Lana Sniderman v. Minister of National Revenue, [1989] 2 CTC 2027

Teskey, T.C.J.:—At issue in this appeal is the right of the appellant to deduct for tax purposes the losses suffered by her in the 1981 and 1982 taxation years. The first issue to be determined is whether the operation known as Simca Kennels was being operated with a reasonable expectation of profit. The appellant submits in the alternative that if the Court should find that there is not a reasonable expectaion of profit that Simca Kennels is a farm operation and therefore is entitled to the restricted farm loss of $5,000 per year pursuant to section 31 of the Income Tax Act.

The Supreme Court of Canada in Moldowan v. The Queen, reported at [1978] 2 S.C.R. 480; [1977] C.T.C. 310; 77 D.T.C. 5213, at pages 313-4 (D.T.C. 5215) stated:

There is a vast case literature on what reasonable expectation of profit means and it is by no means entirely consistent . . . whether a taxpayer has a reasonable expectation of profit is an objective determination to be made from all of the facts. The following criteria should be considered: the profit and loss experience in past years, the taxpayer's training, the taxpayer's intended course of action, the capability of the venture as capitalized to show a profit after charging capital cost allowance. The list is not intended to be exhaustive. The factors will differ with the nature and extent of the undertaking. . . .

The Federal Court of Appeal in Canada v. Morrissey, reported at [1989] 1 C.T.C. 235; 89 D.T.C. 5080, reviewed the Moldowan case. In the Morrissey case, the Minister of National Revenue admitted that the respondent, Raymond Morrissey, was farming with a reasonable expectation of profit. With this admission, the Court stated that the admission meant that the respondent was farming as a business and was conclusive that he was not a Class 3 farmer and that it also implies that the farming was a potential source of income and calls for an inquiry whether it was particularly a chief source of income either alone or in combination with another source. The Court was determining that the respondent therein fell into Class 1 or Class 2 as stated in Moldowan.

The evidence adduced at trial was very sketchy and extremely general. The appellant entered into a partnership with Bobby Krol by written agreement dated April 15, 1980, being Exhibit A-4. The salient parts of this agreement are as follows:

(1) partnership to commence April 15, 1980;

(2) the purpose of the partnership was for raising and breeding purebred dogs;

(3) name to be Simca Kennels;

(4) to be carried on at 29A Gloucester Street, Toronto, or at such other location as the partners may agree;

(5) profits and losses are to be divided in the same ratio as the parties have contributed capital to the partnership;

(6) either partner may draw funds pro rata out of the partnership equal to the partners contribution of capital without the consent of the other.

Bobby Krol has not contributed any capital to the partnership whatsoever. Thus, by the terms of the agreement, the appellant has complete control over Simca Kennels. Notwithstanding that Bobby Krol runs the operation, does the training and grooming, and works full-time for Simca Kennels, by the terms of the agreement the partnership does not owe him anything for his time and efforts. He has not received a wage or remuneration from Simca Kennels. Although Simca does employ some outside help, it is very nominal.

On July 10, 1980, the appellant and Bobby Krol signed a partnership registration for Simca Kennels showing the business activity to be raising, breeding, and showing purebred dogs and operating kennels. The appellant and Bobby Krol entered into a relationship together and, using Bobby Krol's own words, "we were both involved in music and both liked dogs." Neither party had any background or training in the breeding or raising of dogs. In fact, when they decided to start Simca Kennels they even had to pick the breed of dogs that they would concentrate their efforts on.

There is no conclusive evidence that the appellant had a workable plan in 1981 and 1982 that would show there was a reasonable expectation of profit. During all but the last month of the first two fiscal years the appellant lived and operated out of 29A Gloucester Street, Toronto, a townhouse on a plot of land approximately 15 feet by 70 feet. During the first year, Simca Kennels had acquired one foundation bitch Doberman and one Borzoi puppy and they had two pet Dobermans. No additional dogs were acquired in any way during the second fiscal year. During these two years, being the years in question, $5,196 were spent on advertising and promotion, $3,771 on general and office expenses, and the total expenses were $26,466 with no offsetting income.

It is to be noted that the respondent has accepted the quantities of the losses as claimed by the appellant. This, of course, ties the Court's hands on this point, notwithstanding that it has grave doubts as to the legitimacy of some, as well as the quantity of some, of the expenses claimed.

