J. Grant Hardwick and Debbie Hardwick v. Minister of National Revenue, [1994] 1 CTC 2053, 94 DTC 1056

Rowe, D.J.T.C.C.:—The appellant appealed from reassessments of income tax with regard to his 1984, 1985 and 1986 taxation years. The respondent reassessed on the basis the appellant was entitled only to restricted farming losses pursuant to subsection 31(1) of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72,

c. 63) (the "Act"). The appellant’s position is that he is entitled to deduct the full extent of his losses incurred in his farming operation on the basis that farming was a “chief source of income".

The appeals — 89-2184 and 89-1813 of the appellant’s wife, Debbie Hardwick — are from reassessments of income tax for her 1985 and 1986 taxation years, whereby the respondent disallowed the child tax credit as a consequence of having adjusted the income of her husband. Therefore, it was agreed that the outcome of her appeals would be dependent on the disposition of the within appeal of J. Grant Hardwick.

Albert Jeske testified he is a contractor, having moved to Kelowna in 1968 to some property located adjacent to the appellant's farm. He stated that he was familiar with the condition of the property, which was an orchard, and that it had been rented out for several years and was in a rundown condition prior to it being purchased by the appellant. Mr. Jeske stated that he is not an orchardist but he was able to notice the lack of production of fruit on the adjoining property. He saw the appellant construct a house, install a driveway, plant new trees and, over the years, observed the appellant and his wife work extremely hard to improve the property on a continuous basis.

The appellant testified he is a barrister and solicitor living in Kelowna, British Columbia. He is 43 years of age, having been born on a mixed farm in Saskatchewan where he was raised until the age of 18 when he went to university. During the summers, he worked on farms each year until he moved to Kelowna in 1973 to pursue an articling position with a local law firm. While articling, and for two years after his admission to the bar, he kept some livestock on his father's farm and travelled to Saskatchewan during the planting season to assist in seeding the crop. In 1976, his father sold out and moved to High River, Alberta, approximately 70 kilometres south of Calgary. His father now operated a smaller farm and the appellant attempted to purchase land in the High River district but in the years between 1977 and 1980, the price of land was extremely high. He and Debbie Hardwick were married in 1975 and a child was born in 1977. The appellant stated that although he was busy practising law in Kelowna, he "never gave up the hope of being a farmer". He was aware that he had acquired certain skills and values during his lifetime and wanted to pass them on to his children. In the summer of 1980, he saw the farm, which is the centre of this appeal. It was located two miles from Kelowna and the lack of a residence thereon meant he and his wife could design and construct a house that would be suitable to their needs. In addition, there had been a recent planting of five acres of sour cherries. An associate at the law firm had a background in orchards and advised that there were only 500 acres of sour cherries in production in the entire Okanagan Valley. On August 22, 1980 he made an offer to purchase (Exhibit A-1, Tab 3), which was accepted, with a closing date of January 1, 1981. The purchase price of the farm was $350,000. Prior to making the offer to purchase, the appellant undertook certain steps to satisfy himself as to the viability of the property as an orchard. He was provided with financial information pertaining to the 1979 farm revenue in the sum of $21,764 and an estimate of 1980 revenue (Exhibit A-1, Tab 2). The appellant projected the final tally on the 1980 farm production would be in the range of $32,000 to $40,000 due to an increase in the price per pound and the effect of a provincial government subsidy program, known as farm income insurance program, which was introduced that year. The assistance program was calculated on an adjusted cost basis using a model orchard as a benchmark. The program, as originally designed, was to offer a subsidy based on the relationship between the cost per pound of production and the price per pound received by the orchardists. Unfortunately, the program accumulated deficits in the face of a six cent per pound spread between cost of production and selling price and the government reduced the subsidy to a maximum of 2.5 cents per pound.

