Albert T. Wong and Darlene R. Wong v. Minister of National Revenue, [1990] 2 CTC 2123, 90 DTC 1710

Mogan, T.C.J.:—The appeals of Albert Wong and Darlene Wong (husband and wife) were heard together on common evidence. Each appellant has instituted one appeal with respect to the taxation years 1982 and 1983 and a second appeal with respect to the taxation years 1984 and 1985. In each of the years under appeal, each appellant deducted in computing income certain amounts which are identified as farming losses from a 50-50 partnership operated by the appellants under the name “Black Gold Tree Farm". The principal issue for each appellant for each taxation year is whether his or her chief source of income was farming or a combination of farming and some other source of income within the meaning of section 31 of the Income Tax Act. A secondary issue is concerned with the allocation of mortgage interest between land and building.

The appellant, Albert Wong, was born in 1926 in Victoria, British Columbia. The family moved to Saskatchewan in 1928 where his father operated a restaurant and hotel. In 1952, he moved to Calgary and joined the fertilizer division of Cominco. In 1954, he went to work for Sherritt Gordon at Fort Saskatchewan, 20 miles north of Edmonton. In 1968, although he transferred his employment to the Esso Chemical Division of Imperial Oil Limited where he worked until his retirement in 1986 at age 60, he was able to continue residing at Fort Saskatchewan. By 1982, the first year under appeal, he was Management Professional Technical Co-ordinator of Human Resources at the Esso Chemical Division.

The appellant, Darlene Wong, was raised in Alberta. Her grandparents homesteaded in the Edmonton area and the original land remained in the family for 60 years. She was born in 1938; entered university at age 16 and graduated in law at age 21 in 1959. She started to practice law in 1961 at Fort Saskatchewan. In the late 1960s, she operated a fabric and decorating business; and in the 1970s, she ran a consulting business. When these appeals were heard, she was a provincial court judge in the Criminal Division with her office in Edmonton. She had given up the practice of law in 1978 when she was appointed a provincial court judge.

The appellants were married in 1959 and until 1979 resided in Fort Saskatchewan. In 1979, they purchased a parcel of land comprising approximately 18 acres beside the Manning Freeway which joins Fort Saskatchewan to Edmonton about 20 miles away. Their land is 12 miles from the centre of Edmonton and six miles from the old city limits of Edmonton. The land is partly rectangular in the sense that the west limit is perpendicular to the north and south limits which are parallel, but the east limit is the Freeway running in a NE/SW direction.

The soil was fertile but the land had a serious drainage problem. There were two water courses which crossed the west limit and merged near an area referred to as the "dugout" being a large pond in the northern third of the property. To relieve their flooding problem, the appellants obtained advice in 1981 from the district engineer of the Water Resources Administration Division of the Alberta Ministry of Environment. Exhibit A-2 was a drawing of the appellants’ land showing the flooded area together with a letter from the Ministry of Environment. Exhibit A-3 was a series of 22 photographs, six of which showed the flooding on the appellants' land.

Albert Wong stated that he and his wife purchased this particular land because the price was right ($172,000) and it gave them an opportunity for rural living in an urban setting. They were thinking of growing something but were not sure as to what crop or product. In March 1980, they finally decided to develop a tree farm and planted their first seedlings. The person who sold them the land in the fall of 1979 assured them (if such assurance was necessary) that there was adequate water in the dugout. When this appeal was heard in 1989, approximately one-third of the land (six-seven acres) was planted in trees as part of the tree farm and Mr. Wong thought that a little more than half of the land could be planted in trees, perhaps another two or three acres.

When they first purchased the land, there was only the one house and the dugout (pond). In 1982, they built a long steel barn at a cost of $22,000 which is used 1/5 for horses and 4/5 for the storage of implements and machinery; and they also built a "honey annex" at a cost of $4,300. Exhibit A-1 is an aerial photograph in colour taken in 1986 of almost all of the 18 acres showing the house, the steel barn, the dugout, the three areas planted in trees, and a large fenced area to contain the horses enclosing both the dugout and the steel barn. The appellants purchased their first horse in 1980 apparently for a teenage niece who rode it only once. Subsequently, they acquired four additional horses which are broken for riding but neither of the appellants rides. At the time of hearing, they had five horses and Darlene Wong stated that they have brand new saddles and tack which have not been out of the box. In any event, a significant portion of their land is fenced off for the horses and the aerial photo (Exhibit A-1) shows some additional fencing in the area of the old trees.