Up to April 30, 1988, the partnership had spent a total of $14,452 to purchase breeding stock while amassing total expenses of $349,722, with a total income for the same period of $41,849.00, for a total loss of $307,873.

Exhibit A-2 is a forecasted statement of income for the years ending April 30, 1989, 1990, and 1991, prepared March 28, 1989. Although prepared by a chartered accountant, all he has done is taken the figures supplied to him by the appellant. The Court assumes that the April 30, 1989 projected figures would be extremely accurate as the accountant would be working on eleven months actual figures.

Exhibit A-2 also shows a projected income of $2,500 for the April 30, 1989 year with expenses of $47,900, resulting in a further loss of $45,400. Although there is an allowance for grain sales and trees, since neither the partnership agreement nor the partnership registration declaration refers to anything but raising and breeding dogs, the trees and hay cannot be considered as part of Simca Kennels, particularly in light of the fact that the acreage property where the operation was moved to on April 1, 1982 is owned jointly by the appellant and her sister. There is no evidence before as to the date of purchase of the property, as to the financial arrangement and/or lease arrangement, if any, between Simca Kennels and the appellant and her sister. It appears Simca is only a tenant-at-will.

The income, expenses, losses, and money spent on breeding stock for the period April 30, 1981 to April 30, 1988, and the projected three years as shown on the exhibits are set out in Schedule A attached hereto [not reproduced]. At the bottom of the said Schedule A are shown the pro forma figures developed for 1985, 1986, and 1987, being Exhibit A-3. Exhibit A-3 is dated September 17, 1985. There is obviously an error somewhere in this exhibit as it purports to be dated September 17, 1985 yet it says the income for the year ended April 30, 1985 will be $3,650. A review of said Schedule A to this my judgment shows that the appellant in September of 1985 was not able to accurately predict income or expenses for the April 30, 1985 or 1986 or 1987 years. With this history, the Court must be very suspect of the new forecasted statement of income and expenses for April 30 for the years 1990 and 1991 (Exhibit A-2).

It is noted that Bobby Krol was involved in a car accident that resulted in serious personal injuries in October of 1986. However, the statements for the years ending April 30, 1987 and 1988 do not show any wages going out to replace the work that Bobby Krol was performing for Simca Kennels. The appellant claims that these injuries have set back Simca Kennels three years. The Court does not accept this position. The appellant may have chosen to mark time for a period, which is evidence of a hobby as opposed to evidence of a business. If Simca Kennels was a properly operating business the business would have carried on and additional help hired to take up the slack caused by the injuries to Bobby Krol.

Originally, the partners claimed that they believed Simca Kennels would take seven to ten years to start making a profit. They now revise that estimate to seven to fifteen years. Exhibit A-6 is a 'To Whom it May Concern' letter from Richard Meen, M.D., which really is of no evidentiary value. However, he does say it takes five to seven years to produce quality stock. The only real proof is that Simca has been unable to generate a profit to date.

The profit and loss experience to date and as projected does not project a profit, Particularly after charging capital cost allowance, let alone minimal wages for Bobby Krol's efforts, or rent. The appellant and Krol had no training and at best are acquiring the same on the go. Review of the taxpayer's course of action for the two years in question leads to the conclusion that Simca was a hobby. Whether this intention changed at some later date may be up to another Court at another time to decide.

Counsel for the appellant has urged me to look at the two years in question as start-up years for a business that will take in excess of ten years to become profitable. To this end I have been referred to several cases dealing with horse breeding and various forms of livestock. He urges me to draw an inference from these cases to dog breeding. There is no evidence before to make that inference. The appellant was at liberty to call an expert to the stand to attempt to show a similarity between dog breeding and horse breeding or livestock breeding, but chose not to attempt this.

On the other hand, the respondent has drawn to the Court's attention the Walker case [Walker v. M.N.R.], reported at 76 D.T.C. 1225, and the Escudero case [Escudero v. M.N.R.], reported at [1981] C.T.C. 2340; 81 D.T.C. 301, both dealing with dogs and kennels. In both cases the taxpayer's appeals were dismissed as both operations were continuously operated at a loss with no decrease in expenses and no marked increase in revenue. Thus, in each of these two cases, that is the Walker and Escudero cases, the appellant did not have a reasonable expectation of profit.

