Henry Martens v. Minister of National Revenue, [1987] 1 CTC 2016, 86 DTC 1859

Tremblay, T.C.J.:—This appeal was heard on April 16, 1986 in the City of Saskatoon, Saskatchewan.

1. The Point at Issue

The point is whether the appellant, an employee at Dashwood Industries Ltd., is correct in the computation of his income for the 1978, 1979, 1980 and 1981 taxation years to claim ordinary farming losses of $19,522.76, $4,476,00, $21,700.00 and $281.08.

The respondent reassessed the appellant allowing only restricted losses of $5,000 in 1978, $3,488 in 1979, $5,000 in 1980 and $281 in 1981 on the basis that the appellant’s chief source of income was neither farming nor a combination of farming and some other source of income.

2. The Burden of Proof

2.01 The burden of proof is on the appellant to show that the respondent's assessment is incorrect. This burden of proof results particularly from several judicial decisions, including the judgment delivered by the Supreme Court of Canada in Johnston v. M.N.R., [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 assessment or reassessment are also deemed to be correct. In the present case, the assumed facts are described in the reply to notice of appeal as follows:

7. The respondent, when reassessing the appellant for the 1978, 1979, 1980 and 1981 taxation years, ruled, inter alia, upon the following assumptions:

(a) during the taxation years at issue the appellant was employed full time at Dashwood Industries Ltd.

(b) the appellant’s income from employment, investment and farming income for the 1978 to 1981 taxation years was as shown below:

	Gross Farm	Farm
Year	Income	Loss		Wages	Investment		Other
1978	$10,179.04	$(19,522.76)		$27,559.70	$	945.38	$	668.14
1979	30,375.00	$( 4,476.00)		29,168.00		1,084.00		1,126.00
1980	27 ,346.00	(21,700.00)		30,504.00		4,068.00		883.00
1981	39,674.00	(	281.08)	32,203.00	17,480.00		22,709.00

(c) the appellant’s chief source of income was neither farming nor a combination of farming and some other source of income.

3. The Facts

3.01 The appellant born in 1934 in southern Manitoba, was brought up on a small mixed farm: cows, pigs, chickens, turkeys.

3.02 He was 22 when he got married. After starting a dairy business with his father, the latter had a stroke and later another stroke.

The farm was rented out and later sold.

3.03 He then (it was in 1958) started to work with Federated Co-op in the Wholesale Division in Winnipeg until September 1964. His wife Betty also worked as a nurse.

3.04 In 1964, he started to work for Glenway Supply, a window manufacturing company. In 1965, he was transferred to Saskatoon to start a new branch. In 1972, Glenway Supply was purchased by Dashwood Industries. He continued to work for the latter until 1982 as branch manager. Then Dashwood Industries was sold to a competitor, Wilmar Windows. Five months later, the appellant’s position was eliminated.

3.05 In 1983, with his wife and two partners, he initiated a company: Window Warehouse Sask. Ltd. A few months later, he bought the shares of the two other partners who were living in Edmonton. Since then, the appellant has been trying to build a business. He personally never received income from the Company but the latter had some. It was used to acquire inventory.

3.06 The appellant and his wife have two boys, one born in 1962 and the other in 1964. The eldest, Murray, was 11 when they bought a first quarter of land in 1973. His wife, who also was brought up on a farm in Morton, Manitoba, was very pleased to give him support. For the appellant, it was a long-term desire to own a farm and work on it.

3.07 The quarter of land purchased in 1973, located seven miles north west of Saskatoon, was formed of 120 acres of cultivated land and 40 acres of waste land. There was no building on it. They then started to build a house for the family and bought a small tractor. In 1974, they built corrals and shelters for 12 to 15 head of cattle. In 1975, the barn (28' x 48') was built.

3.08 As Exhibit A-1, a schedule of assets purchased from 1975 to 1981, was filed.

The purchase of the $11,000 tractor in 1979 was financed after a $2,000 down payment. During the period involved, the appellant did not own a personal car. He used the one of the company.

In 1981, besides the tractor, he had on the farm a half-ton truck and another old truck.

