Robert A.B. Jones v. Her Majesty the Queen, [1993] 2 CTC 2392

Hamlyn, T.C.C.J. (orally):— This is in the matter of Robert A.B. Jones, appellant and Her Majesty The Queen, respondent. It is an appeal with respect to the 1986,1987 and 1988 taxation years. In respect of his 1986, 1987 and 1988 taxation years the appellant sought to deduct a farm loss in the amount of $66,937; $86,984; $85,286, respectively. The Minister of National Revenue reassessed the appellant to restrict farm losses for the three years in the amount of $5,000 for each year. Notices of reassessment were mailed to the appellant in July of 1990.

The issue to be determined before this Court is whether or not the appellant is entitled to deduct his farming losses as claimed in the years 1986, 1987 and 1988 from his income from other sources. The appellant's position, as stated, was as follows:

The appellant is a medical doctor and farmer. The appellant became involved as an investor in the standardbred horse industry in the 19805. After a period of several years and intense studies and analysis of the standardbred horse industry the appellant made a decision based on business plans and invested substantial time and effort and financial resources in the breeding, raising, racing and selling of standardbred horses.

The appellant further submitted that from 1984 to the present date the appellant has been extensively involved in this undertaking and its promotion and that from the appellant's position that there was a significant profit shown by 1990 on a cash basis.

The appellant further submits that the start up costs, which included the 1986, 1987 and 1988 losses, were incurred on a cash basis and those losses were used to offset income from other sources at the time of filing his annual tax return.

Lastly, the appellant stated that notwithstanding a significant downturn in the standardbred horse industry the objective and plan of the appellant was achieved with the generation of a substantial net income in the 1990 taxation year and that he had similar expectations for subsequent years.

The Minister's decision was based on the assumptions that were found in the reply. These assumptions were that the appellant during the 1986, 1987 and 1988 taxation years was engaged in the full-time practice of medicine and that the appellant earned amounts of money from his medical practice and other sums from his farming operation. That for 1986, 1987 and 1988 the appellant's medical income was: gross income for 1986 $196,623; 1987 $211,253; 1988 $214,753 and this reduced to a net income of $109,058 in 1986; $124,484 in 1987; $118,965 for 1988. The appellant's farm losses in the same years: gross income $52,149 for 1986; $76,484 for 1987 and $29,490 for 1988. The net loss for 1986 was $51,885; 1987 $107,356 and 1988 $85,286. The respondent concluded from all this that the appellant's chief source of income was neither farming nor a combination of farming and some other source of income.

From the evidence that I have heard the appellant has been a medical practitioner since 1975.

He had an interest in farming activities from a young age.

He worked as a youth in farm activities.

He developed an interest in standardbred horses in 1988. He followed that by intensive study including the acquisition of a large library from journals, stallion histories, registries, brood mare summaries and performance records and sales catalogues. He combined this information with his medical knowledge and his interest in horses to develop a plan for investment in the business of standardbred horsebreeding related activities and he invested in horses with three other individuals in 1982. Thereafter he developed a five-year plan. In 1984 he went out on his own. He intended the plan was to acquire brood mares and yearling fillies. The yearling fillies were to be brought to the racing level, raced for two years and then retired to brood mare status at the end of the third year. After the gestation period of 11 months the foals would then arrive completing the five-year cycle. Dr. Jones reviewed the risk found in the horse business, including lameness, illness, economic downturn in the standardbred business and in particular downturn in the yearlings sale market.

It is clear that the time spent in these horse business activities was considerable for the tax years in question and exceeded the hours that he put into his medical practice, 39 hours per week compared to 29 /4 hours per week.

He also recited to the Court that the reassessment by the Minister of National Revenue had an impact on his horse business. He had to sell inventory to pay his reassessed tax bill and as a consequence this cost him considerable monetary success. His capital invested was, in his terms, a large amount. I refer specifically to Exhibit A-1, Tab 6, which reviews his capital contribution to his medical practice as minimal and his capital contribution to his farm practice as considerable. For the years 1984 through to 1992 the taxpayer maintained the horse business goes on to continuous profitability.

To review the taxation years in question from the taxpayer's tax returns, Exhibit A-1, Tab 1. Net farm losses are shown for each and every year, 1986 $66,937; 1987 $86,984 and 1988 $85,286. In particular, the taxpayer through his Exhibit A-1, Tab 3 maintained the horse business was profitable and this was derived from statements of farm operations for the years 1986 through to 1989 by utilization of adjusting the inventory of horses to the appellant's estimate of inventory value on the 31st day of each year.

