Beeline Enterprises Inc. v. Minister of National Revenue, [1990] 2 CTC 2477, 90 DTC 1904

Christie, A.CJ.T.C.:—The issue is whether in computing its income for its 1982, 1983, 1984 and 1985 taxation years the appellant is entitled to deduct the full farming losses it sustained or is it, as alleged by the respondent, confined to deducting the limited losses provided for under subsection 31(1) of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the 'Act"). In each of these years the appellant's year-end was June 30. Consequently the taxation period under review is Jul 1, 1981, to June 30, 1985.

Mr. Harry Snowden was the only witness to testify at trial. He was brought up on what he describes as "not a full-fledged farm”. Chickens and geese were raised there as well as a variety of vegetables. The primary source of his father's livelihood was working for other farmers in the Maplegrove-Bowmanville area in Ontario. From the time he was twelve until he went to work for the Goodyear Tire and Rubber Company when he was seventeen he worked on farms in the same area when he was not attending school. These farms were unrelated to the horse racing industry.

He worked for Goodyear until he established a wholesale rubber business in 1960. Basically this involved buying rubber products in bulk from corporations such as Goodyear, packaging those products and distributing them in Ontario. This business was carried on by Snowden Industrial Rubber & Plastics Ltd. ("Industrial Rubber"), the shares of which were held by Snowden and five others. He had 33% of the shares and the specific shareholdings of the others is not in evidence, but none of the shareholders held a controlling interest. Two of the other shareholders later sold their shares to other shareholders and this reduced the number of shareholders to four. Two years later he had Snowden Rubber Specialists Inc. ("Rubber Specialists") incorporated to carry on a business involving custom moulding and roll covering. Eighty per cent of the shares of this corporation were held by Harry Snowden and his first wife. In 1973 he acquired a small rubber distributor in Quebec whose business was identical to that of Industrial Rubber. This was Thompson Rubber Company (1973) Inc. ("Thompson Rubber”). Snowden held all of the shares of this corporation. Further he was described in evidence as the chief executive or chief operating officer of all three companies.

On October 26, 1977, but with effect as of July 1, 1977, all of the shares of the three corporations were sold to Fleetwood Metal Industries Ltd. which was a wholly-owned subsidiary of Starcan Capital Ltd. of Toronto. It had no experience in the rubber industry and in relation to the sale and acquisition of the shares an agreement was entered into on July 1, 1977, between Industrial Rubber, Rubber Specialists and Thompson Rubber collectively called "the Snowden Group” and Snowden Consulting, Management & Services Corporation ("Snowden Consulting") which was under the control of Harry Snowden. Under this agreement Snowden Consulting agreed, inter alia, to provide the Snowden group with the services of Harry Snowden or someone “of equal or greater experience as determined by the Snowden Group in its sole discretion to that of Harry Snowden". Harry Snowden confirmed that what was essentially intended by this contract was the provision of his services to the Snowden Group by Snowden Consulting. The services to be provided included the management, supervision, superintendency and overseeing of the entire operations of the business of the members of the Snowden Group . . .”. Depending on specified circumstances the contract was to be of five or seven years' duration.

Snowden Consulting was to be paid $78,000 per year plus a “performance bonus on account based on the achievement of Cumulative Average Annual Earnings for the Snowden Group”. On the positive side the bonus could range from $15,000 to $155,000. The calculation was based on a rather complex formula, the details of which are not necessary for these reasons. It is worth noting, however, that the formula was such that under it the performance bonus could operate in reverse, i.e., Snowden Consulting could in any given year owe money to the Snowden Group depending on the financial performance of that group and this in fact happened. It was Harry Snowden's expectation that Snowden Consulting would receive an annual bonus of some $130,000. The provision of the consulting services under the contract could be terminated after five years, i.e., after June 30, 1982, by notice in writing by Snowden Consulting to the Snowden Group. The provisions regarding the performance bonus were to continue after termination of the consulting services and this in fact took place subject to some subsequently negotiated changes, the particulars of which were not given to the court. Schedule B to the agreement provided: “It is understood that the intention and purpose is to provide to the consultant (Snowden Consulting) a performance bonus related to the cumulated average earnings of the members of the Snowden Group over the Term of this agreement." The "Term" referred to was defined as the seven-year period from July 1, 1977, to June 30, 1984.

