Stephen W. Herman v. Minister of National Revenue, [1986] 2 CTC 2288, 86 DTC 1708

Taylor, T.CJ.:—This is an appeal heard in Toronto, Ontario, on July 15, 1986, against income tax assessments for the years 1978, 1979 and 1980, in which the Minister of National Revenue disallowed the full farming losses claimed, but did allow the restricted farming losses, as permitted under section 31 of the Income Tax Act. The notice of appeal reads:

From 1976 to present, the Appellant has been actively engaged in the business of breeding, raising and selling horses. The Appellant has always devoted the majority of his time, capital and attention to his farming business. Additionally, the gross income from the farming business has exceeded that from any other source and net profits (on the accrual basis) have been generated in certain of the years under appeal. Furthermore, the Appellant’s operation has developed over the years to quite a sizeable business, sufficient enough to attract recognition within the industry. Finally, development plans are currently being undertaken with the anticipation that farming will comprise the sole source of income in the near future.

The reply to notice of appeal relates the Minister's position:

— During 1978, 1979 and 1980 the Appellant was a self-employed Chartered Accountant practising in or about the city of Hamilton. In or about 1981, the Appellant ceased to practice alone and became a partner in the accounting firm of Vine and Partners located in or about the City of Hamilton.

— In or about 1977, the Appellant and Suzanne M. Campbell purchased real property located at R.R. #1, Caledonia, for a price of $75,000.00 (the “farm"). Upon purchasing the Farm, the Appellant and Suzanne M. Campbell resided on the Farm.

— The purchase of the Farm was financed as follows:

First Mortgage	$50,000.00
Second Mortgage	10,000.00
Cash	15,000.00
TOTAL	$75,000.00

— In his 1977, 1978, 1979 and 1980 Income Tax Returns, the Appellant claimed farming losses of $4,125.04, $12,604.00, $18,453.00 and $12,218.00 respectively.

— In the years 1977, 1978, 1979 and 1980, the Appellant reported net income of $13,964.00, $23,750.00, $26,282.00 and $20,419.00 respectively from his accounting practice.

— In reassessing the Appellant as stated in paragraph 1 of the Notice of Appeal, the Respondent found or assumed:

— the facts hereinbefore pleaded;

— that there is a reasonable expectation of profit in the farming activities carried on by the Appellant;

— that the Taxpayer's chief source of income for the taxation years in issue was neither farming nor a combination of farming and some other source of income.

— The Respondent relies, inter alia, upon Section 31 of the Income Tax Act, R.S.C. 1952, Chapter 148, as amended.

The testimony and documentation presented on behalf of the appellant was informative and complete. This is a very brief recapitulation of the kind of evidence presented:

Exhibit A-1

CAPITAL IMPROVEMENTS TO FARM

A-2

SUMMARY OF FARMING HOURS WORKED BY STEVE HERMAN

Totals	1978	3,393
	1979	3,481
	1980	3,635
A-3

SUMMARY OF HOURS WORKED STEVE HERMAN ACCOUNTING PRACTICE

Totals		1978	1,686
		1979	1,782
		1980	1,571
		1981	1,140*
♦Joined Vine & Partners in September 1981.
A-5
RESULTS OF OPERATIONS (FARM)
			Net
		Gross	Profit
		Income	(Loss)
1978		$ 14,506	$(16,506)
1979		77,813	13,084
1980		73,806	(25,364)
1981		78,795	(41,331)
1982		137,070	28,385
1983		118,471	6,667
1984		80,938	12,038
1985		182,376	36,169
A-6
FINANCIAL STATEMENTS	For Bankt
(Including Balance Sheet)

+Differ from Income Tax Statements because inventory under Section 28 was included for bank financing purposes. Section 2i will be referenced later in this decision.

A-9

REFERENCE LIBRARY — About 50 different books re “horses”.

A-10

SCHEDULE OF HORSES PURCHASED, RAISED AND SOLD

From 1976 through 1985

A-11

INVENTORY OF HORSES AT END OF YEAR

			No. of
		Cost	Horses
1977		$ 9,100	5
1978		20,455	8
1979		57,845	19
1980		66,414	19
1981		92,593	22
1982		119,729	24
1983		118,700	22
1984		144,975	25
1985		176,735	25
A-12
CAPITAL INVESTMENT
		Accounting
	Farm	Practice	Difference
1978	$28,619	$(11,520)	$40,139
1979	58,632	(3,494)	62,126
1980	28,269	2,878	25,391
1981	26,038	1,336	24,702
1982	81,950	—	81,950
A-13
SUMMARY OF BANK LOANS
			Accounting
		Farm	Practice
1978		$ 15,000	$22,000
1979		24,000	20,613
1980		63,300	20,279
1981		100,000	23,064
1982		84,000	13,418
A-14
GROSS INCOME
	Farm	Farm
	Cash	Accrual
	Basis	Basis	Accounting
1978	$ 16,416	$14,506	$47,939
1979	104,233	77,813	61,638
1980	120,895	73,806	68,807
A-15
NET INCOME
	Farm	Farm
	Cash	Accrual	Accounting
1978	$(11,065)	$(10,928)*	$23,750
1979	(17,014)	8,723	26,282
1980	(7,080)	(12,682)f	$20,419
*Only first full year in operation
tYear of high interest rate.