3.09 Another schedule showing the capital investment in land and machinery was filed as Exhibit A-2.

3.10 Pursuant to the explanation given, the first quarter (160 acres) was purchased in 1973 ($16,000). In 1977, two other quarters (320 acres: 280 cultivated, 40 of waste land) were bought for $99,500. It is located 25 miles east from the first one, on the east side of Saskatchewan River, this side having a better record of moisture than the west side.

In 1978, to help finance, they sold for $48,000 half a quarter (80 acres) of the first land bought in 1973. They used the money to pay account on the mortgage of the second land.

In 1980, the two quarters of the second land were sold for $140,000, that money being used to reimburse the balance of the mortgage and to acquire a three-quarters (480 acres) for $178,000 located not far from the second land he had sold. There remained then around a $100,000 mortgage on the third land. In 1981, “the crop expectations were not being realized to carry the interest on the debt load” (tr. 44). The interest rates being as high as 20 per cent, two quarters of the third land were sold for $130,000. There then remained a half quarter of the first land (80 acres) and one quarter of the third land (160 acres) free of mortgage. If he had not sold those two quarters “the bank would have had them”, (tr. 52)

3.11 In 1973 and 1974, most of the work on the farm was done by the neighbour. In 1975 and after until 1980, the appellant himself was farming the land: “tillage, preparation of the seed bed, seeding, spraying etc.” with the exception of the harvesting which was done by the neighbour. The latter, indeed, owned the appropriate expensive equipment called “combine” which in fact is used by a farmer only two or three weeks per year. It is more economical for the appellant with a few hundred of acres to then pay a neighbour for using such equipment at $17 per acre, than to buy such equipment, with interest and repairs etc.

Since 1981, the quarter located in the east has been rented to the neighbours. The work is done on a custom basis.

3.12 The appellant who had admitted the figures that appear in paragraph 7(b) of the reply to notice of appeal, quoted in paragraph 2.02 above, filed as Exhibit A-3 the following schedule of incomes:

Conclusion: The taxpayer's chief source of income is either farming or a combination of farming and some other source.

3.13 The appellant said he spent a lot of time on the farm, but he was confined to evenings, to weekends, to holidays and to vacation time.

He was then working at Dashwood from 8:30 a.m. to 4:30 p.m. It was a management position. He had very capable staff (15 to 18 employees), which allowed him to be quite flexible with the hours at his job.

If I was needed on the farm for something, I could be reached by telephone, and I could be there in, you know, 15 minutes. The time, you come home after your work day at Dashwood, and you had your evenings, and you had weekends, and holidays, and you know, there was very seldom that I recall whether I took any holidays during the, for vacation, as such.

My holidays were usually during seeding and harvesting time, where I could participate in the critical part of the farming. (tr. 74)

He had four weeks of holidays per year. He also had a carry-over of days or vacations that he had not taken in the earlier years. So he could take a day here and there when required with the understanding from his superiors (tr. 96).

Coming back home after his day work, it was "another work day right there” he said: (tr. 75) repairs of corrals and fences, maintenance work on buildings, repairs of machinery. He ordinarily worked until dark and sometimes after.

During the lunch hour, when he was at work for his employer, he was looking after things that had to be done in the city: buying supplies, parts for repairs, etc.

During the harvesting time, sometimes, he went in the field at 7:00 p.m. and worked “right through the night”.

3.14 His wife was also very active in the management of the farm when he was not there: looking after the yard and the animals. She started to work outside the farm only in 1983, as a nursing assistant at a nursing home.

The two boys, out of school hours, did a lot of the detail work on the farm.

3.15 In terms of crop, the appellant has grown wheat, barley, canola and rapeseed. He was interested in those different types of grain production because on the one hand it is a good practice on the same piece of land to rotate grain each year, and on the second hand, to follow the market as much as possible. Moreover, a farmer is not able to sell his crop as soon as it is taken off the field. He is tied to a quota system fixed by the Canadian Wheat Board, the decision of which mainly depends on the export sales. The initial opening quota is three bushels per acre and can go as high as 15 bushels — even sometime, depending on international needs “the quota is wide open. You (then) can deliver as much as there is room in the elevator for” (tr. 62). However when there is surplus of grain in the elevator and few export sales, the quotas are very small.

As it appears to Exhibit A-3 above (3.12), in December 1980, the appellant had an inventory of 8,000 bushels.