The contract also dealt with matters such as the fiduciary capacity of Snowden Consulting, especially in respect of trade secrets and other confidential information. Provision was made for protecting the Snowden Group from competition directly or indirectly from Snowden Consulting for a specified period of time. A separate agreement dealing with the matters of fiduciary capacity and restraint on competition was also entered into between Harry Snowden and Starcan Capital Ltd.

The appellant succeeded Snowden Consulting as consultant to the Snowden Group. This came about by this exchange of letters. On March 31, 1981, Snowden Consulting wrote Starcan Corporation (presumably the successor to or the parent of Starcan Capital Ltd.) and said:

Mr. H. T. Snowden has resigned as Consultant, effective April 30, 1981 and we therefore have no recourse but to cancel our Consultant Contract with you dated July 1, 1977 as we have no one to fulfil his place.

Mr. Snowden will be making other arrangements directly with you.

On May 1, 1981, Starcan Corporation replied agreeing to the cancellation provided that “it is agreed that Beeline Enterprises Ltd. will provide the services of an individual or individuals deemed appropriate by us in our sole discretion, and provided that all terms and conditions of the original agreement remain in full force. . .". A second letter also dated May 1, 1981, was sent to the appellant by Starcan Corporation. It reads:

We do hereby accept Beeline Enterprises Ltd. as a replacement for Snowden Consulting Management & Service Corporation in the provision of consulting services to the operations of our Snowden Rubber Industries division (formerly comprised of The Thompson Rubber Company (1973) Inc., and Snowden Rubber Industries Ltd. which was originally made up of Snowden Industrial Rubber and Plastics Ltd. and Snowden Rubber Specialists Inc.), provided that it is agreed that Beeline Enterprises Ltd. will provide the services of an individual or individuals deemed appropriate by us in our sole discretion, and provided that all terms and conditions of the original agreement remain in full force and effect including, without limitation, the provision whereby the referenced cumulative performance bonus payments and the Cumulative Average Annual Earnings will be accumulated from Jul 1, 1977.

Harry Snowden said that his work day providing services on behalf of Snowden Consulting under the contract was 9 a.m. to 5 p.m. He estimated the time spent by him on the appellant's farming business during 1981 to 1983 to be "anywhere from two hours to ten hours a week." At the end of February 1983 the provision of consulting services under the contract was terminated and with that so was the payment of $78,000 per annum.

The appellant was incorporated under the laws of Ontario on December 30, 1976. At all times relevant to this appeal 50 per cent of its shares were held by Harry Snowden and the remainder by his second wife Mary A. Snowden. He was the President of the corporation and she was the secretary treasurer. Precisely when the appellant commenced farming is not in evidence, but it began claiming losses in this regard in 1978 and it claimed losses in 1979. In cross-examination counsel for the respondent suggested to the witness that the amounts of the losses were $15,496 and $16,158. He could not confirm or dispute these figures. He later agreed that the annual losses exceeded $10,000. The farming loss in 1980 was $11,388. Additional figures for other years will appear later. Financial statements of the appellant for its 1981 to 1985 taxation years are in evidence and this together with other evidence shows that initially the farming operation was under two divisions of the appellant. One was Bill Sharp Racing Stables. This division took care of the training of horses under the supervision of Bill Sharp. He ended his association with the appellant about the end of 1981 and went to the United States. He was replaced by another trainer, but this was short-lived. Bill Sharp Racing Stables ceased to function in the appellant's 1982 taxation year. The other division was Beeline Stables.

