Her Majesty the Queen v. Charles H. Roney, [1988] 2 CTC 357, 88 DTC 6489

Denault, J.: —This is an action by way of appeal from a judgment of the Tax Court of Canada, dated June 1, 1984, allowing the defendant's appeal in respect of his 1975 taxation year. At issue is the taxpayer's eligibility to deduct from his taxable income full farm losses under section 31 of the Income Tax Act.

A successful businessman, chief executive officer of Universal Investigation Service Limited and vice-president of Universal Alarms Limited, Mr. Roney, pursuant to his intention to carry on a cattle breeding business on a full-time basis, purchased in 1968 and subsequent years 711 acres of farm properties on which to operate his cattle breeding business. In order to efficiently operate this business, the defendant engaged the services of a farm manager and a herdsman who both lived on the farm, and devoted his own time and attention thereto on a daily basis and attended various seminars and shows. He committed capital of over $486,000 for land, buildings and equipment, and purchased cattle for $55,151 which had a market value of over $141,000, with the full expectation that his cattle breeding business would generate substantial profits.

Prior to 1975, there was a good cattle market for the Simmental and Charolais breeds, but in 1975, there was a severe drop in the market, particularly for breeding animals such as those owned by the defendant, because semen rather than cattle began to be shipped to the United States. The defendant intended to dispose of his interest in Universal Investigation Service Limited and to devote his full time to the cattle raising business once he had built it up to a sufficient financial stature. He did not consider cattle raising as a sideline business and he fully expected, when first assembling the land in 1968 and subsequent years, that his income from that source would be very substantial and that it would be his sole occupation in future years.

His chief source of income at all material times was that derived as an employee of Universal and his farming operation did not earn a profit prior to 1975. The farming operation also lost money from 1976 to 1979 when it was terminated. A summary of the defendant's net employment earnings, other income apart from farm losses, gross farm revenue and farm losses, is set out below:

sup>1 Only restricted farm loss of $5000 claimed against other income.

sup>2 i.e. total earnings (minus employment expenses deduction) from both Universal and Universal Alarms Ltd. (hereinafter "Universal Alarms").

In filing his personal income tax return for the 1975 taxation year, the defendant claimed as a deduction from his other income a farm loss of $73,238. By notice of reassessment, the Minister of National Revenue, in September 1977, reassessed the defendant and disallowed $68,238 of the farm loss claimed, applying the provisions of section 31 of the Income Tax Act. The defendant duly objected to the reassessment which was subsequently confirmed. He then appealed to the Tax Court of Canada which allowed the appeal. Mr. Justice Tremblay then decided that the defendant was not a taxpayer for whom farming could reasonably be expected to provide the bulk of income or the centre of work routine, nor a man whose major preoccupation was farming, but he allowed the appeal on the basis that “all the normal and appropriate steps were made to arrive at the change but that some special circumstances prevent the change". He then considered the losses of that year as start-up costs and allowed the appeal.

By way of appeal, the plaintiff argues that the defendant's farming operation was a secondary pursuit to other activities and constituted neither the defendant's chief source of income nor a chief source of income of the defendant in combination with some other source of income, within the meaning of subsection 31(1) of the Income Tax Act.

On the other hand, defendant argues that in 1975, he was carrying on a business of farming and that his chief source of income was from a combination of farming and income from his other businesses. He maintains that he was in the process of changing his occupational direction and that he should be allowed to deduct the full amount of his losses in the 1975 taxation year.

There is no dispute that the defendant was obviously involved in a farming business as defined in subsection 248(1) of the Act.

The issue basically centres around the interpretation of section 31 of the Act Within the fact situation at hand. The provisions of subsection 31(1) are outlined below;

SEC. 31 Loss 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 III 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) /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.