The appellants purchased their first bee hive in 1980 after seeing a demonstration in 1979 about beekeeping. They have had up to 50 hives but, at the time of hearing, were down to 22 hives depending upon the wintering. Although their sales of honey were nominal in the years under appeal, they won certain ribbons for honey in 1982 and 1984 at the Royal Agricultural Winter Fair; and their sales of honey increased to approximately $3,800 and $5,200 in 1987 and 1988 respectively. Also, Darlene Wong has five sheep as a result of her interest in fleece from a pure gene pool collection. It is in connection with tree farming, however, that the appellants claim the right to deduct their losses under section 31 of the Income Tax Act.

Starting in 1980, the appellants have planted seedlings in three different locations on their land and, as stated above, have used about 1/3 of the land (six-seven acres) for this purpose. Albert Wong stated that he has taught himself about tree farming by taking a "greenhouse" course at the University of Alberta in 1982 and by taking a correspondence course from the University of Guelph. About 2/3 of the trees planted by the appellants are blue spruce. In 1989, Albert Wong performed a visual count of the trees they had planted in 3 separate areas on their land and, according to a schedule which he filed as Exhibit A-4, the appellants’ inventory of young trees in 1989 was as follows:

Mr. Wong attempted to value the above inventory of young trees by assuming a fixed value for the different kinds of trees as for example: blue spruce $100; scotch pine $60; manitoba maple $30; ash $30; and ponderosa $75. On the face of Exhibit A-4, the following statement is typed: “Assuming favourable market conditions the above prices are fair—$274,310". He stated that he used his best information to establish the value of the trees growing on his land but admitted under cross-examination (i) that some of the trees were not mature enough to sell in 1989; and (ii) that he could not expect to sell each blue spruce in 1989 for $100. It appears that some of the amounts (values) used in Exhibit A-4 were retail prices from nurseries and landscape gardeners.

Mr. Wong acknowledged that he and his wife had never prepared a budget of what they would expend on the purchase, planting and development of seedlings and what they could expect to recover on the sale of young trees. He was hoping that his trees would be of sufficient quality to sell to a landscape gardener for a premium price but he could not be certain whether the sale of all their marketable trees in 1989 would result in a profit or loss. The table below shows, firstly, the financial results of the appellants’ Black Gold Tree Farm in each of the years under appeal and, secondly, a comparison for each of the appellants between annual salary and the 50 per cent partner's share of the loss from the tree farm.

Black Gold Tree Farm

Partnership - A.T. Wong and D.R. Wong

	1982	1983	1984	1985
Gross Revenue	23.24	74	80.78	380.60
Gross Expenses	20,993.42	21,931.50	22,054.87	24,669.22
(no CCA claimed)
Profit (Loss)	(20,970.18)	(21,857.50)	(21,974.09)	(24,300.98)*
1/2 Portion	(10,485.09)	(10,928.75)	(10,987.04)	(12,150.49)
small error not explained
	Albert T. Wong
Esso Salary	48 ,480	51,360	53,160	55,200
Farm Loss	(10,485.09)	(10,928.75)	(10,987.04)	(12,150.49)
	Darlene R. Wong
Judge’s Salary	65,610.15	69,600.72	73,107.72	76,711.30
Farm Loss	(10,485.09)	(10,928.75)	(10,987.04)	(12,150.49)

I have concluded that the chief source of income for each appellant in the years under appeal was neither farming nor a combination of farming and some other source of income. The appellants failed to discharge the onus of proof. There was, to say the least, inadequate evidence in the following areas:

(a) the number of years required to grow seedlings to a marketable size in the Edmonton area of Alberta;

(b) the number of trees required to be harvested each year in order to operate a profitable tree farm;

(c) the area of land required to plant annual crops of seedlings so that, when the first crop is harvested, there would be a marketable crop in each successive year;

(d) the cost of harvesting and delivering a crop of trees;

(e) the relationship between the price for marketable trees which is paid to the grower (like the appellants) and the price which is charged at the retail level; and

(f) the maximum price which a person could pay for land to commence a profitable tree farm as compared with reasonable land costs to grow grain or raise cattle.

There was no evidence that the appellants started with any basic plan; that they operated with an annual budget; that they knew the cost of planting and growing a seedling to a marketable size; or that they had performed any study to determine if the projected selling price of a marketable tree (several years after planting the seedling) would exceed the aggregate costs of buying and planting the seedling, fertilizing and cultivating the young tree, and harvesting and delivering the marketable tree. Assuming that the projected selling price of a marketable tree would exceed such aggregate costs (and that would appear to be a most generous assumption), that was no evidence that the excess would be adequate to provide a reasonable economic return on the cost of the land plus a reasonable profit for the tree farm operation.

