Henderson v. R., [1999] 1 CTC 2786, 98 DTC 1904

Dussault T.C.J.:

These two cases combine appeals from assessments for the appellant’s 1989, 1990, 1991, 1992 and 1993 taxation years.

The only point at issue is whether the deduction of farming losses sustained by the appellant in each of those years is restricted under s. 31(1) of the Income Tax Act (“the Act”), as the Minister of National Revenue (“the Minister”) found in making the assessments. That provision states that the restriction is applicable “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”.

The substance of the various parts of the Reply to the Notice of Appeal in file No. 95-1134(IT)G (1989, 1990 and 1991 taxation years) is repeated in the Reply to the Notice of Appeal in file No. 96-2494(IT)G (1992 and 1993 taxation years). The facts assumed by the Minister in making the assessments are set out in subparagraphs (a) to (q) of paragraph 14 of the latter Reply to the Notice of Appeal. Those subparagraphs read:

[TRANSLATION]

(a) The appellant received the following income from his employment or his engineering profession and claimed the following farm losses for his 1987 to 1993 taxation years inclusive:

YEAR	ENGINEERING	GROSS	FARM LOSSES
	INCOME	FARM
		INCOME
1987	$130,768	$ 3,866	($ 79,920)
1988	$197,207	$14,257	($ 70,445)
1989	$118,200	$ 3.887	($ 79,681)
1990	$162,872	$ 5,425	($100,849)
1991	$140,528	$24,700	($ 56,771)
1992	$100,000	$12,630	($ 82,187)
1993	$ 96,700	$18,059	($ 77,551)

(b) The farm income of $24,700 reported in 1991 was essentially income from equipment rental.

(c) The appellant has worked as an engineer for over 20 years, primarily in the Canadian West and North, installing pipelines and doing other civil engineering work.

(d) In 1992 the appellant was suffering back pains and after undergoing surgery was relatively inactive from March to August.

(e) Except for a few weeks spent on a farm during summer vacation in his youth, the appellant had little experience of farm work and cattle raising before 1986.

(f) There were no cattle on the farm before 1990 and the appellant had no cattle at the end of 1971.

(g) The appellant worked in the James Bay area for six months in 1989; for the rest of the year he did work relating to engineering bids.

(h) In the first 11 months of 1990 the appellant spent an average of two days a week working on the farm; it was during that year that a stabling barn was built and the land cleared to create pasture.

(1) In 1991, from January to April, the appellant worked in Cochrane, Ontario, several hundred kilometers from his farm.

(j) The income derived by the appellant from the practice of his profession as an engineer was, and in the future probably will remain, his chief source of income.

(k) In 1993 the appellant was involved in a two-year project having to do with an incinerator in the Montréal area and his wife worked at the

Hôpital Général de Montréal as a nurse.

(1) In 1992 the appellant acquired an interest in the Auberge Estrimont in Magog, and he derives a further portion of his income from investments in securities.

(m) Part of the expenses claimed by the appellant arose out of land clearing which was actually a capital investment but which may be deducted in full by farmers under s. 30 of the Income Tax Act.

(n) The appellant’s residence was built on the farm in 1985 at a cost of some $200,000 and the yard and walkway(s) were paved in 1991 at a cost of $15,115.

(o) A Stable was built in 1986, the value of which was estimated by the appellant as some $60,000, and the appellant bought several horses, though he no longer had them in the years covered by the appeal.

(p) In 1985 and 1986 the appellant submitted a five-year rezoning proposal to the Town of Cowansville.

(q) The facts prior to the assessments which are admitted or alleged in paragraphs 3, 4, 5, 6, 8, 9, 10, 11 and 13 of this reply. [sic]

It was in 1983 that the appellant, a professional engineer specializing in civil engineering, and in particular in the installation of pipelines, decided

ibparagraph 7(f) of the Reply to the Notice of Appeal in case No. 95-1134(IT)G refers to □ 1, not 1971.

to purchase a piece of land in Cowansville, Quebec. The appellant said that he had moved over 45 times since his career began in 1971, mainly in the Canadian West and North, and wanted to settle down permanently and begin a viable farming operation. The land, with an area of 313 acres located on the western boundary of the Cowansville urban area, had at that time been abandoned for some 20 years.

After obtaining a permit from the Commission de Protection du Territoire Agricole du Québec (“the CPTAQ”), the appellant began building his residence in fall 1984. The building was completed in spring 1985.