In 1987, the federal government offered some assistance on an ad hoc basis, at the rate of two cents per pound, relating back to the 1983 crop year. The appellant stated that he and his wife had planted more sour cherry trees so that by 1987, 21 acres out of 35 were in production. That year, the appellant was elected president of the Sour Cherry Growers Association. As a result of competition from imported fruit, mainly from Washington State, the price for sour cherries fell. Later, a trade tribunal imposed a levy on U.S. sour cherries but by then the damage had been done. When he purchased the property, the appellant was of the opinion that the farm, having previously been rented out for many years, was not producing to its capacity and could do so if cared for properly. He thought revenue in the sum of $10,000 per acre from sour cherries was reasonable as they had been selling in the late 1970s at 50 cents per pound. After making the offer to purchase, but before taking possession, he obtained permission to enter upon the land and clean out weeds from the fields. Despite being a full-time lawyer and a partner in a busy ten person law firm, he had some flexibility in dealing with demands against his time. He and his wife did not take extended vacation time away from Kelowna. Out of 2,000 orchards in British Columbia, his research revealed only 25,000 acres were in production, averaging 12.5 acres per orchard. Since his production was double that amount, he wanted to arrive at the point where he could quit practising law and derive income solely from farming. However, in order to purchase the farm at a time of rising interest rates in 1981, he took out a $345,000 mortgage from the Royal Bank at 14.4 per cent annual interest, with a five-year fixed term. Prior to the closing date of January 1, 1981, he had been allowed by the vendor to enter on the property and commence building a house. The appellant stated that he and Mrs. Hardwick spent approximately $100,000 from their own funds to build the residence and to pour the necessary concrete for a workshop and shed. At Tab 6 of Exhibit A-1, an equipment list sets out purchases made in 1980 and 1981, totalling $35,000 with a further sum of $30,000 being expended for equipment between 1984 and 1987. The first machinery purchases were funded by resources on hand, including the disposition of a motorcycle to apply on the purchase of a tractor. In 1982, the appellant replanted 250 trees in the sour cherry block and 400 more were added in 1983 to make up a total of 1,400 trees. A truck was purchased at a dispersal sale and the appellant was able to do his own mechanical work and carpentry while he and his wife operated all of the farm equipment. The list of buildings, filed as Exhibit A-1, Tab 4, sets out certain structures on the farm. The interior work on the house was done by the appellant and apart from the concrete pouring, the work on the sheds were done by him. A cabin was also constructed for use by migrant workers which then served as a storage facility in the off-season. The tree inventory (Exhibit A-1, Tab 5) details the number and type of trees used in fruit production. The Spartan apples, developed in the Okanagan Valley, had good storage capacity compared to other types of apples but a chemical — Alar

— was in common usage on the Macintosh apples, which produced a redder apple with increased storage life. As a result, the packing houses could keep the Macintosh apples longer and encouraged growers to produce them. The Spartan became a "poor cousin” to the more popular "Mac", which sold for twice as much as the Spartan. In 1988, Alar was thought to be carcinogenic and was the subject of a campaign by the well-known consumer crusader Ralph Nader, leading to curtailment of its application on apple crops. Thereafter, the Spartan, brought in 23 cents per pound while the Mac sold for six cents. The appellant stated that sour cherries now sell for 35 cents per pound, another example of price reversal in the industry.

The appellant took courses at Okanagan College in spraying and pruning and installed an irrigation system featuring more than 120 pipes which had to be moved manually, a task requiring more than 1.5 hours per day during the period May 1 to September 15 each year. At Tab 7 of Exhibit A-1, the appellant listed activities carried out on the orchard during a typical season. An insect identified as the Pear Psylla, attacked pear trees and Canada did not permit importation of a chemical, available in the United States, which destroyed the pest. As a result, the pear trees had to be washed repeatedly using a sprayer loaded with water and a common household detergent. He purchased a self- propelled limb-lopper to use on the trees and contracted out only the apple tree pruning. In 1985, he and his wife picked the sour cherry crop and in 1986 and onwards, increased production required hiring of up to 25 pickers. The harvesting began at 3:00 a.m. and continued until noon when the heat caused the fruit to crush and tear. The apple picking, which began in late September or early October, was all done by hand, as mechanical pickers were too expensive even though his orchard had the proper density for mechanical harvesting.