The definitive judgment on farm losses is Moldowan v. The Queen, [1977] C.T.C. 310; 77 D.T.C. 5213. Mr. Justice Dickson (as he then was) in Moldowan at page 315 (D.T.C. 5216) made the following comments:

. . . 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 s. 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 carried on farming as a sideline business. Such a taxpayer is entitled to the deductions spelled out in s. 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 Hadley v. The Queen, [1985] 1 C.T.C. 62 at 62; 85 D.T.C. 5058 at 5059, Mr. Justice Joyal summarizes these three classifications:

Suffice it to say at this time that with respect to farming losses, a taxpayer may fall within any one of three classifications. In the first classification, a taxpayer is entitled to deduct all his farming losses and in that respect, such farming losses are treated no differently from losses experienced in any other endeavour. The second category is where the taxpayer is limited, in charging his farming losses, to a sum of $5,000 for any one taxation year. The third classification is where a taxpayer is not entitled to deduct any farming losses at all.

Mr. Justice Joyal also gives a summary of the guidelines provided by the Supreme Court of Canada to determine which category a taxpayer fits into:

Section 31[1] creates no problem for the fulltime farmer whose money, time and efforts are exclusively devoted to his farming operations and who has no other source of income. Treatment of farming losses for such a taxpayer is substantially in accordance with general tax rules. Neither does the section create much of a problem when dealing with a taxpayer who makes no pretense of being a farmer but, nevertheless, owns a country place with sufficient acreage to keep a couple of horses, who spends weekends and holidays there and has a neighbouring handyman look after his stock during the week days. The public is not in the mood to subsidize the losses which might be experienced by such a taxpayer. Such losses are not business losses. They are merely the costs of maintaining a life-style.

Where the application of section 31 creates problems is in respect of a farming operation which is run as a business but where the taxpayer has other sources of income. Such a taxpayer might fit into the first category articulated by Dickson, J., in which case, any farming losses sustained may be charged against the taxpayer's other income. In the alternative, the taxpayer might fit into the second category in which case, his farming losses are, for tax purposes, limited to $5,000 annually.

The issue of whether a taxpayer fits into the first or second category is essentially a factual one. In this regard, the judgment of the Supreme Court in the Moldowan case provides us with certain tests, guidelines and indicia to assist a trier of facts in making his determination.

For example, Mr. Justice Dickson finds that a taxpayer engaged in farming need not have a "source of income”. It is sufficient, he says, that a taxpayer have a “reasonable expectation of profit”. In effect, an operation which suffers a loss may be found to be a source of income.

His Lordship further states, at 314 [5215], that "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 of measurement. . . .”

In applying the test of "reasonable expectation of profit” in relation to a chief source of income, Mr. Justice Dickson lists, inter alia, at 314 [5216], ”. . . the time spent, the capital committed, the profitability both actual and potential. . . ." And he says ”. . . 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.”

In a similar vein, Mr. Justice Dickson lists, again at 314 [5215], a number of criteria which might be considered in the determination of a "reasonable expectation of profit”, such as ”. . . 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.” However, "the list is not intended to be exhaustive”, warns His Lordship.

The Moldowan decision has purified the air. It has provided us with legal principles and guidelines which narrow considerably the field of inquiry in determining under which of the three heads enunciated by Mr. Justice Dickson farming losses might be treated. The decision, of course, is also of a nature where both devil and saint may quote it with equal impunity and immunity.

My task now is to review the main facts in the present case. At the outset, I stress that the plaintiff presented no witnesses but relied on the cross- examination of the defendant's witnesses. I also stress that there is no issue here about the defendant being regarded as a so-called "hobby-farmer"; if so, he would have been disallowed the entire loss. The issue is whether the defendant is entitled to deduct for tax purposes the entire amount of farm losses incurred by him in the 1975 taxation year or whether the deductibility should be limited to $5,000, per subsection 31(1) of the Act.

The evidence adduced by the defendant himself shows that in 1946 he founded Universal Investigation Service Limited, a company that expanded and became one of Ottawa's largest and most experienced security firms providing a wide variety of services. From the beginning and until the date of trial, he was the president of the company which had, in 1975, around 400 full and part-time employees. He had vice-presidents and a personnel director. In 1962, he became a 50 per cent partner in Universal Alarms of which he was a vice-president, a rather small company employing about 30 people. He had a small part to play in that company which in fact was sold in 1987. At the date of trial, the witness said that he was to sell the investigation company in early 1988.

