A. Gagné Construction Ltée v. Minister of National Revenue, [1993] 1 CTC 2199, [1992] 2 CTC 2793

Tremblay, T.C.C.J.:—This appeal was heard on September 25, 26 and 27, 1990, and on January 30 and 31, 1991, at Sherbrooke, Quebec.

1. Point at issue

The point at issue is whether the appellant, a company which has been doing excavation work since 1963, but which obtained supplementary letters patent in 1972 permitting it to operate farming business, is entitled, in the computation of its income with respect to the 1979, 1981, 1982 and 1983 taxation years, to deduct all of the farming losses for those years, varying from $47,000 to $270,000, and totalling $523,000.

The respondent considered these to be restricted losses, and therefore reduced them to $5,000 for each year. For year 1980, the Minister of National Revenue applied part of the loss incurred in 1979 against the profit of $2,175. In support of his assessments, the respondent argued, inter alia, that from 1972 to 1983, the farming business had losses every year except for three years when the appellant's farm income percentage comprised only 3 to 5 per cent of its total income. The respondent also argued that the time spent by the appellant on its farming activities is much lower than the time spent on the excavation business, and that its investment in the farming business amounted to only 10 per cent of the investment in the excavation business.

In the view of the respondent, the farming business was merely secondary. The excavation business always was and still is the chief source of income.

2. Burden of proof

2.01 The burden is on the appellant to show that the respondent's assessments are incorrect. This burden of proof results from several judicial decisions, including the judgment delivered by the Supreme Court of Canada in Johnston v. M.N.R., [1948] S.C.R. 486, [1948] C.T.C. 195, 3 D.T.C. 1182.

2.02 In the same judgment, the Court decided that the assumed facts on which the respondent based his assessments or reassessments were also deemed to be correct unless proved otherwise. In the case at bar, the facts assumed by the respondent are described in subparagraphs (a) to (q) of paragraph 8 of the respondent's notice of appeal. At the beginning of the hearing, the appellant admitted or denied certain paragraphs and indicated that others were "to be reviewed". Paragraph 8 reads as follows:

8. In reassessing the appellant for its 1979 to 1983 taxation years inclusively, the Minister of National Revenue relied on the following facts, inter alia:

(a) the appellant is a company duly incorporated under the statutes of Quebec which specializes in excavation work and has operated since year 1963; [denied]

(b) on November 30, 1972, the appellant obtained supplementary letters patent in order to expand the objects of the company to permit it to operate a farming business; [admitted]

(c) the appellant's fiscal year runs from January 1 to December 31; [admitted]

(d) the appellant reports farm income for income tax purposes using the cash method and for purposes of its financial statements using the accrual method; [denied]

(e) the principal shareholder and president of the appellant is Mr. André Gagné who was, inter alia, the president of the Canadian Hereford Association in 1980; [admitted]

(f) the appellant started its farming business in 1972 by buying a 200 acre land and specializes in raising Hereford cattle, operating under the name "Ranch Lougami" [admitted]

(g) apart from the president, Mr. André Gagné, the vice-president of the appellant and Mr. André Gagné's son, Mr. Michel Gagné works full time managing the "Ranch Lougami”; [admitted]

(h) Mr. Michel Gagné obtained his bachelor's degree in 1975 in biology and bioagronomy from L’Université Laval, and also was or still is a director of the Canadian Hereford Association; [admitted; as well, Mr. Michel Gagné's testimony and Exhibits A-1, A-2 and A-3 confirm these facts. He was even president in 1986.]

(i) apart from Mr. Michel Gagné who was a full time employee of the "Ranch Lougami”, the farming business also hired a full time farmer during some of the years under appeal, as well as two or three other people on a casual basis; [admitted]

(j) on the other hand, the appellant's principal business, i.e. excavation, operates from mid-April to mid- November, with a core of some twenty employees who have worked there for more than 15 years, and supervision of this work is shared by the principal shareholder, Mr. André Gagné and Mr. Denis Belcourt, the manager, who has been an employee for more than 20 years; [denied]

(k) the wages paid in both the excavation business and the farming business are as follows:

	EXCAVATION	FARMING	% FARMING
YEAR	WAGES	WAGES	EXCAVATION
1979	$945,322	$11,271	0.01
1980	989 ,682	11,996	0.01
1981	440,155	59,850	13.5
1982	436,510	55,709	12.7
1983	367,608	54,386	14.8

NOTE: according to financial statements [denied]

(I) the fixed asset values in both the excavation business and the farming business are as follows:

	EXCAVATION	% INCREASE	FARMING	% IN	% FARMING
YEAR	FIXED ASSETS	IN THE YEAR	ASSETS	THE YEAR EXCAVATION
1979 $1,465,983		—	$181,211	..	12.30
1980	1,620,368	10.50	181,211		11.80
1981	1,845,255	13.80	181,211	—	09.80
1982	1,858 ,964	0.007	187,171	3.20	10.06
1983	1,932,396	3.90	187,796	0.003	09.70

NOTE: according to financial statements [to be reviewed: see 3.21]

(m) the appellant’s farming business has accumulated losses from year to year since 1972, except for the minimal profits reported in 1974, 1976 and 1980, as appears in the following table:

			INVENTORY
		PROFITS	BASE	No. OF
YEAR SALES (loss)			FISCAL YEAR ANIMALS
1972	—	$( 5,502)	$ 76,220	——
1973	$ 9,195	( 23,832)	88,020	—
1974	19,477 ( 7,126)		126,500	—
1975	20,290	( 12,147)	185,000	—
1976	26,233 ( 2,477)		242,000	—
1977	34,821 ( 4,920)		299,620	—
1978	95,217 ( 7,767)		348,800	—
1979	102,471	( 47,237)	398,500	171
1980	130,743 ( 2,175)		504,300	189
1981	73,323	’(143,342)	600,000	336
1982	221,723	*(270,365)	328,220	164
1983	91,833	*( 62,115)	327,645	134

NOTE: "A.G.C.L." changed from accrual method to cash method of accounting in 1981. The inventory shown at 31/12/81 was $537,141, and for 1982 it was identical to the figure shown in the financial statements filed on the cash basis: $328,220.