In April 1984, a killing frost at bloom time affected the apples and pears and wiped out the beginning cherry crop. Since young trees build tonnage incrementally, a frost in one season sets back the process by one full year. In November 1985, a fall frost damaged trees, affecting the crop in 1986 and also 1987 production. During his years on the orchard, 1981 was the only completely frost-free year. The appellant testified that, despite climactic conditions such as this, the Okanagan Valley has been the location of successful orchards for more than a century.

The appellant stated that despite all of the work done on the farm by Mrs. Hardwick, not one cent was paid to her in wages or charged out as labour costs against farm income. Between 1981 and 1986, the appellant stated that a reliable estimate of time spent by him farming each year was 1,000 hours, spent as follows:

irrigation — 150

pruning — 150

picking — 50

hauling fruit — 20

tractor time — 300

care of young trees — 200

thinning — 50

fertilizing, repairs, miscellaneous — 80

The appellant stated that the month of November was the only one which generally did not require some work to be done on the orchard. The pruning process began in December and continued through to the middle of April. The orchard, during winter months, did not interfere with his law practice. However, during the summer, he would rise before the sun and spray apples, then go to the office and return to the farm by 4:00 p.m. and work until dark. He was of the view that in 1987-1988, the sour cherries, in combination with other crops, would permit him to treat his law practice as a sideline, to be worked at only if he chose to do so and at a rate to be regulated by him. The house was paid for, they had a large garden, 50 chickens, and a low cost of living. He was aware the land was situated within an agricultural land reserve and would be used as a farm for the foreseeable future. He tried to sell the farm in 1985, had a conditional offer, but it fell through. In 1988, the Kelowna economy was booming and he again took steps to sell the land. On February 28, 1989, he and his wife sold the farm for $520,000 and the agreement (Tab 8 of Exhibit A-1) at page 4 set out the agreed allocation of purchase price. The purchaser was a corporation operated by a well-known family of orchardists and a son now farms the orchard without any extension or deletion of crops from that in place at the time of sale by the appellant.

In May 1989, the appellant bought a farm, with four acres of orchard — producing mainly Spartan apples — 12 kilometres from Kelowna. Between 1990 and 1992 the orchard produced 75,000 pounds of fruit. The new operation was less demanding of his time and he was able to serve as a bencher of the Law Society of British Columbia. In terms of capital committed to the original farm, the appellant stated he put in $140,000 from his own resources, without borrowing, and had another $350,000 capital at risk. By comparison, his law practice, acquired in 1975 and paid for by 1980, had a capital commitment of less than $50,000. His current farm mortgage bears interest at the rate of eight per cent while the best rate on the original farm mortgage was at 11 A per cent when it was renewed in 1986.

In cross-examination, the appellant stated the interest charges of $60,659.90 in 1982, were comprised of mortgage interest, operating loan interest and an equipment loan. He worked at his law practice, 40 hours per week for 11 months per year. His goal was to produce gross revenue of $100,000 per year from hard and soft fruit. He agreed that his net income, in round figures, from the law practice for the years 1982 to 1988 was as follows:

1982 — $90,000

1983 —$64,000

1984 — $52,000

1985 — $69,000

1986 —$57,000

1987 —$70,000

1988 —$90,000

In 1988, the gross revenue from the farm was $51,965.72, approximately 50 per cent of the amount he had been attempting to achieve. On his new farm, he considers 100 per cent of his mortgage interest to be personal and living expense and does not charge any portion thereof against farm income. The new farm is regarded as nothing more than a sideline business. In 1988, he was a member of a political action committee of orchardists attempting to have land removed from the agricultural land reserve designation, an action which led directly to the government handing out two cents per pound by way of a grant to producers. The appellant stated that his farm was in a frost-prone zone and that the "window of vulnerability" was the last half of April and the first week of May. In the mid-1980s the foreign markets shrunk and the competition from Washington State growers was such that, with improved transportation methods, their produce could be in Vancouver quickly and Kelowna's proximity to that large market was no long an advantage. In any event, only 17 per cent of British Columbia produced fruit is consumed within the province.

