Avrum Schwam Holdings Inc. v. Her Majesty the Queen (Informal Procedure), [1994] 1 CTC 2728

Archambault, J.T.C.C.:— These are income tax appeals for the 1987 and 1988 taxation years heard under the informal procedure in Montréal. The Minister of National Revenue (the "Minister") has disallowed farming losses of $24,888 for the 1987 taxation year and $31,159 for the 1988 taxation year pursuant to section 31 of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the "Act"). Counsel for the respondent conceded that there was no issue whether the appellant was carrying on a farming business. The only issue is whether the amounts of farming losses are to be restricted pursuant to section 31 of the Act.

Facts

The facts on which the Minister made his reassessments were the following:

(a) at all material times the appellant was an investment corporation;

(b) the appellant apparently began its farming activity during the 1983 taxation year;

(c) the appellant's farming activity was in the field of horse racing;

(d) the appellant paid a jockey to train the horses;

(e) the appellant had no place of business for the horse racing activity;

(f) the expenses that the appellant sought to deduct dealt with the keeping of the horses;

(g) the appellant’s receipts from farming were very low because they were dependent on winnings from horse racing;

(h) the appellant reported the following amounts:

(i) the appellant’s chief source of income during the 1987 and 1988 taxation years was neither farming nor a combination of farming and some other source of income.

Mr. Avrum Schwam, the sole shareholder of the appellant, stated in his testimony that the company held several investments. It had an interest in two operating companies: 75 per cent in Louben Sportswear Inc. ("Louben") and 140 shares in Paradox. The appellant sold the latter shares in 1987 at a profit of $254,000. It also owned term deposits and shares in publicly traded companies such as Royal Trust and Toronto-Dominion Bank. The financial statements for 1985 to 1990 reveal the following information with respect to the capital of the appellant:

These statements do not show any asset for the horse racing business. The cost of the horses was fully written off by the company in the years of acquisition.

Three schedules were filed as exhibits by the appellant showing the farm loss history, the expenses and the gross income:

Mr. Schwam also testified that the appellant received from Louben a $410,000 dividend in 1984 and a $375,000 dividend in 1988.

With respect to the horse racing activities, he stated that the appellant acquired all its horses with other partners. The horses were generally one year old. Mr. Schwam spent five or six hours a week on the horse racing business while he only spent at most two hours a month on the investment activities of the appellant. The company had no other employees involved in the horse racing business. The training and the keeping of the horses were subcontracted to its co-partners. During the 1987 and 1988 taxation years, the company had an interest in 12 horses. The horses could only race when they were two years old. The company made its money only from race winnings and never sold horses at a profit. The shareholder nor his family was doing horse riding. The company did not have any farm property that the shareholder or his family could enjoy. Horse racing was therefore strictly a business. The witness indicated that the average prize for a first place was between $2,500 and $3,000, for second place, $1,500. The first five places would earn some money. He estimated that the company could make up to $225,000 with its 12 horses if they participated in all races.

Analysis

The leading case on farming losses is a 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. Mr. Justice Dickson outlined the task of the Court in dealing with such issues at page 486 (C.T.C. 314, D.T.C. 5215-16):

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

It is also well known that the onus to show that the assessment of the Minister is erroneous lies on the taxpayer. In this instance, the burden was to show that the horse racing constituted in the 1987 and 1988 taxation years the chief source of income for the company. There is absolutely no problem with the fact that the taxpayer carried on its horse racing activities with a view of making a profit. Its activities amounted to the carrying on of a business. This case did not have the features that we often see in farming losses cases where a taxpayer derives personal enjoyment from the facilities used for the farming business. This was strictly a business activity.

However, the law is very clear that in order to deduct the full amount of its losses, the taxpayer must show that the farming business was its chief source of income. I should review the three criteria developed by the Moldowan case. The Court should not appraise the profitability of a particular business venture with the benefit of hindsight. The two taxation years in issue are 1987 and 1988. It is with respect to these two years that the determination of a chief source of income has to be made. Could it be said that the taxpayer had at the beginning of each of these two taxation years an expectation that its horse racing activities would constitute its chief source of income? This determination has also to consider the intentions of the taxpayer when it started the horse racing activities in 1983. Whether the determination is made in 1983 or in 1987 and 1988, I do not think that one could expect the horse racing activities to be the chief source of income for the company. Horse racing is a very risky business. The potential to make more money is higher but, as with any such type of business, the risk of losing is also very present. The substantial amount of dividend paid in 1984, which was the first full year of operation of the horse racing business, further confirms my view that the profitability of the investments was much better than the risky business of horse racing. Clearly the amount of capital committed to the investment activities of the company are significantly more substantial than to the horse racing activities. It is true that the time spent on the horse racing activities was greater than on the investment activities. However, this is not a very significant factor in these circumstances. It is only one factor to be taken into account in determining what was the chief source of income of the appellant during these two taxation years. A fair appreciation of the facts put forward before the Court leads me to the conclusion that the investment activities of the company, not the horse racing business, were its chief source of income.

Finally, although this was not argued by the appellant, I find that the horse racing activities had no connection with the other activities of the company and the resources devoted by the appellant to the farming were not that substantial. I could not therefore conclude that the appellant’s chief source of income was a combination of farming and another source.[1] For these reasons, the appeals will be disallowed.

Claim allowed.