The losses shown on the financial statements amounted to ($121,548) in 1981, ($288,681) in 1982 and ($47,362) in 1983; [to be reviewed: see 3.18]

(n) the sales figures for the excavation business and the farming business were as follows:

YEAR	SALES	SALES	% FARMING/
	EXCAVATION	FARMING	EXCAVATION
1979	$3,543,215	$102,471	2.9
1980	3,903,696	130,743	3.3
1981	1,991,214	73,323	3.6
1982	2,433,009	221,723	9.1
1983	1,477,410	91,833	6.2

NOTE: according to financial statements [to be reviewed: see 3.17]

(o) the operating profits of the excavation business and the figures for the farming business are as follows:

	EXCAVATION	FARMING
YEAR	OPERATING PROFITS	(loss)
1979	$187,253	$( 47,237)
1980	27,214	2,175
1981	292,568	(121,548)
1982	208,673	(288,681)
1983	1,561	( 47,362)

NOTE: according to financial statements [admitted];

(p) the appellant’s farming activity is a secondary activity, a marginal source of income, and the farming operations exist because the chief source of income exists; [denied]

(q) the appellant’s income for each of the taxation years in issue was not derived primarily from either farming or a combination of farming and some other source, and the respondent restricted the appellant's losses from its farming business under the provisions of section 31 to $5,000 for each of the years in issue; [denied]

[Translation]

As well, in paragraph 10 of the reply to the notice of appeal, the respondent admitted that during the years in issue the farming business had a reasonable expectation of profit, in view of the investment made by the appellant.

3. Facts

3.01 The admissions made in respect of subparagraphs (b), (c), (e), (f), (g), (h), (i) and (o) of paragraph 8 and of paragraph 10 of the reply to the notice of appeal need not be repeated here.

3.02 At the end of December 1971, the appellant purchased part of Mr. Dion’s farm on which the farming business was to be established. In 1973, it acquired the balance of the land, with the house. The 1972 financial statements show that the appellant gave the depreciated value of the farming business's fixed assets as $75,330.

3.03 In the fall of 1972 Mr. Gagné went to the West with the help of a skilled person, Mr. David Fontaine, and purchased a Hereford bull named "Spec- taculor" for the price of $55,000, and 19 young Hereford cows for the price of $25,000. An American farmer offered to purchase a 50 per cent share of Spectaculor for $30,000, but because they were not then familiar with that type of purchase they refused.

3.04 According to Mr. André Gagné, the purchase of the farm and the purebred cattle was something he had dreamed of since the family farm was sold when he was just a teenager. To him, the appellant company was only an intermediary for achieving his goal: making the farming business his chief source of income.

In 1965, he had acquired part of a piece of land from a Mr. Picard, on which there was a maple grove. He had built his house there, and lived there with his family (he had been married since 1950). In 1968 he purchased 12 heifers; in 1970, he purchased the balance of the maple grove along with hybrid and purebred cows.

Mr. Dion's land, which he bought in 1972-73, was next to the land he bought from Mr. Picard, and together the two properties comprised about 190 acres.

In fact, his aim was to retire to his farm at the age of 45. He also gave his son Michel his liking of the farm; Michel was an agronomist, and his nickname was “le boeuf" because he was always talking about raising beef cattle. Both he and his brother Daniel, who found happiness in mechanical things, never had any interest in carrying on the excavation business.

3.05 Mr. André Gagné hoped to be able to sell the excavation business and devote himself full time to the farming business. He kept the excavation business machinery as long as possible. However, he was unable to find a buyer for either the business or the machinery.

3.06 The difficulty in selling the excavation business did not prevent the appellant from doing everything he could to make the farming business a financial success. For Mr. André Gagné, it was only a question of time before it became the principal business, particularly since his agronomist son was devoting all his energy to it.

The plan of action was first to stay out of the milk business, because at that time the market was not good; the cost of quotas was very high and too much time had to be devoted to it in comparison to raising beef cattle.

As well, the beef cattle market was insufficient in Eastern Canada, with Quebec producing only 15 to 20 per cent of the beef consumed. There was therefore a better opportunity to establish a profitable business in this area, particularly by using a purebred breed such as Hereford: in addition to beef cattle, sale of purebred cattle and sale of sperm by artificial insemination were significant factors in generating profits.

3.07 A number of exhibits were filed relating to the Canadian Hereford Association (Exhibits A-3 and A-4), photographs and publications relating to Hereford shows, and auction catalogues, all relating to purebred Hereford cattle (Exhibits A-21, A-22, A-23 and A-32). As well, photographs and catalogues relating to the appellant's farm, called “Ranch Lougami" (Exhibits A-5 to A-20, A-24, A-30, A-32 and A-33) were filed.

3.08 All these exhibits showed not only the extent to which the appellant purchased good cattle and invested in fixed assets, but also that its shareholders were involved in both the Quebec and Canadian Hereford Associations as directors and presidents (2.02, paragraphs 8(e), (f)) and that they were active in shows and auctions.

3.09 In 1973, two heifers from Ranch Lougami were ranked 33rd and 36th at the Exhibition in Toronto. In 1975, one heifer brought in a 2nd prize in Toronto. In 1976, again in Toronto, one of Ranch Lougami's steers was judged grand champion.

In 1978, with its six best head of cattle, Ranch Lougami was judged best breeder, best exhibitor and grand champion at the Exhibition in Toronto.

At the Exhibition in Quebec City from 1978 to 1983, Ranch Lougami was also judged best breeder and best exhibitor.