Debbie Hardwick testified that between 1981 and 1988, she became fully involved in farming. She took classes at the college in spraying, pruning, planting, and handled the contact with the field representatives from the various packing houses. She monitored the ripening crop, supervised pickers, and did all of the things required during the picking season. The hours were long, beginning at 5:00 a.m. and ending at 10:00 p.m. during the high season.

The appellant submitted that his farming activities, although somewhat less consuming of his time than the practice of law, were seasonal in nature. In addition, his overall, extensive, experience in farming was such that his time was productively spent. The capital committed to farming far exceeded that invested in the law practice. The potential for profitability certainly existed and there was a clear and discernable pattern of growth in gross income from the farm, notwithstanding the intervention of serious. difficulties created by weather and market forces. The extent of the profit to be reasonably expected was such that the predominance of income from the law practice would be reversed and the farm would logically continue its evolution to provide the chief source of income.

Counsel for the respondent submitted that the jurisprudence is such, especially in light of recent decisions issued by the Federal Court of Appeal, that the appellant’s farm income was not, and could not have been, other than a sideline business, having regard to all of the factors to be considered.

The seminal case in the area of farm losses is the decision 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. Then, the Federal Court of Appeal in The Queen v. Morrissey, [1989] 1 C.T.C. 235, 89 D.T.C. 5080 reconsidered the issue. As a consequence, Strayer, J. of the Federal Court-Trial Division, in Mohl v. Canada, [1989] 1 C.T.C. 425, 89 D.T.C. 5236, applied the resulting methodology and the extensive analysis done by him at trial in Morrissey to deal with the issue and arrive at the conclusion the taxpayer had produced nothing more than a sideline business. The Federal Court of Appeal then considered full farming losses in the case of Poirier Estate v. The Queen, [1992] 2 C.T.C. 9, 92 D.T.C. 6335 and most recent, the case of Timpson v. M.N.R., [1993] 2 C.T.C. 55, 93 D.T.C. 5281.

In Moldowan, supra, at pages 487-88 (C.T.C. 315; D.T.C. 5216) of the judgment of Dickson, J. (as he then was), His Lordship stated:

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 subsection 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 subsection 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 subsection 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 place 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.

In Morrissey, supra, the taxpayer like the appellant in this appeal, had been granted the concession by the respondent that he was farming with a reasonable expectation of profit. As to the suitability of the taxpayer falling into the category of a class 1 farmer, Mahoney, J. at page 242 (D.T.C. 5084) stated:

On a proper application of the test propounded in Moldowan, supra, when, as here, it is found that profitability is improbable notwithstanding all the time and capital the taxpayer is able and willing to devote to farming, the conclusion based on the civil burden of proof must be that farming is not a chief source of that taxpayer's income. To be income in the context of the Income Tax Act that which is received must be money or money's worth. Absent actual or potential profitability, farming cannot be a chief source of his income even though the admission that he was farming with a reasonable expectation of profit is tantamount to an admission which itself may not be borne out by the evidence, namely that it is at least a source of income.

In Mohl, supra, at page 428 (D.T.C. 5238-39), Strayer, J. stated:

It now appears clear from the Supreme Court decision in Moldowan, supra, as recently interpreted by the Federal Court of Appeal in Morrissey, supra, that, for a person to claim that farming is a chief source of income, he must show not only a substantial commitment to it in terms of the time he spends and the capital invested, but also must demonstrate that there is a reasonable expectation of it being significantly profitable. I use the term “ significantly profitable” because it appears from the Morrissey decision that the quantum of expected profit cannot be ignored and I take this to mean that one must have regard to the relative amounts expected to be earned from farming and from other sources. Unless the amount reasonably expected to be earned from farming is substantial in relation to other sources of income then farming will at best be regarded as a sideline business to which the restriction on losses will apply in accordance with subsection 31(1).

The decision of the Federal Court of Appeal in Timpson, supra, was delivered by MacGuigan, J.A. and the entire judgment is as follows:

The leading case with respect to the deduction of farming losses from income from another source is Moldowan, supra, per Dickson, J., as he then was.