The appellants allocated the $172,000 cost of their property on the basis of $97,000 for the land and $75,000 for the house. Accepting Mr. Wong's evidence that a little more than half of the land could be planted in trees, I shall assume that ten of the eighteen acres will be used only for tree farm purposes. Making a further allocation of the $97,000 land cost on the basis of ten acres for the tree farm and eight acres for house, horses, dugout, bees and other uses, ten acres would cost $53,900 and the remaining eight acres would cost $43,100. This allocation means that the appellants paid $5,390 per acre for the ten acres that would be used for tree farming. There is no evidence showing how a cost of. $5,390 per acre for tree farm land near Edmonton in 1979 would have compared with the cost of land at that time and in that vicinity for grain farming or cattle farming.

Without the benefit of expert evidence, I cannot determine whether $5,390 per acre was in 1979 a reasonable price to pay for land which was to be used only for tree farming. As a matter of common sense, however, I am inclined to the view that the price was much too high for tree farm land. Any person starting a tree farm on raw land must wait several years for a crop of marketable trees. From an economic point of view, this puts the novice tree farmer at a disadvantage with the grain farmer or cattle farmer who can take a product to market in one or two years. In other words, grain and cattle provide a much faster economic return on the cost of land. In my view, a person looking for land to begin a tree farm should want to pay less per acre than the person looking for land to begin a grain or cattle farm. In these appeals, the appellants had planted their first seedlings in 1980 and yet, at the end of 1985 (the last year under appeal), they still had not taken any trees to market.

Residing on these 18 acres adjoining the freeway between Edmonton and Fort Saskatchewan may have provided the appellants with convenient access to their respective employment locations but I cannot resist the conclusion that any persons seriously interested in tree farming would have found equally fertile land farther away from a large city like Edmonton where land costs would not be affected by the market trappings of urban development. Given the location of their land and the price they paid, the appellants were required to prove that they could afford to pay $5,390 per acre to start a tree farm from scratch on only ten acres of land with a reasonable expectation of profit.

Mrs. Wong testified that the Black Gold Tree Farm suffered further losses in subsequent years as follows:

She also listed the following capital outlays in connection with the tree farm:

The total of these capital outlays is $163,833. The total of actual losses suffered by the appellants' Black Gold Tree Farm from 1982 to 1987 is $130,233 and those losses occurred without any deduction for depreciation or capital cost allowance. Therefore, after 1987, the appellants will have to earn profits from their tree farm in excess of $130,000 in order to recover their accumulated deficit of $130,233; before they can set aside any reserve for depreciation of their building and equipment; and before they can earn any economic return on their invested capital of $163,833, leaving aside any profit from their personal efforts in planting and nurturing the seedlings and harvesting the marketable trees.

In my view, the aggregate amount of $274,310 which appears in Exhibit A-4 as the suggested selling price or value of the appellants' inventory of young trees exceeds by a wide margin the fair market value of those young trees in 1989. The evidence was that the appellants hoped to sell their trees to a landscape gardener. That being the case, the appellants cannot use ordinary retail prices when valuing their stock of trees. They would have to provide for the cost of cutting and delivering the trees. They should have excluded from Exhibit A-4 the many young trees which were not marketable in 19[8]9. And finally, all trees would have to be valued in accordance with their height because, for marketing purposes, they are priced at a fixed sum per linear foot. Exhibit A-4 is an inadequate and superficial attempt to value in 1989 the appellants’ stock of trees.

When the appellants purchased their property in 1979, they paid $52,000 in cash and borrowed $120,000 with a mortgage. For the purpose of deducting mortgage interest in the computation of farm income, they allocated the $52,000 cash payment to the house and they allocated the principal amount of the mortgage on the basis of $97,000 to the land and $23,000 to the house. Upon reassessment, the respondent challenged this allocation and disallowed the deduction of a portion of the mortgage interest on the basis that the cash payment of $52,000 and the principal amount of the mortgage should have been allocated pro rata to the cost of house and land. The position of the parties may be summarized as follows:

The appellants have assumed that their losses with respect to the tree farm would be deductible in computing income. Their decision to allocate 100 per cent of the cash payment to the house appears to be an attempt to make a greater portion of the mortgage referable to the tree farm operation and, therefore, a greater portion of the mortgage interest deductible in computing income. The question is whether the principal amount of the mortgage has been reasonably allocated between land and house because only the interest on the portion of the mortgage reasonably allocated to farm land should be deductible. In my view, the respondent's allocation of the cash payment and the principal amount of the mortgage is more reasonable than the appellants' allocation. The appellants seem to think that a mortgagee would lend them 100 per cent of the allocated value of the land and only 30 per cent ($23,000) of the allocated value ($52,000) of the house. Having regard to the fact that the cash payment of $52,000 was approximately 30 per cent of the total purchase price of $172,000, it is more reasonable to conclude that the mortgagee would want the appellants to acquire a 30 per cent equity in both the land and the house. The question of a reasonable allocation of proceeds from a mortgage is more fully discussed in Lee et al. v. M.N.R., [1989] 2 C.T.C. 2228; 89 D.T.C. 443 at pages 2230-31 (D.T.C. 444-45).