3.10 In the fall of 1978, the appellant started an embryo transplant program, which it was anticipated would produce exceptional results. This new technique consisted in taking the embryo from a purebred cow inseminated by a bull of the same quality and inserting it into a recipient surrogate female in good health, but of lesser quality. The resulting calf should be top quality, if it reached term.

As soon as the embryo was transferred, the process could be recommenced at the next ovulation of the top quality cow, and a new embryo created which would be transferred also.

Thus, starting with one top quality cow, between ten and twelve purebred calves could be produced within a year. Because these calves could be sold after six or eight months for between $1,200 and $1,600, and the main expenses amounted to purchasing the recipient female and its feed, the appellant was justified in anticipating an attractive source of income.

At the sale of Elite cattle in October 1980 in Uxbridge, Ontario, the average price of cattle one year old and over was $6,400 per head (Exhibit A-21). At that sale, bidding indicated that young top quality females about one and a half years old sold at between $1,450 and $3,800, a young cow born in January 1978 sold for $54,000, another born in March 1979 for $7,500, in April 1979 for $13,000, and in April 1980 for $12,000.

Moreover, a female born in April 1980 sold for $2,100, a female born in March 1980 for $4,250, another born in March 1980 for $2,750, and a male calf born on April 14, 1980 on the ferme Saguenay in Ville de la Baie, Quebec, sold for $12,500.

On other farms, a calf born on February 3, 1980 sold for $2,500; one born on February 2, for $44,000; one born on March 3, for $42,500; one born in January 1980, for $33,000; one born in March 1980, for $7,400; one born on March 21, 1980, for $36,000; and one born on March 13, 1980, for $86,000.

The result of the transplant program in financial terms would therefore have been as anticipated by the appellant, had it not been for problems encountered in transplanting the embryo into the surrogate cow, which resulted from the fact that there were no expert veterinarians on site. These experts had to be brought in from Toronto, and cattle even had to be sent to Toronto. Only a third of the surrogate mothers were successful. The others stayed on as boarders during that time.

The experiment continued until 1981. “Insemination and veterinary" expenses were $26,530 in 1979, $31,350 in 1980 and $42,300 in 1981, while previously they had been on the order of $12,000. As well, the appellant purchased 100 cows as surrogates, some of which were paid too much money. They were subsequently sold for slaughter, and so at a lower price.

At the auction in October 1982, two animals produced from embryos transplanted into surrogates were sold for $4,300 (No. 97 on Exhibit 1-2) and $10,400 (No. 99 on Exhibit 1-2) respectively, for an average of about $7,000. The appellant asserted that that showed that if the transplant program had worked it would have been a financial success.

3.11 After the auction sales at which the appellant's directors attended in 1980, they had planned to prepare a sale at Ranch Lougami. In spite of the advice of a friend of the ranch to proceed with the sale in 1981, it was decided to set the sale for September 25, 1982. They believed that this time period would allow them to build up the herd and so make more money.

Ranch Lougami advertised to this effect in“ "The Canadian Hereford Digest" in 1981 (Exhibit A-22) and 1982 (Exhibit A-23). As well, a special colour publication entitled "Lougami-Bluehills" advertised the sale of cattle from Ranch Lougami (Asbestos, Quebec) and from the Bluehills farm (Georgeville, Quebec) on September 25, 1982. The best animals of the two herds, with their pedigrees, were shown. All of this advertising cost more than $20,000. The sale of the Lougami cattle produced $84,835 (Exhibit 1-2), when sales of more than $250,000 were anticipated.

The first reason was the revival of the Charolais breed. The weakness of this imported breed was that cows tended to lose fetuses during their first years of calving. In about 1981, a solution was found to this problem. In 1982, the popularity of the Charolais resulted in Herefords becoming less popular. The second reason was the death of 30 calves from diarrhea.

Finally, the economic recession was at its deepest in 1982 and had also struck farmers.

3.12 Following this failure, and a loss of $270,000 in 1982, despite a gross income of $221,700, it was considered best in 1983 to reduce inventory. Because of the economic crisis, prices and markets were falling in the farm sector as well, and this went on until 1985. The accountant and the banker even suggested to the Gagnés that they consider something else; they did not want to abandon it. They hoped that the sugar bush could be operated to better advantage, and in early 1984 they heard some talk about testing stations.

3.13 The testing station is a farm to which a number of purebred steers are brought. They are fed on a specific diet to obtain a superior quality of meat. The government of Quebec, whose specialists in the department of agriculture established the terms, provided the expertise, and it wanted private enterprise to take the initiative in building and administering the eight or nine stations of this nature in Quebec. The Association des stations d'épreuves de taureaux de boucherie des Cantons de I'Est was then formed, and Mr. Michel Gagné became its vice-president.

In April 1985, after a thorough study of all the implications of establishing a testing station, the appellant decided to apply for the right to do so. Mr. Michel Gagné then resigned as vice-president of the association.

On October 2, 1985, the appellant entered into a contract with “La station d'épreuves de taureaux de boucherie des Cantons de I'Est" (Exhibit A-34). The appellant undertook, inter alia, to provide premises which could hold a minimum of 115 steers and to comply with the rules concerning feed, insurance, and so on. The company undertook to pay the appellant $1.15 per pound of weight gained during the complete duration of the test, with a minimum of $300 payable in three instalments: $125 when the steer went in, $150 in the middle of the period and the balance at the end.

The slaughter steer genetic assessment station certificate for the Cantons de I'Est station (051) for 1990-91 was filed as Exhibit A-25. This document acknowledges that the appellant’s station had a capacity of 357 slaughter steers: 202 in Building 1 and 155 in Building 2. This document was issued by the ministère de I'Agriculture du Québec on August 23, 1990.