The background to the appellant's involvement in the horse racing industry is that in 1975 Harry Snowden, with two others, bought a racehorse, Lormor Lee, which they kept for one year before it was claimed in a claiming race. About six months later a horse called Shy Away Tommy was claimed which was kept for a year when it, in turn, was claimed. I infer from the evidence that it was about this time that the appellant became involved with race horses because, as mentioned, it was in its 1978 fiscal year that it commenced claiming farming losses. In late 1978 or early 1979 Bestman Hanover was purchased and it was about this time that it was decided to get the appellant involved in horse racing in a more substantial way. This decision was arrived at in consultation with a number of persons involved in the horse racing business. Harry Snowden also subscribed to publications relating to the industry. He did not attend seminars or meetings devoted to studying the industry, but he did attend at racetracks and at auctions of horses. Three horses were then bought that were racing in the United States. They were left there and it was intended to build on those three horses plus Bestman Hanover, but the last-mentioned animal was claimed a short time later.

In October 1980, after a four-month search, Mary Snowden purchased a 22- acre farm in Whitchurch-Stouffville Township, Ontario, at a foreclosure sale. The bulk of the cash paid on the transaction, $75,000, was her funds and the farm was mortgaged in the sum of $135,000. The barn was just a shell and the well was unfinished. The farmhouse needed plumbing, wiring, construction of stairs and decorating. Over $30,000 was spent on it so that the son and daughter-in-law of Mary Snowden could live there and look after the horses that it was intended would be brought to the farm. For this they enjoyed the use of the house rent-free. Four paddocks were built and a great deal of work was done to the barn including the construction of ten stalls. On April 1, 1981, a lease was entered into between Mary Snowden as lessor and the Beeline Stables division of the appellant as lessee, which I regard in law to be a lease between Mary Snowden and the appellant. The lease provided:

The Lessee shall be responsible for monthly payments of the first Mortgage to Bramber Consulting & Management, in the amount of $1,682.24 payable monthly, commencing April 30th, 1981. The Lessee shall be responsible for all costs pertaining to the farm except for the Home which shall be the responsibility of the Lessor. The Lessor shall pay realty taxes for the Home and Lessee taxes for Farm.

The term was for two years and, in addition to making the mortgage payment, the lessee was to pay $1,000 per year on September 1, 1981 and on September 1, 1982.

It was intended that the appellant would acquire, breed, train and race horses and that the tempo of these activities would increase when the consulting contract between the appellant and Starcan Capital Ltd. came to an end.

About the time the appellant entered into the lease Harry Snowden did some projections regarding the appellant's involvement in the horse racing business. He is not sure if the document was used in negotiating bank loans. The bottom line of these projections showed losses of $43,700, $37,000 and $14,500 for 1981, 1982 and 1983 respectively. Profits were anticipated of $8,500, $28,500 and $48,500 for 1984, 1985 and 1986 respectively. There is also in evidence a document entitled "History of Horses". It reads:

This evidence was supplemented by another document prepared by Mr. Snowden expanding on the history of the animals:

Baroness Wilma purchased in 1979 and raced at various tracks.

Sent to Lana Lobell Farm and bred to Nero in early 1980 1st foal Mary My Love 1981 and died of joint disease 4 weeks after birth.

Loss estimated $25,000 as Nero's stud fee went to $20,000 US next season. 2nd foal Beeline Star—General Star is sire 1982

3rd foal Beeline Omaha—Armbro Omaha is sire 1983

Both yearlings sold in 1984 along with Baroness Wilma in foal again to Armbro Omaha

Key Shaw purchased in 1979 and raced at various tracks. Sent to Kawartha Farms Peterboro & bred to Senor Skipper

1st foal Beeline Dave 1981

2nd foal Beeline Heather 1982

3rd foal Beeline Annie 1983

Sold in foal & also above yearlings in 1984

March Janet claimed for $17,500 & raced at various tracks. Lost her in a claiming race within 6 months for $18,000. Traded Benedict Hanover for her in 1982 to use as a brood mare

1st foal in 1983 Beeline Shawna (killed by lightning)

2nd in foal in 1984

Startling Chris purchased at Woodbine sale for $5,000 in 1982 in foal to Senor Skipper. Had filly Beeline Joanne.