In the years under appeal, the appellants each deducted in computing income one half of the net loss suffered by their tree farm partnership as shown in the above table. When issuing the reassessments which are under appeal, the respondent adjusted the net loss from the tree farm primarily to disallow the excess mortgage interest which was more reasonably allocated to the house. The respondent then allocated the remaining farm loss 50-50 between the appellants and permitted each of them to deduct an amount up to $5,000 in accordance with the formula in subsection 31(1) of the Income Tax Act. The appellants claim that their deductible farm loss should not be restricted to the $5,000 amount and they raise the principal issue with respect to “chief source of income”. The appellants rely on the following statement by 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 at page 314 (D.T.C. 5215): "One would not expect a farmer who purchased a productive going operation to suffer the same start-up losses as the man who begins a tree farm on raw land.”

That statement is undoubtedly true but, in my view, the Supreme Court was only drawing a comparison and was not suggesting that all start-up losses suffered by a tree farm would be deductible. Immediately preceding the above quotation, the Supreme Court had referred to the decision in The Queen v. Matthews, [1974] C.T.C. 230; 74 D.T.C. 6193 in which the Minister of National Revenue had disallowed the deduction of any tree farm losses on the basis that there was no reasonable expectation of profit. Mr. Matthews owned two tree farms covering almost 200 acres. The Federal Court—Trial Division held that there was a reasonable expectation of profit. In that case, there was no issue concerning “chief source of income”.

Another tree farm appeal is the recent decision of the Federal Court-Trial Division in Madronich v. M.N.R., [1989] 1 C.T.C. 247; 89 D.T.C. 5093 but the issue there was reasonable expectation of profit and not "chief source of income”. The same can be said of The Queen v. Gorjup, [1987] 2 C.T.C. 129; 87 D.T.C. 5348 relied on by the appellants.

In Morrissey v. Canada, [1989] 1 C.T.C. 235; 89 D.T.C. 5081, Mahoney, J. delivered the judgment for the Federal Court of Appeal and stated at page 242 (D.T.C. 5084):

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.

I find those words to be particularly applicable here because, notwithstanding the significant concession made by the respondent in each assessment under appeal wherein he allowed the formula deduction permitted in subsection 31(1), I would have been inclined to hold that the appellants’ tree farm did not, in the period 1982-1985, have a reasonable expectation of profit. It does not appear to have been a "source of income" at all in those years but that situation may have changed after 1986 when Mr. Wong retired. The area under cultivation for trees (six-seven acres) was very limited and there was too little evidence of profitability brought before the Court. In Hoeft v. Canada, [1989] 1 C.T.C. 350; 89 D.T.C. 5144, Martin, J. stated at page 354 (D.T.C. 5147): “I do not have to make a finding with respect to the time spent or mode of life of the defendant because, like Mr. Morrissey, he cannot bring himself within the test of potential profitability.”

I was satisfied on the oral evidence that the appellants as husband and wife worked diligently and long hours at the planting and growing of seedlings on their small acreage but their evidence fell a long way short of proving that their tree farm was or could be their chief source of income in the years 1982-1985. The following comments by Strayer, J. in The Queen v. Connell, [1988] 1 C.T.C. 247; 88 D.T.C. 6166 at pages 250-51 6168 have particular application to each appellant herein:

While the Minister has, by applying subsection 31(1), conceded that the taxpayer's farming is "a source of income” and this implies some expectation of ultimate profitability, this is not determinative of whether the taxpayer could have a reasonable expectation that his farm income would be his chief source of income either alone or in combination with another source of income. It is hard to see how such an expectation could be entertained in the circumstances of 1979 and 1980 when he was earning a salary of respectively $61,199 and $69,510. . . . On the facts it is difficult to see how he could have had a reasonable expectation of his farm income even being significant in relation to his employment income so as to constitute one of his chief sources of income.

For the reasons set out above, the appeals herein are dismissed.

Appeals dismissed.