3.16 He then had also in the same year 1980 eight to ten head of cattle. During the years involved he had as many as 15. The average value was $500 apiece. They were all sold in 1984.

With respect to cattle, he did not have the intention to create a large operation of a few hundred animals. He owned a few animals, first as an interest for his sons, so that they would become familiar and involved with animals and also as a diversion from just straight grain farming.

3.17 The appellant said that in the years 1978, 1979, 1980, they really expected 35 to 40 bushels per acre; they realized only 25 to 30 bushels per acre. If they had realized the 10 bushels more, computed with 360 cultivated acres, at $5 per bushel, this would have given $18,000 more per year.

In 1985, his neighbours realized 40 bushels per acre.

3.18 Pursuant to the appellant’s income tax returns with respect to the 1982, 1983 and 1984 taxation years (Exhibts R-1, R-2 and R-3), the income and losses were as follows:

The main current expenses during the years 1979, 1980, 1981, 1982, 1983 and 1984 were as follows:

3.19 Following the reassessments issued by the respondent, the appellant had to pay $13,000 in taxes, “it was no dream anymore”, (tr. 83) His wife went to work, they sold the cattle.

3.20 With his fair salary, “. .. I was using every available dollar that I had to build my farm base, as far as the land and equipment was (sic) concerned”, (tr. 83)

Without his salary, it would have not been possible to acquire the land and machinery.

3.21 In 1986, he would like to consider himself a farmer but he is unable to look to that as a sole means of support. He lives on a farm but it is not a full-time operation (tr. 51).

However, during the years involved 1978 to 1981, it was his intent that the bulk of his income would come from the farm, “not only the bulk of my income, but ultimately it was supposed to be my only source of income”. (Tr 88)

After building his home, the appellant explained that he had a plan concerning grain production. The first step was to purchase the three quarters on the east side of the Saskatchewan River. After if he had to sell a part of the quarters he owned because of the economic climate, and purchase other quarters, again he sold a part of them. It was only to take advantage of the market place, to increase his equity and finally to establish a viable farming unit. “If I had been able to continue on the same basis for maybe another three to five years, I would have been in a position where I could look to farming as my only involvement”, (tr. 114, 115)

The main reason why he did not succeed in his plan was that the crop yield expectations were not what he had projected “. .. if you miss a rain . . . your yield is down . . .”. The second reason was “the drastic rise of interest rates that just made the expenditure . . . You could not produce enough grain to cover the costs”. (tr. 116, 117)

4. Law — Cases at law — Analysis

4.01 Law

The main provision of the Income Tax Act involved in this case is 31(1). It reads as follows:

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 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) /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

Counsel for the parties referred the Court to the following cases at law:

(1) W. Moldowan v. The Queen, [1977] C.T.C. 310; 77 D.T.C. 5213.

(2) J.-M. Auffrey v. M.N.R., [1984] C.T.C. 3002; 84 D.T.C. 1808.

(3) K. B. Bright v. M.N.R., [1984] C.T.C. 2988; 84 D.T.C. 1804.

(4) C. H. Roney v. M.N.R., [1984] C.T.C. 2701; 84 D.T.C. 1431.

(5) P. Knaak v. M.N.R., [1984] C.T.C. 2460; 84 D.T.C. 1397.

(6) W. M. Kerr et al. v. M.N.R., [1984] C.T.C. 2071; 84 D.T.C. 1094.

(7) D. R. Piche v. M.N.R., [1984] C.T.C. 3032; 85 D.T.C. 23.

(8) Ray Z. Rivers v. M.N.R., [1984] C.T.C. 2933; 84 D.T.C. 1802.

(9) The Queen v. Paul E. Graham, [1985] 1 C.T.C. 380; 85 D.T.C. 5256.

(10) P. Karnick v. M.N.R., [1984] C.T.C. 3009; 84 D.T.C. 1833.

4.03 Analysis

4.03.1 The general point is whether the appellant’s chief source of income is “neither farming nor a combination of farming and some other source of income . . .” as used in section 31(1) of the Act quoted above.

In this respect, the Supreme Court of Canada, in the well-known Moldowan case (4.02) makes the following comments (the Court refers to subsection 13(1) of the former Act which is the same wording as 31(1) of the new Act):

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.