At the time the Trial Judge decided this case in 1987, the implications of the Moldowan test had not been so fully spelled out by this Court as they have been since in Morrissey, supra, Gordon v. Canada, [1989] 2 C.T.C. 277, 89 D.T.C. 5481 (F.C.A.), Roney v. M.N.R., [1991] 1 C.T.C. 280, 91 D.T.C. 5148 (F.C.A.), Connell v. M.N.R., [1992] 1 C.T.C. 182, 92 D.T.C. 6134, Poirier, supra.

The trial judge limited his examination solely to the question of the taxpayer's reasonable expectation of profit (Appeal Book at 147):

I am satisfied on the evidence here that the plaintiff had a “ reasonable expectation of profit”. Most assuredly this profit did not arise as soon as the plaintiff predicted but the market, the high interest rates and the time required to gain credibility all conspired to delay what he had every right to expect — a profit.

But this consideration gets, at best, only to a finding that farming is a" source of income,” not that it is "a chief source of income”, as required by subsection 31(1) of the Income Tax Act.

We find this case to be on all fours with Poirier, supra, where we said at page 10 (D.T.C. 6336):

It is. . .now clear 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. . . .

Applying the present view of the law to the facts in the case at bar, it is patent to us that farming was in a subordinate position to the respondent's employment occupation. Farming comes closest to a rough equality on the time factor, but it lags far behind on the capital and income tests.

In our view, the trial judge would have come to the same conclusion in the case at bar if he had applied the correct legal test.

The appeal should therefore be allowed with costs both here and in the Trial Division, the decision of the trial judge of May 12, 1987, set aside, and the reassessments for the 1977 and 1978 taxation years restored.

The schedule of the appellant's farming income and expenses for the years 1982 to 1987, inclusive is as follows:

As noted earlier, income from the law practice for those years ranged from $52,000 to $90,000.

There is no doubt that the appellant was an experienced, hard-working individual who, with the assistance of his wife, was able to perform a great many tasks that might otherwise have been the subject of hiring or contracting out. He applied himself to the task of growing fruit and acquired a substantial amount of expertise in that area. A substantial amount of time each year was devoted by him to farming: 1,000 hours per year up to 1986, and 1,200 hours per year thereafter. Based on the appellant's testimony, the time spent at the law practice would have been in excess of 1,800 hours per year. There was a substantial amount of capital committed by the appellant to the farm but $100,000 was applied to the construction of a residence and almost the entire amount of the actual land purchase price of $350,000 was financed. There was a large amount of capital at risk in the form of a mortgage and other borrowing which, at times, approached the sum of $400,000. It is the amount of interest required to service the debt which created a drain on farm income, especially in the early years. By 1987, the total interest charges were $42,702.82, out of a total yearly expense of $87,032.63 and gross farm income was still at slightly more than $50,000. The fruit industry in the Okanagan Valley was battered by various combinations of climate and market forces and it may be that the prospect of a competently managed, average size orchard producing, in an average year, sufficient income to sustain a family of modest needs, is remote. For the appellant, in terms of the profitability of the farming operation, both actual and potential, farming lagged far behind his law practice. The potential for profit, had the weather and market conditions been better, would have been considerably greater than what actually resulted but still would have been in a subordinate position to the practice of law for the years under appeal. The appellant indicated that his projections for farm revenue were twice the actual revenue generated by 1988 but even a doubling of that revenue, while constituting a more favourable comparison to non-farm income, still would have been subordinate to the law practice income, and compared to that source, would still have to be regarded as a sideline business. It is an imprecise process by which all of these factors are taken into account and there is no scientific method of assigning a particular numerical value to one or other of the factors involved. As MacGuigan, J.A. stated in Poirier, supra, at page 10 (D.T.C. 6336):

It must be remembered that it is the cumulative impact of the various factors for determination that governs, not any one factor taken disjunctively. . . .

The Minister was correct in restricting the appellant's losses pursuant to subsection 31(1) of the Income Tax Act. The appeal of J. Grant Hardwick is dismissed. The appeals of Debbie Hardwick, being dependent on the outcome of the appeal of her husband, are also dismissed.

Appeals dismissed.