Based on the above documentation and the supporting testimony of Mr. Herman, the agent for the appellant summarized the position in argument as:

. .. The business itself is quite significant in size and scope, takes a lot of time, involves a lot of work, a lot of manual work, physical work, a lot of mental work; involves breeding, foaling, rearing, marketing horses; syndications: buying and selling, choosing stallons; and it’s a very labour intensive business .. .

And we know that a substantial amount of time was spent on the farm and that from the purchase in 1977 through to the present, the farm has grown, both in gross and in net. The activities have been profitable. The inventory has risen now to $170,000 or so. The name is respected in the industry. The horses sell well at yearling sales.

He has cut down on the amount of time that’s spent on accounting, and in the years in question he was only spending one-third of his hours on the accounting to begin with. I don’t think it was reasonable or expected of him to totally give up a source of revenue that is a significant source and requires a minimum amount of work.

Since 1982 through '85 he has in fact been in a profit position. He has also reported losses for tax purposes, and the losses for tax purposes tie directly into that question we spoke of earlier of inventory. If the Income Tax Act did not allow inventory to be deducted for farming any more than it’s deducted for any other source of income, there wouldn’t have been losses, with the exception of ‘80 and ‘81.

Roger M. Bender*, a taxpayer, was a full-time employee who also carried on a livestock farming business. And I’m sure you’re aware of the facts in this particular case. Page 1292, Mr. Bender is compared to Mr. Hadley:

(1) He made a substantial investment.

(2) He brought his organizational and analytical skills to the business.

(3) His expectations were that the farm would some day provide the bulk of his income.

(4) The losses were the result of depressed market conditions.

Unlike Mr. Hadley, Mr. Bender decided to weather the storm, and I don’t see what the particular result was of that weathering of the storm, if he subsequently became successful or not. Certainly, Mr. Herman has been.

Giving consideration to all the evidence provided, the level of activity, the amount of time, energy, skills put forward and reviewing the jurisprudence available to us, I feel that Mr. Herman should be allowed full deduction for farm loss, as claimed, and should not be subject to Section 31.

*Roger M. Bender v. The Minister of National Revenue, 86 D.T.C. 1291.

One basis for the “full farming loss” proposition of this appellant was that when the accounting and income tax treatment of inventory (in his case “horses”) permitted under section 28 of the Income Tax Act, is taken into account — even if only for “bank financing” purposes (See Exhibit A-6 above) his operation was showing a profit during more periods than it was showing a loss, — if the records were included up until 1985. It has been noted before in judgments (i.e. James Leakos v. M.N.R., [1986] 1 C.T.C. 2245; 86 D.T.C. 1190), that merely putting together some form of “semiaccrual” financial statements to include inventory, for the precise purpose of showing that a “profit” can be calculated, as opposed to a cash loss, leaves that result open to question. That ’’semi-accrual” criticism cannot be levelled at the appellant in this case, since the “financial statements” (Exhibit A-6 was supported by detail in Exhibit A-7) reflect a complete balance sheet for this operation. While Mr. Herman might have been providing one set of financial statements to the Bank, and another set to Revenue Canada, that is not relevant to a determination of the issue before the Court. The section 28 of the Act question however, is not the main point for me in any event.

The main point still is whether Mr. Herman fulfils the conditions under section 31 of the Act — referenced in William Moldowan v. The Queen, [1977] C.T.C. 310; 77 D.T.C. 5213 (S.C.C.), Paul E. Graham v. The Queen [1983] C.T.C. 370; 83 D.T.C. 5399 (F.C.T.D.), Harold S. Hadley v. The Queen [1985] 1 C.T.C. 62; 85 D.T.C. 5058 (F.C.T.D.), and Bender (supra), which provide for the tax relief he seeks. No evidence or argument was advanced in the appeal in support of the Minister’s assessment, which persuaded me that there was a difference of substance between the facts in the abovenoted jurisprudence and the facts in this matter. The circumstances of this case are such that they appear to me to fit the criteria outlined in the relevant current case law.

The appeal is allowed and the matter referred back to the respondent for reconsideration and reassessment. The appellant is entitled to party and party costs.

Appeal allowed.