In order to demonstrate the great value of the testing station system, the appellant filed photographs of two 10-month-old Hereford calves. One was taken in 1978 (Exhibit A-32) and the calf weighed 950 pounds. This calf, which was owned by Ranch Lougami, had been judged the champion at the Toronto Exhibition that year. The people behind the animal were taller than it by almost half their height. The second photograph, taken in 1986 (Exhibit A-33), shows a calf which had followed the treatment program at the testing station and weighed 1,070 pounds. The people behind it were taller than the animal by only their head and a little of their shoulders.

3.14 Ranch Lougami's profits or (losses) for the period from 1984 to 1989 were as follows:

In 1984 and 1985, the respective cost of changes in inventory in the operating expenses was $54,440 and $170,865.

The following table (Exhibit A-26) shows the changes in the figures for the period from 1985 to 1989:

Number of slaughter steers placed under control at the Asbestos station and for all stations in Quebec during the last 5 years

ASBESTOS				ALL STATIONS
TEST	No of	No of	No of	No of	No of	% OF STEERS
YEAR	tests	steers	stations	tests	steers	IN ASBESTOS
85-86	3	195	7	13	781	25.0
86-87	2	261*	7	11	793	32.9
87-88	2	309	8	12	936	33.0
88-89	3	373	8	11	895	41.7
89-90	2	315	9	14	954	33.0
TOTAL 12		1,453 —		61	4,359 33.0

"' The steers in the second lot died in a fire. A total of 108 steers had been brought in that second lot.

[Translation]

In 1988-89, the appellant's cost was 0.82 per pound gained and the rate paid per pound gained was $1.22 (Exhibit A-27).

3.15 It should be noted that the cattle were owned by various farmers who delivered them to Ranch Lougami. If an animal died, as happened when there was a fire on November 13, 1986, the loss was borne by the owner of the animal. After remaining at the station for 183 days, the animals were sold at auction. The price was paid to the owner. Regardless of the sale price, the appellant was guaranteed payment for each pound of growth. If the sale price for the cattle shot up, the owners received the profit, not the appellant. Thus, the appellant asserted, while it did not expect outrageous profits, this testing station operation provided a stable income.

3.16 In support of its argument that over a period of 10 to 15 years the appellant's intention was to operate the farming business as a chief source of income and the excavation business as a secondary business, a table of the sales of each business over the period from 1972 to 1989 was filed. Sales of the excavation business (Exhibit A-39) went from $1,100,000 to $2,600,000 in 1977, followed by a sudden decrease to $1,600,000 in 1978. In 1979, the business rose sharply again to $3,600,000 and $3,950,000 in 1980. Then in 1989 it fell again, this time to $650,000.

For the farming business (Exhibit A-40), gross income started from zero in 1972 and rose slowly to $150,000 in 1979; it fell back to about $95,000 in 1981, climbed to $275,000 in 1982 and then fell again to $110,000 in 1983. The business again went up and reached $550,000 in 1988, and its income then fell to $420,000 in 1989.

3.17 The appellant filed statements for both its businesses showing sales, operating profits, salaries, inventory, fixed assets and promotion as Exhibit A-38 en liasse.

Sales for the two businesses were as follows:

3.18 The operating profits from the two businesses were as shown below in the first two columns. The third column describes the profits from the farming business before deducting the salary paid to Mr. Michel Gagné starting in 1980 and to his wife Ginette starting in 1983. These deductions total between $28,000 and $35,000 per year.

Counsel for the appellant advised that the 83-89 average was a loss of about $47,723 for the excavation business and of about $606 for the farming business.

The averages were calculated from 1984 to 1989 because of variations which had to be made in the accounting methods.

The purpose of deducting the salaries is to put the appellant's farming business on the same footing as an unincorporated farming business in which all the profits (or losses) were profits or losses to the unincorporated taxpayer as in Moldowan (4.02(2)).

On the other hand, however, it seems that in 1980 there was an error in respect of the farming business: a profit of $2,175 and not a loss of $47,906 (see 2.02(8)(o)) should show in the 2nd column.

In the 3rd column, therefore, we should add Mr. Michel Gagné's $38,823 salary, which gives a profit of $40,998 instead of a loss of $19,083.

3.19 The salaries for the excavation business and for the farming business were as follows:

3.20 The stocks or inventories of the appellant's two businesses were as follows:

3.21 The fixed assets book value for the two businesses were as follows:

The book value is the purchase price of the property less depreciation. From 1980 to 1989, the appellant did not purchase any other assets for the excavation business, the idea being to cut back on this business's activities.

3.22 Promotion expenses incurred by the excavation business include advertising, entertaining and gratuities:

3.23 The source of the figures in the various tables set out above is the appellants financial statements, as they were explained by Mr. Christian Côté, an accountant with the firm Raymond, Chabot, Martin, Paré and the appellant's auditor and consultant. This accounting firm, which had acquired the accounting firm Bélanger, Hébert of Asbestos at the end of 1981, continued with that firm's clients, including the appellant.

As well, the graphs corresponding to each of these tables,which were based on them, were filed as Exhibits A-40 to A-49.

3.24 The maple grove was managed as a cottage industry from 1966 to 1985. Starting in 1986, it was modernized in order to make the 15,000 maple trees profitable. Profits of $6,916 in 1985 increased to $35,571 in 1986.

The "syrup bank” has now opened the market and the appellant sells its product through three "Provigo" stores and confectionaries.

3.25 The accountant, Mr. Christian Côté, compared the average of $6,400 obtained from the compilation done at the time of the Élite sale in 1980 for cattle one year old and over (3.10) with the average for the sale of cattle of the same quality and category, that is, over one year old, in September 1982 at Ranch Lougami, which was 1,809. He found a difference in price of 3.5 times less, or $4,591 per head.

