Clément Rivest v. Minister of National Revenue, [1985] 2 CTC 2031, 85 DTC 436

Tremblay, TCJ [TRANSLATION]:—This appeal was heard on June 29, 1984 at Montréal, Quebec.

1. Issue

The issue is whether the appellant, a dentist, was entitled in computing his income for 1978, 1979 and 1980 to deduct restricted farm losses of $4,389.50, $5,000 and $4,802 respectively. The appellant maintained that during these years he was involved in partnership with a horse trainer in breeding and racing horses.

The respondent disallowed the said expenses on the basis that there was no reasonable expectation of profits from the said farming activities. According to the respondent, these expenses must therefore be regarded as personal and were not deductible in computing the appellant’s income.

2. Burden of Proof

2.01 The appellant has the burden of showing that the respondent's reassessments are incorrect. This burden of proof results from several judicial decisions including a judgment of the Supreme Court of Canada in Johnston v MNR, [1948] CTC 195; 3 DTC 1182.

2.02 In that same judgment the Court held that the facts assumed by the respondent in support of the reassessments are also presumed to be true until proved otherwise. In the instant case the facts assumed by the respondent in the reply to the notice of appeal read as follows:

2. In assessing the appellant for the 1978, 1979 and 1980 taxation years, the respondent relied inter alia on the following assumptions of fact:

(a) During the taxation years in question the appellant was a dentist and derived substantial income from his profession;

(b) During 1977 the appellant formed a partnership with a horse trainer for breeding and racing horses;

(c) During the years in question the appellant spent part of his leisure time taking care of his horses;

(d) During the years in question there was no reasonable expectation of profit from these horses;

(e) In his tax returns the appellant claimed the following amounts as farm losses:

1978 — $4,389.50

1979 — $5,000.00

1980 — $4,802.00

(f) The appellant reported the following income and expenses in connection with the race horse operation:

	1978		1979	1980
Income	$	0	$ 350	$ 500
Expenses	$11,779		$8,086	$4,584

3. Facts

3.01 With the exception of subparagraph (d) of paragraph (2) of the reply to the notice of appeal, concerning the facts assumed by the respondent, all other subparagraphs were substantially admitted by the appellant. The said paragraph (d) was denied.

3.02 The appellant’s partner during the years in question was Mr Claude Emond, who has been a horse trainer and driver for many years. This partnership began in 1977. This farming operation's fiscal year ends on May 31 of each year.

3.03 The appellant’s financial statements for the years ending on May 31 of each year from 1978 to 1982 (Exhibit 1.1) show the following figures for this particular operation:

For the year ending on May 3, 1983 there was apparently neither a profit nor a loss.

3.04 The appellant said that he was by experience fairly familiar with horses since he had been brought up on a farm where there were always horses. In addition, he had been going to racetracks since 1970. Finally, in 1983 he repurchased the 12 /2-acre farm located at Epiphanie, Quebec for the purpose of breeding horses.

3.05 During the 1978 taxation year, with Mr Emond, he bought two horses, first Leecoeur (fall 1977) and Leevert (March 1978). These two horses were sons of First-Lee, a stallion which had shown its mettle on racetracks. They paid $11,000 for both of them, or $5,500 per partner.

3.06 Two horses were purchased through the Sodiq circuit, which was set up primarily to promote the breeding of Quebec horses and the development of high-quality Quebec horse breeds. This circuit is said to be attractive to investors purchasing young one or two year olds. The distance run is apparently shorter and the purse rules less strict.

3.07 Leecoeur, who in training had run the mile in two minutes eight seconds, was promising. As a result of an outbreak at Blue Bonnets in 1978, however, he caught a throat infection which put him out of commission. He had to be destroyed in 1979.

3.08 Leevert, who was about 27 or 28 months old when he was purchased, was a horse that required greater patience. He was nervous. He would become excited in the stalls. He had nonetheless won six starts at the Connaught race track. A page from the Connaught track in 1980 shows Leevert's performance (Exhibit A-1). In 1979 he had an accident that affected one knee. In 1980, even though he was still disabled in one knee, Leevert showed good form. In the summer of 1982, he was entrusted to Mr Réal Turenne. The latter gave evidence in court. He is the chief trainer at Blue Bonnets. Since 1969 he has been doing the races there every evening. He is a man of experience who has trained 17 horses. According to him, an injured knee is not fatal. The best veterinarian hospital is in New York, where the horse is treated with cortisone. Leevert received an injection in Montréal, however, to remove the inflammation but the knee swelled up. There was a bony growth in the knee area. According to the veterinarian, the chances for recovery had become very slight. The horse had to be destroyed in September 1982. He was seven years old at the time. If his knee problem could have been solved, he would have been worth $15,000.

Nevertheless, in 1982, despite his handicap, he still won three races in Trois-Rivières. Owing to bad weather and the poor condition of the track, he had to run in mud, which had not helped his knee.

3.09 The association between Mr Emond and the appellant ended in May 1982. The appellant subsequently continued to run the farming operation alone, without another partner, and is still doing so at present. He nevertheless entrusts the training of his horses to Mr Turenne, as he did in the summer of 1982 with Leevert, and to other trainers as well.

3.10 In October 1983, the appellant purchased Re Adaptor for $1,700, an 18-month old foal who according to the appellant “paid his way last year”. He apparently won $5,000.

