C R McCambridge v. Minister of National Revenue, [1981] CTC 2314, 81 DTC 251

The Chairman:—The appeal of Mr Charles R McCambridge is from an assessment by which the Minister of National Revenue reduced to $5,000 the farm losses of $40,996 claimed by the appellant in his 1974 taxation year 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 within the meaning of subsection 31(1) of the Income Tax Act, SC 1970-71-72, c 63, as amended and that the maximum allowable farm loss was $5,000.

At the commencement of the hearing, counsel for the appellant sought to introduce the appellant’s tax returns covering the period 1972 to 1978 inclusive. Counsel for the respondent objected to the production of tax returns beyond 1974 as being irrelevant to the appellant’s 1974 assessment.

The appellant’s source or sources of income prior and subsequent to the taxation year are for purposes of this appeal, a necessary part of the facts on which the taxpayer may properly rely in opposing the Minister’s assumption that the appellant’s chief source of income was neither farming nor a combination of farming and some other source of income. I do not feel that the issue can be determined on the basis of the returns for taxation year alone and the said tax returns were accepted as Exhibit A-1.

The appellant’s statement of facts reads as follows:

1. The Appellant resides in the City of Ottawa and Province of Ontario.

2. The Appellant acquired a farm in 1972 on which his principal residence was situated from the time of the acquisition of the farm up to and including the period under appeal.

3. During 1973 and 1974, the taxpayer acquired cattle and horses and in addition spent considerable money in putting the farm and buildings situated thereon into a repaired and operating state and as well acquired machinery and equipment necessary for the operation of a cattle and horse business.

4. From the time of acquisition of the farm until January, 1974, the taxpayer worked the farm with no outside help and in January, 1974 hired individuals to work with him in his farming business.

5. The taxpayer’s investment in cattle was initially in the “Angus” breed but has subsequently been changed to the “Charolais” breed. The initial stock of horses acquired by the taxpayer were pure-bred Arabian.

6. In order to create a viable and economical farming operation, a two or three year period is necessary to elapse prior to profits being generated from the disposition of cattle and horses.

7. In computing his income for the 1974 taxation year, the appellant claimed a farm loss of $40,996.00, deducting the said amount from income.

8. On September 7, 1976 the Respondent re-assessed the Appellant and reduced the amount of the loss claimable to $5,000.00, applying section 31 of the Income Tax Act and stating that the Appellant’s chief source of income for the 1974 taxation year was neither farming nor a combination of farming and some other source of income.

The assumptions of fact on which the Minister bases his assessment are:

ga) the Appellant purchased the subject farm in September of 1972 for 50,000.00 and sold it in July of 1975 for $125,000.00 after having made some improvements and additions to it;

(b) the Appellant was interested in showing prize cattle and horses and took part in various shows;

(c) the Appellant in his 1974 taxation year had as his chief source of income his profit from carrying on his dental profession;

(d) farming for the Appellant in his 1974 taxation year was merely a sideline business.

5. The Appellant claimed $40,996.00 in his 1974 taxation year as a farming loss which the Minister disallowed in part.

The issue must be determined on the facts of this appeal which are really not in dispute. As pointed out by both counsel, the fact that the Minister’s assessment has the effect of restricting the amount of farm losses claimed is an admission that the appellant’s farming activities constituted a business. Moreover, implicit in the assessment is the Minister’s assumption that the appellant’s farming business did have a reasonable expectation of profit.

The sole issue therefore is whether the appellant’s chief source of income was from farming or a combination of farming and some other source. It is the respondent’s submission that although the appellant was engaged in farming which did have a reasonable expectation of profit, it was a sideline business whose profit was not sufficient to be considered as the appellant’s chief source of income nor was it in combination with some other source of income or the appellant’s chief source of income in 1974, the taxation year under appeal.

The appellant submits that his intention, his investments and his activities support his contention that his chief source of income was from his farming or a combination of farming and some other source and concludes that section 31 of the Act does not apply to the facts of this appeal and that the appellant’s farm losses should not have been restricted but allowed in full.

Subsection 31(1) of the Act 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

(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 deductions in respect of expenditures described in section 37, 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 deductions in respect of expenditures described in section 37” 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 Supreme Court decision in William Moldowan v The Queen, [1977] CTC 310; 77 DTC 5213, cited by both counsel is not only the leading case on the point at issue, providing as it does three specific and practical tests in applying section 31 of the Act. It also provides, as I see it, basic principles on which more marginal facts can also be legally considered.