As at the 1982 auction sale, 32 animals over one year old were sold. There were lost earnings of $147,000 ($4,591 x 32) compared to the 1980 price, not counting the lost earnings for animals under one year old sold for which we could do a similar calculation.

In September 1982, sales of cattle brought in $221,723. If we deduct $85,000 from the auction sale on September 25 and 26, the remainder is $137,000, and if instead of lost earnings of 3.5 times we use just two times, we then get $274,000. If we add the part of the lost earnings calculated above for animals over one year old, we then get total lost earnings of $421,000 ($274,000 + $147,000). This amount would have fully covered the net loss of the farming business for 1982, which was $288,681, according to witness Côté.

3.26 Mr. Yves Charland, who testified for the appellant, is an agronomist and regional animal production adviser (nutrition and genetics) for the Quebec department of agriculture. He has worked there since 1968. He started as a local adviser.

This witness explained that one of the farm programs established by the Quebec department of agriculture to assist the beef cattle industry is the stabilization insurance plan implemented in 1976. The aim of this plan is “to establish a fund for producers who belong to the plan to protect them against significant price reductions” [Translation]. The government provides $2 for each dollar contributed by a member to the insurance fund.

There is an equation for calculating the compensation paid to provide a guaranteed income: cost of production according to a model plus 90 per cent of the salary of a specialized worker, which was estimated at $26,060 in 1979, less the average market price.

The document from the department of agriculture from which the above definition and calculation was taken is chapter 17 of an operating manual which we might call the “Stabilization plan program" [Translation] (Exhibit A-36). A table showing figures for 12 years, from 1976-77 to 1987-88 (Exhibit A-35), shows clients, premiums, compensation, advances and annual surplus (or deficit).

It appears from Exhibit A-35 that no compensation was paid in 1978-79 and 1979-80. For the other years, contributions varied from $14 per 100 pounds (in 1980-81) to $64.33 (in 1986-87). The highest compensation was paid between 1981-82 and 1986-87. Total compensation paid to the insured parties during the 10 years was $169,043,916.

The witness stated that it was quite clear that during those years the premiums paid by the insured parties were lower than the compensation received.

3.27 As a testing station operator, Ranch Lougami was classified by Mr. Charland as one of the best stations of the nine that exist in Quebec.

With his skills as an agronomist and his long experience, Mr. Michel Gagné is certainly one of the most qualified testing station operators in Quebec, according to Mr. Charland.

4. Law — Case law — Analysis

4.01 Law

The principal provision of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the"Act") involved in this case is subsection 31(1), which reads as follows:

31. Losses from farming where chief source of income not farming

(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.

4.02 Cases at law

The parties referred to the following case law:

1. CBA Engineering Ltd. v. M.N.R., [1971] C.T.C. 504, 71 D.T.C. 5282 (F.C.T.D.); [1974] C.T.C. 888 (F.C.A.);

2. Moldowan v. The Queen, [1978] 1 S.C.R. 480, [1977] C.T.C. 310, 77 D.T.C. 5213;

3. CA Burns Ltd. v. M.N.R., [1981] C.T.C. 2001, 81 D.T.C. 14;

4. Arthur Bell Holdings Ltd. v. M.N.R., [1983] C.T.C. 2533, 83 D.T.C. 486;

5. Bio-Test Laboratory Inc. v. M.N.R., [1983] C.T.C. 2348, 83 D.T.C. 295;

6. Buchanan Forest Products Ltd. v. The Queen, [1986] 2 C.T.C. 7, 86 D.T.C. 6282;

7. Blair Supply Co. Ltd. v. M.N.R., [1984] C.T.C. 2560, 84 D.T.C. 1457;

8. Tillsonburg Glass & Mirror Ltd. v. M.N.R., [1985] 1 C.T.C. 2345, 85 D.T.C. 307;

9. Ace Salvage Alberta Ltd. v. M.N.R., [1985] 2 C.T.C. 2277, 85 D.T.C. 568;

10. The Queen v. Graham, [1985] 1 C.T.C. 380, 85 D.T.C. 5256;

11. The Queen v. Morrissey, [1086] 2 C.T.C. 389, 86 D.T.C. 6509 (F.C.T.D.); [1989] 1 C.T.C. 235, 89 D.T.C. 5080 (F.C.A.);

12. Mohl v. The Queen, [1989] 1 C.T.C. 425, 89 D.T.C. 5236 (F.C.T.D.);

13. Nijjar v. The Queen, [1990] 1 C.T.C. 147, 90 D.T.C. 6092 (F.C.T.D.);

14. Service d'Administration Champlain Inc. v. M.N.R., [1990] 2 C.T.C. 485 (F.C.T.D.);

15. Hadley v The Queen, [1985] 1 C.T.C. 62, 85 D.T.C. 5058 (F.C.T.D.);

16. Monette v. M.N.R., [1988] 2 C.T.C. 2089, 88 D.T.C. 1467 (T.C.C.);

17. Plante v. The Queen, [1983] C.T.C. 341, 83 D.T.C. 5378 (F.C.T.D.);

18. Roney v. M.N.R., [1984] C.T.C. 2701, 84 D.T.C. 1431 (T.C.C.); [1988] 2 C.T.C. 357, 88 D.T.C. 6489 (F.C.T.D.); [1991] 1 C.T.C. 280, 91 D.T.C. 5148 (F.C.A.).

4.03 Analysis

4.03.1 The problem is not whether during the years in issue the appellant's farming business had a reasonable expectation of profit. This fact is admitted by the respondent, in view of the investment made by the appellant (2.02, last part). Rather, the issue is whether the losses then incurred are losses arising primarily from farming or a combination of farming and some other source of income within the meaning of subsection 31(1) of the Act.

In Moldowan (4.02(2)), at page 487 (C.T.C. 315; D.T.C. 5216), the Supreme Court explained the three kinds of losses contemplated by the Act:

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 limitations 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 carries on farming as a sideline business. Such a taxpayer is entitled to the deduction 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 carries 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 issue here is whether the farming losses fall within class 1 or class 2.