3.11 In November 1983 he also bought a broodmare Ikorismo aged fourteen years. She had previously been on a breeding farm. She had apparently had a foal that had sold for $32,000. The mare had been purchased for $11,000. A foal was born on April 7, 1984. In June 1984 she was again with foal, after mating with Sunday Model, another famous stallion.

3.12 According to the appellant, during the years in question and afterward, he spent between six and seven hours a week with the horses. Mr Emond in fact took care of the horses and exercised them. He, the appellant, did not do the training. According to him, being a trainer was an occupation in itself. In taking in a trainer as a partner, he said he had made a wise choice. He likes horses and yet has enough experience to know whether the trainer is doing his job properly.

3.13 When there was a decision to be made, he took an active part in it.

3.14 Mr Guy Malo, an employee of the respondent, testified that he had met the appellant at the time of the audit and had visited the stables.

According to him, the appellant was not spending enough time on the horses and his knowledge of the field was not sufficient for such an operation.

4. Act — case law — analysis

4.01 Act

The principal provisions of the Income Tax Act concerned in the case at bar are 18(1 )(h), 31(1) and 248(1), namely the definition of “personal or living expenses".

18(1) In computing the income of a taxpayer from a business or property no deduction shall be made in respect of

(h) personal or living expenses of the taxpayer except travelling expenses . . .

31(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.

248(1) In this Act, “personal or living expenses" includes

(a) the expenses of properties maintained by any person for the use or benefit of the taxpayer or any person connected with the taxpayer by blood relationship, marriage or adoption, and not maintained in connection with a business carried on for profit or with a reasonable expectation of profit.

[Emphasis added.]

4.02 Case law

The parties referred the Court to the following cases:

1. William Moldowan v The Queen, [1977] CTC 310; 77 DTC 5213;

2. Joseph Shiewitz v MNR, [1979] CTC 2291; 79 DTC 340;

3. A J Lewis v MNR, [1984] CTC 2306; 84 DTC 1267.

4.03 Analysis

4.03.1 In Moldowan, the Supreme Court referred to the former section 13 of the Act, which is the same as section 31 of the present Act:

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 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 nonbusiness farming are not deductible in any amount.

In the case at bar the issue is whether the appellant is a gentleman farmer or whether his farming activities should be regarded as a hobby.

The respondent maintained that this is a hobby since there is no reasonable expectation of profit. These are consequently personal and living expenses that are not deductible. The Supreme Court said the following concerning reasonable expectation of profit:

There is a vast case literature on what reasonable expectation of profit means and it is by no means entirely consistent. In my view, 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 Queen v Matthews, [1974] CTC 230; 74 DTC 6193. One would not expect a farmer who purchased a productive going operation to suffer the same start-up losses as the man who begins a tree farm on raw land.

4.03.2 With the evidence presented, the various criteria set out by the Supreme Court should be examined: (1) the profit and loss experience in past years; (2) the taxpayer's training; (3) the taxpayer's intended course of action, and (4) the capability of the venture as capitalized to show a profit after charging capital cost allowance.

4.03.3 The profit and loss experience in past years

The financial statements show a series of losses from 1978 to 1981 and a net income in 1982. In this latter year there was not even a gross income. It was by adjusting inventories that a net income was arrived at.

In 1983 there were neither profits nor losses (para 3.03).

According to the evidence, however, it was as a result of bad luck (outbreak of disease and knee injury) that there were no winnings. Originally both horses certainly had good potential, owing to both their pedigrees (para 3.03) and their performance (para 3.08).

In addition, it seems that development in the Sodiq circuit, while the horses are young, makes it possible for them to be profitable more quickly than development in other circuits (para 3.06).

The purchase of Rex Adaptor in the fall of 1982 at the age of 18 months was part of the same course of action as the purchase of the first two horses. According to the appellant, he paid his way (para 3.10).

4.03.4 The appellant's training

The appellant had a knowledge of horses in general and of race horses in particular (para 3.04). He nevertheless went into partnership with a good trainer (para 3.02) and later the training of the horses, which is an occupation in itself, was carried out by other trainers. The Court is of the view that the appellant has met this criterion.

4.03.5 The Court is of the view that the appellant intended from the outset to make money with the horses. This was recognized by counsel for the respondent.

4.03.6 Capability of the venture

At the time the horses were purchased, with the quality of the horses purchased, with the organization as constituted (in other words in partnership with a qualified trainer), with the investment made, did the appellant have the capability to show a profit taking into account that the operation was just starting up? The Court believes that he did. It also believes that his association with a qualified trainer could make up for a lack of specialized knowledge. In addition, by relying on his partner, he was not obliged to be present every day.

4.03.7 Furthermore, the appellant’s subsequent conduct, in purchasing another foal in the fall of 1982, is consistent with the initial investment. The purchase of the family farm in 1983 to breed foals is a slightly different operation but still falls within the same general course of action. The future concrete results will tell the story.

4.03.8 The preponderance of the evidence in my view favours the appellant's thesis that there was a reasonable expectation of profit in the years in question.

5. Conclusion

The appeal is allowed and the matter referred back to the respondent for reassessment in accordance with the above reasons for judgment.

Appeal allowed.