In 1968, the defendant started thinking of his retirement years, and as a result of conversations that he had with friends, he was convinced that cattle breeding could be a profitable enterprise. He had no previous experience on the farm except for work as a boy during the summer months for three or four years. After extensive conversations with friends that were involved in the cattle breeding business, he was convinced that he could make large sums of money not only on the cross breeding but on importation of European cattle, mainly Charolais and Simmental. He expected to make between $150,000 to $200,000 a year in this type of business. In 1968, he purchased a first property consisting of an old house, several outbuildings which he improved and pasture land. He bought cattle in western Canada, a Hereford-Holstein cross to develop a "Hayes Converter" — by the name of Senator Hayes, a breeder — but he was soon to go on the breeding of Charolais cattle. His farm manager, residing on the farm, was taking care of the cattle. After a while, his enterprise requiring considerably more space than was provided at the first farm, he looked for another farm property which he found about one mile away from his first purchase. He bought this property of 100 acres and the house, and in order to supervise the operation from a closer point, he moved his family from Ottawa into that house. He still lives on the farm. In 1972, he purchased another farm consisting of 400 acres plus a house and outbuildings and installed the farm manager on that property. A herdsman was also hired, living on the first farm. By 1973, he bought another farm, a pasture land of 100 acres. He then owned 711 acres of farm property.

His intention was to develop a business that he could retire to and produce an income to allow him to live in the manner to which he "had become accustomed”. In 1975, he was slowing down his activities and worked reduced hours to devote time to the farm. He was then spending 30 hours per week working with his companies and 15 to 16 hours per week on the farm. In fact he spent Wednesdays and evenings on the properties, checking the cattle in the fields, the fencing, and going over the general operation with the farm manager", i.e. checking the health of the animals, buying machinery, and assuming the general supervision of the operation. He would also spend between 150 to 200 hours a year attending sales and conventions. His wife was responsible for the bookkeeping, the breeding records and the registration of cattle.

The cattle breeding business is not an easy one and it takes time either to breed cattle or to develop a good reputation as a breeder which ultimately allows a breeder to make a profit from his operation. In the seventies, one had to obtain a permit to get European cattle into Canada. These permits were limited and his first purebred Charolais was imported in 1972. In fact, from 1968 on the defendant went through three different designs for breeding until he ultimately terminated his operation. He initially tried to develop the so-called “Hayes Converter", then bought his Charolais cattle in 1970, and later changed his interest for Simmental animals. It has been suggested that it can take 10 to 15 years before a breeding operation may generate maximum profit. But the defendant expected interim profit so that he would have reached the break-even point in seven to eight years from 1968. In 1975, he was still in what he called a “starting-up stage". Unfortunately, during that year, there was a precipitated market decline for various reasons which were explained by Mr. Baird, a retired farmer and former employee of the Federal Department of Agriculture, Livestock Division. He explained that it was not before 1965 that Canada opened the border to cattle being imported from Europe. Because of a rigourous health program prior to importation, the animals being held in quarantine for six months, very few animals were imported in that first year. They were all Charolais and the semen produced by the bulls went for sale, mainly to the United States, because at the time the U.S. health requirements did not recognize the importation from Europe. Imported animals to Canada could not be re-exported to the United States at the time. But in 1975, the American commercial cattle market went into a cycle slump and, due to the fact that American breeders had, through ten years of semen production importation from Canada, built up a herd of purebred animals, the demand for semen from Canada was drastically reduced. Realizing that there was no chance that his cattle breeding operation would achieve the status of a profitable business, the defendant started to slow down the farming business and he closed the cattle operation in a “distress sale" and completely disposed of his herd in 1979. Following discussions over the defendant's farming operations with officials of the Department of National Revenue in 1977, his accountant, Thomas L. Beveridge, took the position that Mr. Roney's farming operation had the potential to become a chief source of income and he retained Mr. Baird, a retired farmer and professional agriculturist, to demonstrate the worth of the operation and the viability of it.