He also asked the Court to consider a further exhibit in A-1, being Tab 5, the impact of the reassessment on his horse business. To consider Tab 6 capital investment in borrowing. Tab 2 revenue analysis.

Jurisprudence and legislation

In terms of jurisprudence and legislation in relation to the question, farming as a chief source of income, the following is set forth. The Moldowan position [Moldowan v. The Queen, ([1978] 1 S.C.R. 480, [1977] C.T.C. 310, 77 D.T.C. 5213] provides a two tier test for determining the category of losses. One, does the taxpayer have a reasonable expectation of profit; and two, is farming the taxpayer's chief source of income. Where a taxpayer who is in the business of farming incurs a loss, the loss is subject to the rules applicable to business losses. The test for chief source of income is both relative and objective. The Court must look at the taxpayer's reasonable expectation of income from his various revenue sources.

What is required for farming to be a chief source is a favourable comparison of farming with the other source of income. Including the time spent; the capital committed; the profitability both actual and potential. Moreover, all the factors must be considered accumulatively to determine impact. No factor stands alone. It is not necessary the factors be of equal value. What must also be considered is subsection 31(1) of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the"Act"), which begins:

Where the taxpayer's chief source of income for the taxation year is neither farming nor a combination of farming and some other source of income.

From the case law we find combination as found in section 31 means that it is not necessary that there be a connection by way of physical relationship integration or interconnection between the sources of income. Moreover it is not simply the sum of two sources. As well it contemplates farming as being the major pre-occupation of the taxpayer's economic activities.

Now, the Act does not specifically require the other source of income be either subordinate or sideline. The Moldowan decision that has been referred to me by the appellant, Mr. Justice Dickson utilized the subordinate sideline in his analysis of the classes of farming activities. Judge Bowman in Hover v. M.N.R. (1992), [1993] 1 C.T.C. 2585, 93 D.T.C. 98 at page 2599 (D.T.C. 108), reviewed these descriptions and said:

. . . if I am to give effect to the word “combination”, that by “subordinate” he intended to include a source of income that although substantial is integral to the very existence of the farming operation. . . .

. . . [If] farming [is] a mere sideline operation with no realistic prospect of being a chief source of income, alone or in combination [it is outside the definition].

Judge Bowman further found:

Subordinate means the overall analysis subordinate to the overall objective of the taxpayer that being farming notwithstanding it is not subordinate in terms of cash generation.

Analysis

This taxpayer spent considerable time on his farm business. In fact he spent more time on his farm business than his medical practice in the taxation years in question. This taxpayer also did commit capital from 1984 through to 1992 on a cumulative basis to $125,828 and did borrow money from 1984 through to 1992 on a cumulative basis of $222,000.

This taxpayer was involved and used all his expertise and time in developing knowledge and skill to operate his farm business. In terms of income the taxpayer's income from his medical practice far exceeded his income from the farm business. The net gain on farm income only resulted after the disposition of inventory to satisfy the tax re-assessment. By reducing his inventory he diminished the expectation of future profitability in the plan that he put forward to the Court.

Conclusion

There did not appear to the Court's satisfaction the potential for farm income to equal the medical practice income. Nor was there evidence to show the medical income was integral to the farm income in the sense that the medical income was subordinate to the overall farm objective. I refer back to the Hover decision.

I also could not conclude that the business of farming, albeit important to the taxpayer, was the primary pre-occupation of his economic life.

On the question of profitability the arguments made by the appellant are diminished when one considers the profitability only occurred when there was a substantive reduction in inventory and that the inventory adjustments made by the taxpayer at the end of the year were without full substantiation before the Court. Thus, notwithstanding the time spent, the capital committed and the tacit admission by the Minister by restricting the farm losses that there was a reasonable expectation of profit, significant Tong term reasonable expectation of profit, or potential profit from farming to this appellant for the taxation years in question was not clearly demonstrated to this Court. Full farming losses can only be deducted where a taxpayer's chief source of income is farming, nor a combination of farming and some other source of income in the sense that the other source of income is subordinate to the overall objective of the taxpayer, that is farming. In this case I cannot conclude that the medical practice source of income of the appellant was subordinate to the farm source of income. I also cannot conclude from the evidence that the farming was the overall economic objective of the taxpayer, although it was important for the taxation years in question was neither farming nor a combination of farming and some other source of income. On that basis, unfortunately for the taxpayer, I must dismiss the appeal.

Appeal dismissed.