Sold both in late 1983

Benedict Hanover purchased this well bred colt from Hanover Farm for $35,000. Never did much. Raced at several tracks, finally traded him for March Janet.

Cashmere Bay N claimed in 1980 for $25,000 and sold within a year for $12,000

Coaltron Road purchased in 1979 and raced at various tracks. Sold in 1980.

Glowlite N traded for a yearling Beehive Dave in 1983 and raced with a little success. Lost in a claimer for $4,000 in early 1984.

Passive Miss purchased at Woodbine sale, raced at several tracks without success. Sold for $500 when she went lame.

Empty Glass' [1] purchased in Kentucky for $4,000 in 1984 and raced here at Greenwood, Mohawk & Flambero Downs and did quite well. She was claimed in 1985 for $26,500 and was the last horse of our stable to go.

Pops Best claimed for $12,000 in 1980. Only had for 3 races finished 3rd, 1st and 4th & was reclaimed for $12,000.

Above represent 11 horses purchased; 8 young horses born from mares; 3 mares sold in foal.

The farm was listed for sale in May 1984 and sold in 1985. The decision to end the farming business was made in August 1983, at which time the appellant had already suffered uninterrupted losses in respect of it since its 1978 fiscal year. On February 8, 1983 after negotiations that commenced in early December 1982, the assets of Rubber Specialists, the manufacturing company in the Snowden Group, were purchased by Cardinal Rubber Manufacturing Company Ltd.. The sale came about because Starcan (it is not known precisely which Starcan company is referred to) was “being hounded by the bank to sell something to alleviate their cash flow problems." Cardinal Manufacturing Company Ltd. was incorporated by Harry Snowden and three other individuals. He had 40 per cent of the shares. The remaining 60 per cent was divided 40, ten and ten. Harry Snowden assigned these reasons for the appellant discontinuing its farming business. There was the creation of Cardinal Manufacturing Company Ltd. and his involvement with that corporation plus the poor financial performance of the farming business and the lack of additional capital to contribute to it. At the time of the decision to get out of the farming business he said his concern was "how do I I do it without taking too big a bath.” Later he decided to “wind it down as best I could without taking too big a pasting." I believe these observations reflect the witness's own appreciation of the condition of the appellant's farming business at that time. While I accept that there was mixed motivation behind the decision to end the farming business, the inference that I draw from all of the relevant evidence is that the primary causative factor was the unsatisfactory financial performance of that business.

What was significant and important during the years under review were those aspects of the appellant's business relating to the consulting contract and its farming activities. The following compares the agreed upon (Exhibit A-1, Tab 13) financial results from the appellant's business related to horse racing and other matters, primarily the consulting contract:

After the appeal at hand was instituted by notice of appeal dated September 29, 1988, which was received by the registry of this court on October 3, 1988, two decisions of special importance pertaining to a taxpayer's entitlement to deduct full farming losses in computing income were delivered. Both are included in the respondent's list of authorities. The first is the judgment of the Federal Court of Appeal in Canada v. Morrissey, [1989] 1 C.T.C. 235; 89 D.T.C. 5080 (judgment rendered December 21, 1988) and second is the judgment of the Federal Court-Trial Division in Mohl v. Canada, [1989] 1 C.T.C. 425; 89 D.T.C. 5236 (judgment rendered April 11, 1989) which follows and applies Morrissey.