The Supreme Court added:

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 recognize 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 restrict 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.

[Emphasis added]

Earlier, at page 486 (C.T.C. 314, D.T.C. 5215), in seeking to determine the meaning of the expression "chief source” in section 13(1), the Supreme Court stated :

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

It is clear that“ combination” in section 13 cannot mean simple addition of two sources of income for any taxpayer. That would lead to the result that a taxpayer could combine his farming loss with his most important other source of income, thereby constituting his chief source. I do not think subsection 13(1) can be properly so construed. Such a construction would mean that the limitations of the section would never apply and, in every case, the taxpayer could deduct the full amount of farming losses.

4.03.2 The appellant's main argument is that in a business of this nature it had given itself between 15 and 20 years to become profitable, first, and then to replace its chief source of income. Referring to paragraph 3.18 and to the averages set out in the first two columns, the appellant argued that the farming business would have become the chief source starting in 1984, and even in 1983, if we consider that the farm loss was then lower: $606 as compared to $47,723 for the excavation business (3.18, last part). The graph in Exhibit A-41 clearly shows the curve for the figures in the first two columns in paragraph 3.18.

As well, the appellant argued that if we deduct the salaries paid to Mr. Michel Gagné and his wife starting in 1980, shown in the third column in paragraph 3.18, as if the business were not incorporated, the positive result is still greater in favour of the appellant's argument.

4.03.3 Since profit is not the only factor to be considered, even though it is the most important, the appellant noted that the "inventory" factor also supports its position: the figures for the farming business's inventory (3.20) show that the lowest inventory, $76,220 in 1972, was higher than the highest figure for the excavation business, $65,465 in 1983. The highest figure for the farming business was $600,000 in 1981.

4.03.4 At first glance, the book value of the fixed assets (3.21) supports the respondent's position, because of the very nature of the expensive machinery required by the excavation business. However, the appellant argued, if we look at it more closely we find that the excavation business purchased its last machinery in 1980, in keeping with its logic that it would steadily decrease the activities of this business. It may be seen that the fixed assets fell steadily from $530,800 in 1980 (in 1979 and 1980 the increase resulted from corrections in the accounting system) to $190,000 in 1989. Old equipment was repaired rather than buying new equipment. The figure for the farming business, on the other hand, reached $200,000 in 1988 and $182,000 in 1989.

The appellant contended that the figures in paragraph 3.21 and in the graph in Exhibit A-47 clearly show that the excavation business was becoming increasingly secondary.

4.03.5 On the other hand, the "salaries" factor (3.19) favours the respondent's position. The appellant noted, however, that the logical result of the decision to reduce the activities of the excavation business was that salaries paid by that business reached a peak in 1979 at $945,322 for 71 employees and reached its lowest point in 1989 with $164,631 for 14 employees with weekly earnings of $595. According to Mr. André Gagné, the appellant kept only the oldest employees. The overall figure for salaries paid by the farming business is in itself not very high, although from $2,100 in 1972 it reached $43,000 in 1989, because of the nature of the farming business, where almost everything is mechanized (feeding, cleaning). The graph in Exhibit A-46 clearly shows the figures set out in paragraph 3.19.

4.03.6 The "sales" factor (3.17) also favours the respondent's position. However, according to the appellant, the gradual increase in sales by the farming business, reaching $420,500 in 1989, and the decrease shown by the excavation business starting in 1980, with $3,955,000, falling to $669,462 in 1989, once again demonstrates its assertion that it was replacing the excavation business with the farming business. The figures in paragraph 3.17 are illustrated by the graph in Exhibit A-39.

4.03.7 In support of its position, the appellant referred the Court to the decisions in Roney (4.01(18)), Hadley (4.02(15)) and Monette (4.02(16)).

4.03.7(1) In Roney (4.02(18)), the appellant had received an income of $220,000 from employment and dividends in 1975. He deducted his farming losses of $73,238. The respondent argued that he was entitled only to the restricted losses. The farming losses from 1972 to 1980 were from $37,328 to $16,862, the largest loss being in 1975, the year under appeal. The appellant raised herds of Charolais Simmental cattle on a farm covering 711 acres of land.

On the basis of the evidence presented, the Tax Review Board concluded in 1984 that in 1975, the year under appeal, the chief source of income was his employment and the dividends received. However, since the appellant had taken most of the essential steps for changing sources, and in view of the nature of the operation, the Board held that the appellant was entitled to all of his start-up costs, as the Supreme Court had held in Moldowan (4.02(2)), cited above, even though the appellant was not yet a full-time farmer.

After citing primarily the decisions in Moldowan (4.02(2)) and Hadley (4.02(15)), Denault, J. of the Federal Court, Trial Division concluded that the appellant might reasonably have expected his farming operation to provide the bulk of his income, or be the centre of work routine. The Minister appealed that decision.

On February 16, 1991, the Federal Court of Appeal reversed the decision of Denault, J., relying primarily on the fact that in 1975, the year in issue, Mr. Roney had a farming loss of $133,676.64, or about a third of his investment, because of the drastic reversal in the market. However, that year, he projected that he would reach the break-even point, that is, where gross income would be at least equal to expenses. The taxpayer filed an appeal with the Supreme Court, which has agreed to hear it.

4.03.7(2) Hadley (4.02(15) also concerns the raising of purebred cattle, which was started in 1972 on a farm of about 700 acres. Both previously and subse- quently, the appellant owned car sales and rental dealerships. By 1975, the appellant had invested more than a million dollars in his farming business. Prices fell after 1973 to such a point that the market price was lower than the cost of feeding the cattle. In 1976, he suffered a loss of $450,000, and in 1977, $138,000. He sold his farm in 1978. The appellant claimed all of his losses, but the respondent restricted them to $5,000. As in the case at bar, the respondent had admitted that there was a reasonable expectation of profit.