In dismissing the Moldowan appeal, the Supreme Court found that the taxpayer spent but a few hours a day for only a part of a year in his horseracing activities; that the horse-racing operation was not a business carried on for profit or with reasonable expectation of profit and considered that the taxpayer’s chief source of income was neither farming nor a combination of farming and some other source and was only entitled to losses provided for in subsection 13(1) or 31(1) of the Act.

In the instant appeal the Minister admits that the taxpayer was carrying on a farming business which had a reasonable expectation of profit. The facts of the instant appeal are therefore quite different from those of Moldowan.

The three classes of farmers, as envisaged by Mr Justice Dickson, are:

(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.

The basic facts on which the learned Justice seems to have established his three tests in determining the chief source of income is the bearing of farming or farming and some subordinate source of income to the taxpayer’s means of livelihood and mode of living which can only be determined by the facts.

The facts in this appeal-can be viewed in the light of both paragraphs 1 and 2 above which, for purposes of interpretation, should in my opinion be read together. If paragraph 2 had been stated positively, it would in fact reflect the purport of paragraph 1\in that a taxpayer who looks to farming or farming and some subordinate source of income for his livelihood would be free of the limitation of section 31 of the Act.

The wording of the first two tests as well as the learned justice’s accompanying remarks take into account the taxpayer’s intentions relative to his actual or to a potential source or Sources of income as his chief source of income, not only for the current year, but also for future years as well. In other words, the learned justice recognizes the possibility for a taxpayer to move toward or away from farming as his chief source of income.

At page 314 [5215] of Moldowan, Mr Justice Dickson states:

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.

That is the basis of the appellant’s submissions.

The respondent’s contention is that for the appellant, farming is, has been and will be a sideline business which raises a crucial question: What is farming as a sideline business which is not hobby farming?

Mr Justice Dickson, as I understand it, considers that it is farming which is subordinated to or an auxiliary of some other activity engaged in by a taxpayer in the process of earning a livelihood.

It is very significant in my view that the learned Justice did not ignore the real possibility for a taxpayer to change or attempt to change his chief source of income.

Having stated that “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.”, Mr Justice Dickson goes on to say at 315 [5216]:

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 (I) 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.

The taxpayer’s personal activities in relation to earning his livelihood are again stressed and the possibility for a taxpayer to change his occupational direction is specifically referred to. I do not believe that the three tests were meant to exclude transitional periods in which the taxpayer can be seen to be moving towards farming as his chief source of income; nor is it for several reasons an objective test of chief source to use the net income of farming activities at the beginning of the transitional period in which farming expenditures are inevitably high.

I do not think that one can rightly conclude that a taxpayer does not look to farming as his chief source of income on the sole basis that the profit from farming is not sufficiently high to be considered as chief source in the year under appeal as suggested by counsel for the respondent. The taxpayer’s activities, “the time spent”, the importance he gives to farming, “the capital committed” and the “profitability”, but actual and potential from farming as a livelihood cannot, in my opinion, be determined on the basis of any one particular taxation year. A change of operational direction from dentistry to the business of breeding cattle and horses for purposes of sale can only be ascertained by the facts as seen over a longer period of time.

As in many other instances, the taxpayer’s declared intention of making farming his chief source of income is of course not by itself sufficient. The taxpayer must clearly establish the facts which support his contention that he looks to farming (or farming and some other source of income) which is not subordinated to or auxiliary of some other major source of income for his livelihood and that he is not looking to farming as a sideline business.

Summary of Facts:

The appellant is a practising dentist who, very shortly after opening his dental practice in 1972, purchased a 100-acre farm and residence in Smiths Falls, Ontario. It is the appellant’s evidence that, as a boy, he worked on farms, engaged in cattle and horse raising and would have preferred becoming a veterinarian rather than a dentist, were it not for the lack of finance.

After effecting necessary repairs on the residence and farm buildings, he purchased farm equipment and commenced the operation of breeding Angus cattle and Arabian horses in 1973. From 1972 to 1974 the appellant carried out his farming operations without outside help. In order to do so, he scheduled his working hours in his dental practice to 20 to 24 hours a week. The remaining work days and weekends, he operated the farm with the help of his wife.

The appellant alleges that he moved his dental office to be closer to the farm and continued to spend a considerable portion of his work week operating the farm. Part of the appellant’s income from his dental practice was invested in the farming operations. In 1978 the appellant hired a dental hygienist in order to help increase his income from dentistry while spending more time in farming.

The appellant sold the farm in 1975 but leased the land from the purchaser and continued his farming operations uninterrupted from 1972 to 1979 and, to my knowledge, still does. Subsequent to selling the farm, the appellant established his residence near the leased farm.