In the earlier and generally regarded as the classic farming loss case of Moldowan v. The Queen, [1978] S.C.R. 480; [1977] C.T.C. 310; 77 D.T.C. 5213, Mr. Justice Dickson (later Chief Justice) said at page 315 (D.T.C. 5216):

In my opinion, the Income Tax Act as a whole envisages three classes of farmers:

(1) a taxpayer, for whom farming may reasonably be expected to provide the bulk of income or the centre of work routine. Such a taxpayer, who looks to farming for his livelihood, is free of the limitation of subsection 13(1) (now subsection 31(1)) in those years in which he sustains a farming loss.

(2) the taxpayer who does not look to farming, or to farming and some subordinate source of income, for his livelihood but carried on farming as a sideline business. Such a taxpayer is entitled to the deductions spelled out in subsection 13(1) in respect of farming losses.

(3) the taxpayer who does not look to farming, or to farming and some subordinate source of income, for his livelihood and who carried on some farming activities as a hobby. The losses sustained by such a taxpayer on his non-business farming are not deductible in any amount.

In Morrissey, Mr. Justice Mahoney, speaking for the Court, said at page 242 (D.T.C. 5084):

The appellant has admitted that the respondent was farming with a reasonable expectation of profit. That means he was farming as a business and is conclusive that he was not a class 3 farmer. It also implies that farming was a potential source of income and calls for an enquiry whether it was potentially a chief source of income either alone or in combination with another source. In considering subsection 31(1), it seems to me that potentiality, rather than actuality, is the question in all cases since the provision applies only where there is a loss in a taxation year. This is not, of course, to say that actual profitability in other years may not be evidence of the potential for profit in years of losses.

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

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

It now appears clear from the Supreme Court decision in Moldowan, as recently interpreted by the Federal Court of Appeal in Canada v. Morrissey, [1989] 1 C.T.C. 235; 89 D.T.C. 5080, that, for a person to claim that farming is a chief source of income, he must show not only a substantial commitment to it in terms of the time he spends and the capital invested, but also must demonstrate that there is a reasonable expectation of it being significantly profitable. I use the term "significantly profitable” because it appears from the Morrissey decision that the quantum of expected profit cannot be ignored and I take this to mean that one must have regard to the relative amounts expected to be earned from farming and from other sources. Unless the amount reasonably expected to be earned from farming is substantial in relation to other sources of income then farming will at best be regarded as a “sideline business" to which the restriction on losses will apply in accordance with subsection 31(1).

The appellant has failed to place evidence before the court that can lead to the conclusion on a balance of probability that in the years under review there was a reasonable expectation of the appellant's farming business being significantly profitable in the sense that those words are used by Mr. Justice Strayer in Mohl. While it encountered unanticipated setbacks, e.g., the death of horses, failure of horses to perform as hoped and difficulty with trainers, these are not at all unusual matters in what has been often judicially recognized as the high risk nature of the horse racing industry. The existence of this high risk factor was acknowledged by Harry Snowden in the course of his testimony and by counsel for the appellant in argument. The figures cited regarding the appel- lant’s farming business and their relativity to the consulting aspect of its business speak for themselves and say something that can only be interpreted as unfavourable to the appellant's position regarding farming being for it a chief source of income.

Before closing these reasons there is a further matter with which I wish to deal because it was much emphasized by counsel for the appellant in argument. His submission, as I understand it, is that payments made under the consulting agreement were in truth and substance a method of making deferred payments on account of the purchase price of shares of the Snowden group acquired by Fleetwood Metal Industries Ltd. and these payments are properly to be regarded as an infusion of capital for the purpose of the appellant's farming business. I also understand that this argument is confined to amounts paid as performance bonuses. Indeed I regard it as necessary to do so because the $78,000 payable under the contract clearly relates to the provision by Snowden Consulting of the services contracted for by the Snowden group. The time spent on delivering these services by Harry Snowden refutes any suggestion that might be made to the contrary. But even if the bonus payments are treated in the manner suggested by the respondent this does not, having regard to all of the facts of this case regarded in the light of Moldowan, Morrissey and Mohl, lead me to the conclusion that the appellant is entitled to deduct full farming losses.

The appeal is dismissed.

Appeal dismissed.