In this case it is argued that the Court should take into account the “increase in value of the stock." There is no hard evidence before the Court of the present value of the stock. The appellant simply said, "I would not sell my stock for less than $20,000 an animal.” Again, expert testimony could have been called to attempt to show a large increase in value. However, when you look at the outlays of cash for breeding stock over the first eight years and over the 1990 and 1991 projected years, the Court finds that the appellant has not established that the present value of her stock is near as high as indicated, or in fact is anything more than what it was paid for.

The appellant is the vice president of finance and a shareholder of Roblan Distributors Limited, the owner/operator of Sam The Record Man, earning from her full-time employment with that firm in 1981 and 1982 the sums of $238,999.96 and $259,909.80 respectively. Since she for all intents and purposes is the true owner/operator of Simca Kennels as a result of the partnership agreement, her main source of income is from her full-time job with Roblan Distributors.

As to the intention of the appellant, the Court must look at all the facts and not just "the stated intention” of the appellant. The appellant's counsel argues that the entering into of the partnership agreement should be interpreted as an intention to establish a viable business. The Court does not accept this position and looks at the agreement as a means by which the appellant maintained absolute control of the adventure. This, in essence, was a cohabitation agreement which protected her should her relationship with Bobby Krol break up.

Thus, during the taxation years in question, the intention must have been to indulge in a hobby. It may well be that at some later time the appellant will be able to demonstrate a change of intention. Until there is an intention to operate a profitable business there cannot be any start-up costs. Once the intention is formed, then the Court must be satisfied on all the facts that there is a reasonable expectation of making a profit.

The evidence adduced in respect of the taxation years subsequent, to the years under appeal has only an incidental relevance to the determination as to the validity of the assessment under review. Given the lack of proven facts concerning the operation in subsequent years at Nobleton on lands owned by the appellant and her sister, the question of who owns the improvements is not clear and what tenure has not been answered. Obviously if Simca Kennels was a business operation with a reasonable expectation of profit there would have been some provision for rent.

Thus, on review of all the evidence, the Court cannot accept that the losses for 1981 and 1982 taxation years are start-up costs for a business that has a reasonable expectation of making a profit. Having decided that in 1981 and 1982 years the appellant was operating a hobby or a business that did not have a reasonable expectation of making a profit, I thus must decide if she is entitled to restricted farm losses.

Although reading the headnotes of the Moldowan case, supra, and Demers case [Demers v. M.N.R.], reported at [1987] 2 C.T.C. 2247; 87 D.T.C. 537, would lead a person to believe that a restricted farm loss can be applied even if there isn't a reasonable expectation of profit, I am satisfied that there must be two elements to obtain restricted farm losses, namely:

(1) operation of a farm, and

(2) reasonable expectation of profit.

The Court rejects the argument that Simca Kennels is a farm operation. A townhouse in Toronto on a 15 by 70 foot parcel cannot be considered a farm. It is argued that the breeding and raising of dogs in itself creates a farm as this is livestock and by definition, as set out in section 248 of the Income Tax Act, Simca Kennels is farming. Livestock are domestic animals such as cattle and pigs, bred or kept on a farm for use and commercial profit. This does not include dogs. The authority for this statement is taken from two American cases namely: Howard and Heron v. Nashville, 248 S.W. 894, and Henderson v. Lancaster and Wallace, 2 LA APP at page 680. The American cases also show that turkeys, geese, and fish are not livestock, notwithstanding that they are being raised on a farm and for commercial gain. The Court finds that the raising and breeding of dogs is not livestock; therefore, the operation at Gloucester Street cannot be a farm operation and therefore the alternative argument fails.

Notwithstanding that this is not a farm, I wish to respond to the question of reasonable expectation of profit. Mr. Justice Dickson, as he then was, in the Moldowan case, supra, at page 313 (D.T.C. 5215) says:

If the taxpayer in operating his farm is merely indulging in a hobby, with no reasonable expectation of profit, he is disentitled to claim any deduction at all in respect of expenses incurred.

The Federal Court-Trial Division in the Gorjup case [Gorjup v. The Queen], reported at [1987] 2 C.T.C. 129; 87 D.T.C. 5349, found as a fact that the taxpayer had a reasonable expectation of profit. I do not believe that Taylor, J. decided the Demers case on this legal principle but on the type of facts that the Court looked at in the Gorjup case, and therefore I distinguish the Gorjup case. The difference between Class 2 and Class 3 farmers, as defined by Moldowan, is a reasonable expectation of profit. On this point as well the appellant fails to meet the requirements for the restricted farm loss as requested.

The appeals are therefore dismissed.

Appeals dismissed.