There has been difference of opinion on whether the word “combination” in subsection 13(1) requires some “connection” by way of physical relationship or integration or inter-connection between farming and the subordinate activity which provides another source of income. Paragraph 3(f) of the Income War Tax Act of 1917, as amended, made reference to “connection” in defining the permissible deductions from income derived from the chief business, trade, profession or occupation of the taxpayer in determining his taxable income. Paragraph 3(f) read:

(f) deficits or losses sustained in transactions entered into for profit but not connected with the chief business, trade, profession or occupation of the taxpayer shall not be deducted from income derived from the chief business, trade, profession or occupation of the taxpayer in determining his taxable income.

The word “connected” is not found in section 13 of the present Act. As Thorson P. said, obiter, in Simpson v. M.N.R., [1961] C.T.C. 174; 61 D.T.C. 1117 there is no reason why there must be such a limitation. I share this view. See also Dorfman v. M.N.R., supra, at 154 [6134] and Bert James v. M.N.R., [1973] C.T.C. 457 at 464; 73 D.T.C. 5333 at 5337.

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 limitation of the section would never apply and, in every case, the taxpayer could deduct the full amount of farming losses.

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) 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 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 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 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 recognizes 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 limit 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.

4.03.2 First, the argument given by the appellant and described in the second part of Exhibit A-3 (para. 3.12) to establish that the appellant’s chief source of income is either farming or a combination of farming and some other source, must be set aside as a whole because the combination cannot be simple addition of two sources as said in the Moldowan case quoted above — even if some elements in this argument may be used perhaps to establish one of the points involved in the solution of the problem.

Rather it is more appropriate to consider the ingredients which are significant to determine the reasonable expectation of income from the various revenue sources and the ordinary mode and habit of work of the appellant as suggested by the Supreme Court of Canada in the Moldowan case.

4.03.3 In the instant case, the reasonable expectation of profit for the years involved is not a point at issue because the respondent considers the appellant as a gentleman farmer, which is the second class of farmer envisaged by the Supreme Court, for which it is already required to have a reasonable expectation of profit.

Can it be said, however, that the profitability of the farming operation is both actual and potential? If I considered, during the years involved, the gross income (para. 2.02); the high interest rates and amounts paid (paras. 3.10 and 3.18); the cash flow taken by the start-up expenses, i.e. the tools that the appellant had in hands: up to three and a half quarters of good land (now one and a half quarters free of mortgage), the appropriate buildings (barn, corral), the main appropriate machinery, I arrive at the conclusion that there was a viable unit with profitability both actual and potential.

4.03.4 The ordinary mode and habit of work and time spent for each source of income are also criteria suggested by the Supreme Court in the Moldo- wan Case.

The appellant had been working for a window manufacturing company (para. 3.04) since 1964, when he bought his first quarter of land in 1973 (para. 3.07). Having been brought up on a farm, it was a long-term desire to own a farm (paras. 3.06 and 3.07). He built a home and started to acquire appropriate assets (para. 3.08) to become mainly a grain producer. Even if he acquired up to 15 head of cattle however it was not his main purpose (para. 3.16). His employment income was devoted to his farming operation (para. 3.20).

He spent more time working on his farm than for his employer. Indeed he has been working 35 hours per week for Dashwood. And he spent over 40 hours per week on his farm, without computing his four weeks of holidays per year and the other days of vacation and without considering the time spent on the farm by the other members of the family: his wife and his two boys (paras. 3.13 and 3.14).

The Court must conclude that there was a change in the appellant’s mode and habit of work and the appellant’s use of his time in favour of the farming operation.

4.03.5 The capital committed clearly appears from the schedule A-1 (para. 3.08) and the schedule A-2 (para. 3.09) showing mainly amounts invested in machinery, buildings and land.

The Court is satisfied of the amounts involved and the appropriate assets acquired.

4.03.6 In the Moldowan case, Dickson, J. (as he then was) said 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.

I think the appellant made a first step to change his occupational direction when in 1973 he bought his first quarter of land and built a home. However, this could hâve not been significant.

In my opinion, the actual step was in 1977 when he purchased the second piece of land (two quarters). He then had a plan concerning grain production (para. 3.21).

In my view, the preponderance of evidence favours the appellant's thesis.

Conclusion

The appeal is allowed with costs for the reasons given above.

Appeal allowed.