Doug Smith Holdings LTD v. Minister of National Revenue, [1985] 1 CTC 2320, 85 DTC 265

Cardin, TCJ:—Doug Smith Holdings Ltd, incorporated on October 21, 1975 under the Business Corporations Act of Ontario, is appealing from an assessment of income tax by which the Minsiter of National Revenue disallowed the totality of farming losses sustained by the company in amounts of $3,957, $9,529, $12,343 and $759 ($26,588 total) in the fiscal years 1976 through 1979, respectively.

The principal shareholder and sole director of the appellant company is Doug Smith who, prior to July 1978, was a full-time employee of Marmoraton Mining Company Limited. Subsequently, in 1978 he commenced a part-time employment as a bartender.

The objects of incorporation were two-fold: 1) the operation of a gas station and automotive repair shop which was operated by Doug Smith, his wife and two daughters until October 1978; and 2) the ownership, management and training of racehorses and animals of all kinds and to enter any deals with respect to the same. After October 1978, the gas station business having been discontinued, the appellant’s only activity was with respect to racehorses.

Doug Smith, the president of the appellant, is a licensed horse trainer and driver and owns a three-horse stable and racing equipment. The training track at the Marmora Fair Grounds was available to the appellant year-round.

On September 28, 1976, the appellant corporation purchased a Canadian standardised yearling named “Obie Killean” (whose sire had earned $301,796 in two years of racing) which was trained for harness-racing. During the first year of the appellant’s ownership, the horse was trained in Florida but subsequently was trained by Doug Smith at the Marmora Fair Grounds.

Obie Killean was raced at the Greenwood Raceway in Toronto and finished third — one length behind the winner. The horse subsequently sustained an injury making him unfit for racing and, in 1978, was sold for $222; the appellant was then given another horse called “Steady Joe” as part of the transaction. Steady Joe was thereafter traded for a horse named “Copper Cliff’ which eventually was sold for meat. During the relevant period, the appellant corporation owned only one horse at a time.

During the period 1976 to 1979 inclusive, the appellant’s total earnings were $293 in 1977 and $683.90 in 1978 (including the sale of Obie Killean for $222) as compared to losses of $26,588 for the same period.

There can no longer be any doubt that “farming” includes “maintaining horses for racing” (section 248 of the Income Tax Act, RSC 1952, c 148), nor is there any dispute that subsection 9(2) allows the deduction of losses incurred in the operation of businesses. The problem here, however, centres around the application of section 31 which, as I see it, is an exceptional provision of the Income Tax Act (as amended) dealing specifically with farming losses, the issue in this appeal.

Although the facts of Upstream Holdings Inc v MNR, 36 Tax ABC 227; 64 DTC 608, (cited by the appellant) are very different from those of the case at bar, the principle that the incorporation of a company raises a presumption of an intention to carry on a business cannot seriously be disputed. The nature of that presumption, however, is not conclusive — it is rebuttable.

If a taxpayer incorporates a company, admittedly with the intention of carrying on a business and fails, for whatever reason, to proceed with it, there is no business and the presumption of his intention to carry on a business must necessarily fall. Similarly, if a taxpayer engages in any kind of activity which does not have a reasonable expectation of profit, he is not for tax purposes in business whether he incorporated a company for that purpose or not.

It is the appellant’s contention that as an incorporated company, it was engaged in business of training and racing horses and as such all business losses should be allowed under subsection 9(2). The facts are that, while the appellant did not till the soil or grow crops, it was nevertheless engaged in farming activi ties, at least in part up to October 1978, which gave rise to farming losses. In my opinion, the provisions of subsection 31(1) rather than subsection 9(2) are applicable under the circumstances.

The respondent contends that the appellant did not , in the years under appeal, have a reasonable expectation of profit from his horse-racing activities and was, therefore, not in the business of farming. He submits that none of the farm losses are deductible. Alternatively, the respondent suggests that if the appellant was in the business of farming, only restricted farm losses calculated in accordance with subsection 31(1) of the Act are deductible.

The respondent rules out completely the appellant’s contention that all the farm losses claimed by the appellant can be deducted either under subsection 9(2) or subsection 31(1). Subsection 31(1) reads as follows:

31. (1) Loss from farming where chief source of income not farming—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 .. .