The appellant stated that his objective with the farming operation was to devote himself to raising registered purebred cattle so he could create a job that would enable him to remain at home full time and give up engineering. In connection with the application he made to the CPTAQ in 1984 for the permit to build his residence, the appellant described his objectives as follows (at p. 2 of Exhibit A-1):

[TRANSLATION]

Development Project (L506/R3726/T2/BT2) test_linespace (240>217.60) 0.847 0965_4803_4937

We have sufficient resources that will enable us to meet the following schedule:

Short term: (0 - 2 years)

• preparing soil and sowing;

¢ application of soil enhancers and fertilizers;

¢ application of pesticides and herbicides:

° construction of fences.

Medium term: (0 - 5 years)

• improvement of surface and underground drainage;

¢ purchase of tractors and tillage tools:

• purchase of cattle for fattening;

• construction of farm buildings.

Long term: (0 - 10 years)

• clearing and drainage to improve productivity.

The appellant admitted that he had done no other long-term planning and that the time needed to get the land in good shape, rebuild the fences and construct buildings was much longer than initially expected. As well, although he thought in 1985 that he would be able to earn a substantial income with 50 breeding cows, he now says that because of a drop in market prices, for one thing, he would now need 85.

Although he had considerable expertise in the field of planning and de- velopment, the appellant had almost no experience in cattle raising as he had only worked on a farm on a few occasions in the summer when he was teenager.

In 1984 the appellant, assisted only by his wife and children, began the work of developing his land section by section, whether into cultivated fields or pasture land. They had to pick up stones, clear brush, remove old fences and build new ones, sow, harvest and so on. Obviously, they also had to buy heavy equipment and the tools needed to do these various rather extensive jobs, which continued until 1990 and even in later years. As the appellant pointed out, all this could not be done overnight.

The appellant built his first barn himself in 1990. Measuring 90 by 160 feet, it could be used to feed 100 animals. The second one, to be used pri- marily for storing forage, was begun in 1992 and completed in 1994. Be- tween 1989 and 1991 the appellant harvested 6,000 to 7,000 bales of hay a year.

The appellant’s intention of starting to raise beef cattle took shape in 1989 for the first time, when he purchased his first 20 Angus cattle.

However, these animals had to be sent to a neighbour some kilometers away to spend the winter since all the necessary fences had not yet been installed. The neighbour, who had the same breed of cattle, was apparently the first person to import them from Western Canada into Quebec. Over the next summer, some 60 head of Red Angus and Black Angus cattle, includ- ing the 20 head owned by the appellant and the year’s calves, were brought onto his land. That was apparently when they decided to divide them up, the appellant wishing to keep the Red Angus breed and his neighbour prefer- ring the Black Angus.

In 199] the herd consisted of 35 to 40 head, including 25 breeding cows. In 1993 it consisted of 75 to 80 head. In 1993 or 1994 the appellant bought back 10 bred cows. The herd consisted of 125 head in 1995, and of 157 in 1996, including 77 breeding cows and four top-quality bulls. Some 26 head recognized as genetically superior were for sale. In 1997 30 head were sold at a price of $1,000 each.

The animals were not penned inside but were put out to pasture. The barn had a feed distribution system and automatic heated waterers which provided a year-round water supply. In fact, the appellant said he had in- stalled the various equipment so as to reduce the need for labour. When he was travelling for extended periods, the appellant said, his wife and children did what was needed.

The appellant’s farm has a large wooded area, and during the years at issue the appellant’s farm income was mainly derived from selling logs or firewood and hay and, in 1991, from renting farm machinery.

Naturally, the appellant is a member of the Union des producteurs agricoles (“U.P.A.”) and is registered with the Ministère des Ressources naturelles of the Government of Quebec as a timber producer. On October 30, 1996 he joined the Syndicat de Gestion Agricole, Lac Champlain (“S.G.A.L.C.”), an organization of producers the purpose of which was to help them manage their operations better. Michel Boutet, an agronomist and management consultant for the organization, was called to testify for the appellant. Mr Boutet was consulted by the appellant in October 1996 for assistance in making farming his main source of income and making the operation viable, and he acknowledged the colossal amount of work done by the appellant on his land and the exceptional quality of the buildings and facilities, which reflected the appellant’s engineering experience. However, he admitted that the business had to make certain structural adjustments to increase the herd to meet the 1995 provincial standard, which was 85 breeding cows. In his submission, the buildings should also have been expanded to accommodate more animals, and the maintenance costs reduced by purchasing more up-to-date machinery. As to the market situation, Mr. Boutet noted that despite the drop in prices for slaughter animals in recent years, a recovery could be expected and the Red Angus breed chosen by the appellant, though not widespread, had a great future in Quebec. Mr. Boutet said he had begun a three-year program with the appellant to make the operation profitable and achieve financial independence.