Given the substantial investment in the farming business, and that the losses suffered were beyond his control, and relying on the tests set out in Moldowan (4.02(2)), Joyal, J. concluded that the farming losses should be allowed in full.

After noting that a million dollars had been invested, Joyal, J. also pointed out that he hired good management and studied all available material on the purebred farm business, and that in a few years he had one of the largest purebred cattle in the area. He had even been recognized as a prime breeder of Charolais cattle in Eastern Canada, and he hoped that it would produce substantial income. None of this came about because of subsequent events which were beyond his control and caused prices to drop, according to Joyal, J.

In the case at bar, counsel for the appellant argued that the facts relating to her client were substantially the same as in Hadley (4.02(5)) and submitted that we should reach the same conclusion.

In Hadley (4.02(15), the Department of National Revenue has appealed to the Federal Court of Appeal.

4.03.7(3) Monette (4.02.16))

While continuing to practise his profession as a psychiatrist in the Trois- Rivières region, Mr. Monette established a horticultural business. He bought a farm and built a greenhouse on it, in which at first he planted young trees of various species and tropical plants. He subsequently concentrated his efforts on growing spruce trees. He spent forty hours per week on this. During 1979 and 1980 he had losses which he claimed as business losses; the Department of National Revenue restricted the losses to $5,000, relying on section 31.

However, in view of, inter alia, the competent organization of the business, the net income of $12,230 in 1986 and the forecast of $28,105 net income in 1987, Judge Rip concluded that in 1979 and 1980 the combination of the farming business and the medical practice comprised Mr. Monette's chief source of income. During those years, the income from the medical practice permitted Mr. Monette to borrow funds for the farming business. Judge Rip also referred to Moldowan (4.02(2)) concerning, inter alia, the eligibility of start-up expenses.

In the case at bar, counsel for the appellant contended that even though the business was not horticulture, the facts were nonetheless somewhat similar in terms of the support provided by the excavation business and of the competent organization of the farming business and the income in the subsequent years.

4.03.8 Arguments of counsel for the respondent

4.03.8(1) Counsel for the respondent first summarized the testimony of the two principal witnesses. He drew attention to the testimony of Mr. Charland, inter alia. However interesting it was to set out the policy of the Department of agriculture and the theoretical model of the farm used to determine the level of compensation which the stabilization insurance might pay (3.26), this testimony in no way confirmed that the farm was financially viable. The witness used the example of a farm where almost no debt servicing had to be as- sumed. The witness dealt solely with the insurance situation where an attempt is made to compensate the insured parties in a reasonable manner, according to counsel for the respondent.

4.03.8(2) The respondents main argument is that the fact that in 1984 the appellant changed its farming activities from raising purebred Hereford cattle to slaughter steer testing stations providing substantial profits in no way altered the situation that prevailed in the years in issue, from 1979 to 1983; counsel argued that income tax is a yearly matter.

The respondent's second argument is that the appellant's evidence relating to its desire to sell the excavation business was hardly strong evidence. Counsel referred to Bio-Test Laboratory Inc. (4.02(5)), inter alia.

4.03.8(3) Bio-Test Laboratory Inc. (4.02(5))

In that case, the appellant, a corporation which had owned a laboratory for a number of years, purchased a 150 acre farm in 1977 where it raised and trained race horses.

The appellant had argued that it wished to sell its laboratory to devote itself to farming activities alone. However, the Court found that the intention to sell the laboratory was not confirmed by the facts or documents showing an offer to sell or purchase. As well, the argument that the laboratory could not have been expanded because of City of Ottawa bylaws was not confirmed by evidence of such a bylaw.

Also, in that case, the fact that there were 30 employees working in the laboratory and three on the farm did not favor the appellant. Despite substantial investment in the farming business, the Court did not find that the farming business had become the chief source of income and that the laboratory business had become a secondary business, taking into account that the test of actual and potential profitability did not support the position taken by BioTest Laboratory Inc.

Counsel for the respondent argued that in the case at bar the facts are substantially the same in respect of profitability. He noted that from 1972 to 1984 the excavation business showed a profit 13 times out of 14, while the farming business did so twice out of 14 times.

4.03.8(4) Counsel for the respondent referred to the appellant's argument that in years 1979 and 1980 the excavation business started to fall off and no further investment was made in it.

He noted, however, that in those years the appellant had sales of $3,543,215 in 1979 and $3,957,962 in 1980: the two years when gross income was the highest.

As well, according to counsel for the respondent, purchases and repairs of trucks and heavy machinery in 1979, 1980 and 1981 amounted to $500,000.

4.03.8(5) R. Morrissey (4.02(11)

In that case, the issue was similar to the issue in the case at bar, and the Federal Court of Appeal rejected in December 1988 the principle that the three tests set out in Moldowan with respect to time spent, capital committed and actual and potential profitability—had to be interpreted disjunctively to determine whether a source was the chief source. Mahoney and MacGuigan, JJ., for the Court, held that the three tests must be considered as a whole, and that it was not sufficient that one single test be met in order for a source of income to become the chief source. The Court allowed the appeal by the Department of National Revenue, reversing the decision of Strayer, J. of the Trial Division.

On a proper application of the test propounded in Moldowan, 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.

However, Desjardins, J, dissenting, supported the opinion of Strayer, J. that the tests set out in Moldowan must be interpreted disjunctively. It should be noted that Morrissey (4.02(11)) is on appeal to the Supreme Court.

4.03.8(6) Godfrey Mohl (4,02(12))

In April 1989 in Mohl which was similar to the case at bar and to Morrissey (4.02(11)), Strayer, J. based his decision on the decision of the Federal Court of Appeal in Morrissey, In his conclusion, he stated:

It now appears clear from the Supreme Court decision in Moldowan as recently interpreted by the Federal Court of Appeal in The Queen v. Morrissey 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).