With respect to the application of subsection 31(1) it is, in my view, irrelevant that the appellant is a corporation. However, for the years 1976, 1977 and part of 1978, the appellant’s chief source of income does not appear to me to have been a combination of the gas station and the training and racing of horses. After October 1978, the appellant’s only activity was training and racing horses.

The Supreme Court decision in William Moldowan v Her Majesty The Queen, [1977] CTC 310; 77 DTC 5215, was cited by both counsel. Although the actual wording of Dickson, J, as he then was, may be somewhat more difficult to apply to a taxpayer which is a corporate entity, the underlying principles in his classification of the three types of farmers lose nothing of their validity. At 315 (DTC 5216), the learned Justice stated:

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 non-business farming are not deductible in any amount.

On the basis of the evidence, the bulk of the appellant company’s income in 1976, 1977 and up to October 1978, could not reasonably be expected to come from the training and racing of a horse which was done by Doug Smith on a part-time basis. The bulk of income could only reasonably be expected to come from the operation of the gas and automotive repair station in which Doug Smith, his wife and their two daughters were actively involved. In those circumstances, the appellant does not meet the criteria set out by Mr Justice Dickson with respect to the first of his three-tier classification, commonly referred to now as full-time farmers. The appellant, therefore, is not eligible for deduction of the totality of the farm losses claimed.

The question now becomes whether the appellant company in the years 1976 to October 1978, could look to the training and racing of horses as a subordinate source of income and thereby be entitled to restricted farm losses under subsection 31(1)? To meet the requirements of Mr Justice Dickson’s second category of farmers as set out in Moldowan (supra), farming (training and racing horses) must be a sideline business of the taxpayer. In order to qualify even as a sideline business, the activity must under normal operational conditions be clearly seen to be a potential source of income and have a reasonable expectation of profit — a determination which can only be made on the specific facts of each case.

The appellant correctly pointed out that no evidence was adduced to support the respondent’s statement that there were a lot of losers in the horse-racing business. The Court gave no weight whatever to that argument because we are not dealing here with the horse-racing business generally but with the appellant’s own horse-racing activities.

I have no trouble in accepting that the appellant’s intention, indeed its hope, was to make money from racing horses or that Doug Smith was a qualified trainer and licensed driver. I also appreciate that considerable taxable income can be derived, or that deductible losses can be incurred in the business of horseracing. However, more than training a horse and entering it in races is necessary before that activity, for tax purposes, can qualify as a business, even a sideline business.

From an objective view of the evidence, it is obvious that the appellant’s horse-racing activity, particularly as it was operated in the years under appeal, was a very risky one indeed. Of the three horses acquired by the appellant for racing, all had to be disposed of for one reason or another during the years under review. There was no change in the appellant’s horse operation after October 1978 when racing became the company’s only activity, and no hard evidence was adduced as to proposed operational changes in the appellant’s conduct of its racing activities by owning and racing one horse at a time.

While it is true that there are risks in any business — too high a degree of risk, pure speculation, or simple wishful thinking can conceivably negate the essence of a business — an activity that can objectively be seen as having a reasonable expectation of realizing a profit. The activity must also be carried out according to normal operational business standards if it is to qualify as a business.

In the instant appeal, the appellant corporation’s financial statements for the pertinent taxation years show total earnings with respect to horse operation of less than $1,000 and the losses claimed, over $26,000. The company, however, did not include, in its statements, expenses normally incurred in sheltering, grooming and feeding, maintaining training and racing the horses which were kept in a stable belonging to Doug Smith who also carried out at no cost all the above chores necessary to race a horse.

Omitting to include these normal expenses in its financial statement substantially reduces the company’s expenditures and real losses with respect to its activity of racing horses. Whatever other conclusion may be drawn from that fact, it appears that the company itself in not following normal business and accounting principles did not consider its horse-racing activity a business.

On the basis of the evidence, the possibility for the appellant company of even meeting its normal operational expenses of racing horses in the manner it chose to do in the taxation years under appeal is, in my opinion, very remote indeed. I conclude that the appellant corporation did not succeed in establishing that it had, in any of the years under appeal, a reasonable expectation of making a profit from its horse-racing activities and it was therefore not in the business of racing horses. None of the expenses claimed in the 1976, 1977, 1978 and 1979 taxation years are deductible under either subsection 9(2), subsection 31(1) or paragraph 18(l)(a) of the Act.

The appeal is dismissed.

Appeal dismissed.