The appellant’s farm operations consisted in the purchase, the breeding and sale of Angus or Charolais cattle and pure Arabian horses. Having hired a trainer, the animals were trained for showing at animal exposition with a view to potential sales.

The following table, produced as Exhibit A-3, summarizes the figures contained in the appellant’s tax returns from 1972 to 1978, (Exhibit A-1); a statement of income from the appellant’s farm operations for 1979, (Exhibit A-2), as well as balance sheets of the appellant’s dental practice for the years 1972-1973 and 1974, (Exhibits R-1, R-2 and R-3).

EXHIBIT A-3

	1972	1973	1974	1975	1976	1977	1978 1978	1979
Net
Professional	18,734	35,800	39,107	39,546	35,235	27,974	71.968.21	55,652
Income
Gross
Farm	Nil	3,025	3,105	6,641	29,850	5,400	11,200	48,200
Income
Livestock
	Nil	10,355	14,721	18,799	7,026	2,971	Nil	3,706
Purchases
Livestock
	Nil	905	3,105	6,641	29,850	5,400	10,000	48,200
Sales
Net
Farm	Nil	(22,278)	(40,996)	(39,970)	(17,030)	(15,681)	(11,000)	16,411
Income

I am satisfied on the basis of all the eveidence and on the figures of the above table that farming was a major concern in the appellant’s mode of life and potential source of income. I must nevertheless determine the narrow issue as to whether the appellant was operating a farm as a side line business or whether he was looking to farming for his livelihood and if farming could be expected to provide the bulk of the appellant’s income and be the centre of his work routine.

There can be no doubt that farming did not provide the bulk of the appellant’s income in the taxation year under appeal. I do not believe however that the appeal should fail on that fact alone.

The declared intention of the appellant to phase out his dentistry practice and to engage principally in farming is not unsupported by the facts.

The appellant purchased the farm and commenced operations very shortly after he started his dental practice. From the beginning, the evidence is that the appellant spent more time in operating the farm than he did practising his profession. In giving evidence the appellant, a credible witness, showed more interest in farming than he did in dentistry. Part of his professional income was invested in the farm and his whole attitude during the period 1972-1979, whether in scheduling his work hours, moving his dental office and residence closer to the farm, the aborted attempt to purchase another farm on which to carry on farming, all indicate to me that, for the appellant, farming was more than a sideline business.

It is significant, in my opinion, that in 1973, 1974, 1975, 1976 and 1977, when the appellant’s average income from his profession was roughly $35,000 per year, he purchased over $53,000 of livestock in that period of time. In 1977, even though his professional income dropped from $35,000 to $27,000, he nevertheless invested almost $3,000 in livestock. It is only after having hired a dental hygienist in 1978 that his professional income rose to $71,968 and left him freer to attend to his farming. In 1979 his professional income fell to $55,652 but he nevertheless invested another $3,706 in livestock.

It would have been difficult indeed for the respondent to contend that the appellant had no reasonable expectation of profit from his farm operations. From 1973 to 1979 the appellant’s gross farm income was $3,025, $3,105, $6,641, $29,850, $5,400, $11,200 and $48,200 respectively. The net farm losses decreased from a high of $40,996 In 1974 to $11,000 in 1978, showing a profit of $16,411 in 1979.

In 1979 the appellant’s net income from his profession was $55,652 while his gross farm income was $48,200. While the bulk of the appellant’s income cannot yet be said to come from farming, it is of sufficient magnitude compared to his professional income to confirm the appellant’s declared intention of looking to farming as his chief source of income.

No one can realistically expect to realize a profit in the first years of a cattle and horse breeding operation nor should one be surprised that the sale of livestock on a large scale such as occurred in 1976 and 1979 would reduce the appellant’s capital assets, as was suggested by the respondent in his contention that the appellant’s farming operation was a sideline business. After the 1979 sale, the appellant still had I believe 19 animals, most of which were Arabian horses. I cannot see how these transactions, which are normal in the breeding business or any other business, justify the conclusion that the appellant’s operations are a sideline business.

The facts, as I see them, support the appellant’s evidence given under oath that he changed occupational direction as early as 1973 and that from that time on he, in the words of Mr Justice Dickson, committed his energies and capital to farming as a main expectation of income and is not disentitled to deduct the full impact of start up costs.

For these reasons, the appeal is allowed and the matter referred back to the Minister for reassessment on the basis that the appellant’s chief source of income was from farming or a combination of farming and some other source of income. The farm loss restrictions set out in section 31 of the Act do not apply to the facts of this appeal.

Appeal allowed.