4.03.8(7) Counsel for the respondent argued that during the years in issue the source of income of the farming business was the raising of cattle. The profitability of that source was such that it was necessary to find another source in order to show a profit: the testing station.

Counsel argued that income tax is a yearly matter. He contended that we cannot conclude that the existing farm source (cattle raising) was the chief source during the years in issue, or even that the chief source was a combination of farming and some other source.

4.03.8(8) Nijjar (4.02(13))

In this case, in the years 1979 to 1982, the taxpayer's net income from a trucking business varied from $14,157 to $33,572. During those same years, gross farm income from a blueberry farm was from $2,400 to $3,707, resulting in losses of $10,759 to $49,135. The Department of National Revenue restricted deductible losses to $5,000 under section 31.

The evidence was that during the years 1979 and 1980 the taxpayer's farm activity involving potato and cauliflower growing was unsuccessful. He planted eight acres in blueberries in 1982, and seven in 1983. In 1989, he had 21 acres of blueberries. He wanted to add five or six acres more in 1991. According to an expert in the field, the blueberries planted in 1982 and 1983 will reach maturity in 1993 or 1994, and will be able to produce 8,000 pounds per acre.

Applying the decision of Strayer, J. in Mohl (5.02(12)), cited above, and commenting on the decision of the Federal Court of Appeal in Morrissey (4.02(11)), Pinard, J. of the Federal Court, Trial Division held that during the years in issue the taxpayer did not have the potential of profitability required to become a chief source of income.

4.03.8(9) Service d'Administration Champlain Inc. (4.02(14))

Again applying the principles set out in Morrissey and Mohl, Pinard, J. of the Federal Court-Trial Division held that the taxpayer corporation's farm activities could not essentially comprise a chief source of income because although there had been significant investment, there was no potential profitability and no significant profits could be expected. This case is on appeal to the Federal Court of Appeal.

4.03.9 Decision

4.03.9(1) If we consider, in this case, the tests proposed in Moldowan (4.02(2)), that is, time spent, capital committed and profitability, should we conclude that the appellant's chief source of income was a combination of farming and some other source of income or not?

The tests described above are in the process of being interpreted by the courts, and this process is not yet over. This Court is bound by the decisions of the courts above us: the Federal Court and the Supreme Court.

4.03.9(2) In examining Roney (4.03.7(1)), Hadley (4.03.7(2)) and Monette (4.03.7(3)), we see that investment, time spent on farming and losses which were beyond the taxpayer's control were determinative factors.

4.03.9(3) These factors are important in the case at bar as well. The investment made in inventory (3.20) supports the appellant's position, while the salaries paid (3.19) and the fixed assets (3.21) devoted to each business support the respondent's position. However, it must also be understood that these expenses were determined by the nature of each business. As well, we must consider the consequences of the expenses in each case. Thus in raising beef cattle, the mechanical systems for distributing feed and cleaning the stables in farming eliminate a great deal of labour.

On the other hand, the investment in heavy machinery for excavation (3.21) is much more substantial than investment of the same kind for raising cattle.

However, the Court finds that the steady decrease, on theone hand, in both Salary expenses and fixed assets and in the excavation business up to 1989, indicates the appellant's definite intention to get out of this activity. On the other hand, the steady increase in the same aspects of the farming business up to 1989 shows the appellant's intention to make farming its chief source of income one day.

4.03.9(4) There remains the final important test, actual and potential profitability.

The decision of the Federal Court of Appeal in Morrissey, in which there was a dissenting opinion (now on appeal to the Supreme Court), and the decision in Mohl by the Federal Court, Trial Division, are binding on the Tax Court of Canada at this point.

Was the appellant's farming business profitable?

Are we to consider profitability in the years in issue only, i.e., from 1979 to 1983, or must we also consider the subsequent years?

I am of the opinion that we must consider the source of income that existed in the years in issue and find its effects in the subsequent years.

Income tax is a yearly matter, and so we must first consider the facts as they existed in each of the years in issue. We must then ask whether the organization or structure of the source of income which existed at that time produced profits in the subsequent years. Was there a potential source of income which was reflected in later years? Or do we find profitability in subsequent years arising from an organized source of income which already existed in the years in issue?

4.03.10 In the years in issue, the source of farm income was cattle raising. We know that during that period, from 1979 to 1983, except for a small profit in 1980, the other years showed losses, as had the preceding years since 1972 as well, except for 1974 (3.17).

We know that after the failure of the auction sale in 1982 and the contributing economic crisis, Ranch Lougami started to reduce its inventory and to look for another source, which was found and put into operation in 1984 and 1985: the testing station (3.12 to 3.15).

It is clear from the evidence that while the testing station, as it was organized, did not produce outrageous profits, it nonetheless provided an attractive and stable income (3.13, 3.14, 3.15). I would even say significant profits" as that expression was used in Morrissey (4.03.8(5)) and Mohl (4.03.8(6)). With the evidence adduced concerning the intention to change the source and the evidence concerning investment, salaries and the distinctions made above (4.03.9(1), (2) and (3)), the Court would find it easy to allow all of the farming losses in 1985 and 1988 (3.14).

In 1985, the new source was already potentially present when it was first organized. Moreover, the start-up expenses would be fully justified.

4.03.11 In my opinion, because of the new case law by which this Court is bound, the losses in the years in issue must be considered as restricted losses.

4.03.12 With respect to subsection 31(1) of the Act, the Court notes that this section has been in existence for over forty years and that the $5,000 allowed for restricted losses has not changed with the cost of living and the devaluation of the dollar. What is the value of $5,000 in 1948 dollars today?

5. Conclusion

The appeal is dismissed.

Appeal dismissed.