Mr. Baird’s report, based on his own experience as a renowned breeder, shows that there was a reasonable expectation of profit in 1975. It particularly shows that for an investment of $4,000 to $5,000 on an imported Simmental cow arriving in Canada in 1971, one could expect an anticipated inventory value, based on 1972-73 prices of $115,500. His report concludes that "therefore it was reasonable to conclude in 1972 using an expected level of production in current prices that an excellent opportunity for profit existed.” His report also shows that for the purpose of his study, he divided the defendant's cattle into four groups, the Charolais group, the Hereford and Hereford X Charolais group, the half-Simmental group and the full-blood Simmental group. For each of these groups, the expert stressed the number of heads, the problems encountered and his conclusions. Despite the fact that the defendant was not a knowledgeable breeder, that he did not have time to establish his reputation as a breeder, that he had no established market outlet or program for merchandising the production of the breeding herd, the expert still maintained that the defendant very definitely had a reasonable expectation of profit.

Analysis

By allowing the defendant to deduct only limited losses under subsection 31(1) of the Act, the plaintiff has excluded the defendant from the first class and concluded that he is a farmer in the second class. The onus is on the defendant to establish that on the preponderance of probability the Minister’s assessment is wrong.

In my opinion, the defendant has met the test set forward by the Supreme Court of Canada in the Moldowan case.

The evidence adduced shows that the defendant changed his occupational direction from that of an executive to farming as a main expectation of income. In fact, in 1975, the defendant was "a taxpayer, for whom farming may reasonably be expected to provide the bulk of income or the centre of work routine" (cf. Moldowan, 315 (D.T.C. 5214)).

Numerous precedents were cited to me by counsel on both sides. Some may be relevant and persuasive but in each case, it remains strictly a question of facts. For instance, in a very similar case, Hadley v. The Queen, [1985] 1 C.T.C. 62; 85 D.T.C. 5058, Mr. Justice Joyal allowed the deduction of the full farm losses taking into account amongst other things the substantial investment of capital into the farming activities. Although the taxpayer did not perform physical labour on the farm but put his organizational and analytical skills to the business, while getting substantial income from his other business operations, his expectations were that his purebred farming operation would provide the substantial bulk of his income in the future. But he suffered financial losses and finally had to dispose of his herd.

In the present case, the following facts have to be retained in favour of a deduction of full farm losses. Firstly, the size of the farming operation, some 711 acres, is one that is commensurate with an ability to generate large profits over a period of time. Secondly, the evidence showed that the farm was a well equipped operation with a good number of purebred and half- bred cattle and that this was a viable ongoing business. Thirdly, there was a large amount of capital injected by the defendant. Fourthly, the defendant moved his family on the farm where he had a view over the general operation of the farm and he obtained the services of a farm manager and a herdsman to help operate the farm and to make it a successful business enterprise. Fifthly, the defendant applied his considerable business experience to his farming business with a view to deriving substantial income therefrom. He later had to close down the operations due to special circumstances which were out of his control.

Had the Court not come to the conclusion that the farming activities of the defendant might reasonably be expected to provide the bulk of income or the centre of his work routine, the incurred losses could be characterized as start-up costs, and even then, the taxpayer would be allowed the full deduction of same. In the Moldowan case (at 315 (D.T.C. 5216)), Mr. Justice Dickson, as he then was, stated that:

. . . 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.

In Ronald Timpson v. The Queen, [1987] 1 C.T.C. 389; 1987 D.T.C. 5266, the plaintiff was a medical doctor who did not live on the farm premises. He appealed losses suffered in his purebred cattle farming operation while continuing to practise medicine on a full-time basis. The Minister took the position that his losses should be restricted to $5,000 per annum but Cullen, J., in allowing the appeal, accepted expert testimony, as in this case, that the purebred cattle industry is a long-term business and “for that very reason start-up costs must be allowed over an extended period of time, even to 15 years mentioned by one of the witnesses" (at 394 (D.T.C. 5270)). In The Queen v. Gorjup, [1987] 2 C.T.C. 129; 1987 D.T.C. 5348, even though the issue in that case was the taxpayer's eligibility to deduct from his taxable income "restricted farm losses", the Court found that ten years is not an unreasonable length of time to experience start-up costs.

For these reasons, the action is dismissed with costs.

Action dismissed.