moldowan v. The Queen, [1978] 1 S.C.R. 480, [1977] C.T.C. 310, 77 D.T.C. 5213, the Supreme Court of Canada provides a comprehensive analysis of the issues relevant to this dispute. The Court concluded that the Act envisages three classes of farmers:

1. Taxpayers for whom farming can reasonably be expected to provide the bulk of their income or the centre of their work routine. Such taxpayers are not restricted by subsection 31(1) and are therefore entitled to deduct the full amount of their farm losses from their other income.

2. Taxpayers for whom farming can be regarded as a sideline business, providing only a less than significant portion of their income. These taxpayers’ allowable farm losses are restricted by the formula established in subsection 31(1) to a maximum of $5,000. [2]

3. Taxpayers for whom farming is simply a recreation or hobby. They are not entitled to deduct any of their farming losses from their income, as these are considered non-business losses and are therefore treated as personal living expenses under paragraph 18(1 )(h) of the Act.

Following Moldowan, it is now settled law that the test to be used to determine what a taxpayer’s chief source of income is both a relative and objective one. The Court should examine: (i) the taxpayer's reasonable expectation of income from each of his revenue sources; and, (ii) the taxpayer's ordinary mode and habit of work. In order to test each of these, the Court should consider various factors for each source of income, including, but not limited to: the time spent, the capital committed, the actual and potential profitability. The requirements of this test were recently restated by the Federal Court of Appeal in Poirier Estate v. The Queen, [1992] 2 C.T.C. 9, 92 D.T.C. 6335, where the Court ruled that:

. . . what is required for a determination that farming is a chief source of income is a favourable comparison of farming with the other source of income as to such matters as the time spent, the capital committed, and the profitability, both actual and potential

[Emphasis added.]

Time spent

The Minister argues that the best indicator of the commitment of human resources in these two divisions should come from their respective personnel records. The requirement of so many more employees for the trucking division supports the Minister’s contention that farming was a relatively minor enterprise. I have difficulty with this proposition, however, because the conditions of the two endeavours are so different. The evidence is that, as the trucking business expanded over the years, in order to render suitable service on a competitive basis, it was necessary to haul over longer and longer runs. One effect of this was to require two or three drivers per vehicle, where originally one had been adequate. Trucking can scarcely be considered to be a labour intensive enterprise, but obviously in the years in question, it was required to increase its employment without any corresponding increase in profit. As against this, it is clear that both Mr. and Mrs. Desjardins ceased any significant contribution to the trucking business and devoted all of their time to farming. I consider this to be more significant in terms of the determinations that I am directed by the Moldowan decision, supra, to make with respect to time spent.

Capital committed

While it is true that a comparison of the capital committed during those ten years, 1980-90, seems to point to a finding adverse to the taxpayer, the same cannot be said of a similar comparison for the years in dispute, namely 1980, 1981 and 1982. During those years, the taxpayer invested over $220,000 for the purchase and improvement of the farm land and the machinery and equipment necessary for its exploitation, while a total of only $51,335 of capital was committed to the trucking operation. This comparison serves to buttress the taxpayer's argument that it had lost faith in the short to medium-term viability of the trucking industry and that it expected farming to soon provide it with the bulk of its income.

Profitability

Finally, the defendant argues that a comparison of both the actual and potential profitability of the trucking and farming operations verifies that farming could only be, at best, a sideline business for the taxpayer. The analysis overlooks the fact that in the years in question the farm operation was just beginning. In many similar disputes, I have noted that farm operations lose money for the first several years and often realistically have only a slim chance of genuine profitability for the foreseeable future. Here, however, the taxpayer claimed that a chance for profit was realistic and proved it very soon after start-up. Indeed by 1983, the trucking operation incurred a loss of $15,586 while the farming profit was $5,814.80 on an accrual basis, and, on a cash basis, the farming loss was $12,825.80 lower than the trucking loss.

Conclusion

With only a few years of formal schooling, it is doubtful that Mr. Desjardins would even have been able to fully appreciate the complexities of a modern business plan. He stated that he never did any of the bookkeeping, and didn't even know how he was paid by the corporation, except that his wife would provide him with money when he needed it. It is clear that Mr. Desjardins was a man guided almost purely by his instincts and observations. He felt that trucking rates were artificially high because of the limited number of brokers in the area at the time and he was always worried about the long-term. He did, however, know that many cow/calf farmers were able to achieve a modest and stable lifestyle with a reasonable sized herd.

In my view, the taxpayer here did everything expected of a person for whom farming was to be not only a business, but one which had the potential to provide a source of income which would compare favourably with his income from the trucking business. The couple devoted all of their time and energy to the farm from the start, leaving the operation of the trucking business to their son and clearly changing the centre of their work routine. They ran it as a business and unlike many other such ventures where the farming enterprise started out losing money and was doomed to continue to do so for an indefinite period of time, the taxpayer here expected to turn the corner on profitability within a short period of time and did so.

The appeal is therefore allowed with costs. The matter is returned to the Minister for the appropriate reassessments.

Appeal allowed.