Because the parties referred to several events which occurred after the years at issue, with a view to providing a more complete picture of the situation, it is worth including some financial information to supplement the table set out in subparagraph 14(a) of the Reply to the Notice of Appeal. In 1994 and 1995 the appellant’s (net) employment and business income from his profession as an engineer was $188,014 and $138,187, respectively. In the same years, the gross farm income was $21,669 and $29,676, resulting in a loss of $71,732 and $110,842 for each of those years, respectively. In 1996 the (net) income derived by the appellant from his profession came to a total of $146,626 while the gross farming income was $48,934, producing income of $5,575 after adjustments for inventory. In actual fact, because the farm expenses amounted to $100,122 and gross income to $48,934, there was an operating loss of $51,188 before the adjustments.

Although the appellant mentioned work done on his farm in 1985, no financial information was supplied about that year or about the 1986 taxa- tion year.

To complete the financial information, I should note that the appellant had large investments, including residential and apartment buildings and se- curities, which produced substantial income. As indicated in subparagraph 14(1) of the Reply to the Notice of Appeal, the appellant also purchased an interest in the Auberge Estrimont in Magog, Quebec in 1992.

Claude Charpentier, au auditor with Revenue Canada, did an audit of the appellant’s operations with the help of a technical adviser, Réal Lamarche, who had some 20 years’ experience. In February 1993, Mr. Charpentier vis- ited the appellant’s farm for the purposes of his audit. According to his tes- timony, his first reaction was astonishment at the exceptional quality of the buildings, equipment and facilities, the likes of which he had seldom seen. He was also amazed to find that despite this quality the farm was generating very little activity compared with other profitable operations. At that time, he estimated that this made [TRANSLATION] “the expectation of profit more problematic”. The very slow growth in the herd was also noted.

Additionally, he said the appellant told him that he expected to retire as an engineer in 1997, when he hoped to have 50 breeding cows which might produce 50 calves a year for sale. According to the appellant’s own calcula- tions, at $1,000 a head he expected to have annual gross income of $50,000.

As noted earlier, the appellant admitted at the hearing that he had to revise his forecasts of the number of breeding cows needed to arrive at a certain level of profitability. However, it was clear from his testimony that what he eventually expected to receive from his operation was a net income of only $30,000. I will return to this point later.

Of course, at the meeting between Mr. Charpentier and the appellant they discussed the time the appellant spent on farm work as compared with the time he devoted to his professional activities as an engineer. This is an important point, and the last one I will discuss in the summary of the facts.

The appellant challenged the allegations of fact contained in the Reply to the Notice of Appeal regarding the time spent on his engineering work as compared with his work on the farm. The appellant said he gave up his full- time job as an engineer for Les constructions du Saint-Laurent in 1984. However, because the company wished to continue to benefit from his ex-

pertise in pipeline construction and did not want him to offer his services to anyone else, he was promised a retainer of between $50,000 and $100,000 annually, in addition to $1,000 a week and profit-sharing when he worked on company projects. The appellant said he kept a diary and he estimated the time spent on engineering at between 25 and 30 percent, or an average of 100 days a year. He thus maintained that he had worked seven days a week all year and spent an average of two days a week on engineering and five days a week on farm work.

In his testimony, the appellant also commented on the allegations of fact set out in subparagraphs 14(g) to (k) of the Reply to the Notice of Appeal, which refers to some of his activities as an engineer. In cross-examination the appellant admitted that he had lived on his income as an engineer and his investment income. He said he had always worked at least two days a week as an engineer. He admitted that it was not until 1991 that he received an annual retainer, regardless of the number of days worked, in addition to a weekly salary and a percentage of profits. He maintained that despite the fact that there were no animals on the farm until 1990, he had always spent 75 percent of his time there since there was in any case always something to do.

Without going into detail, it appears to me that the appellant’s testimony regarding the time spent on his various engineering projects and his work on the farm in the years at issue is sometimes difficult to reconcile with the account given to Claude Charpentier of Revenue Canada in 1993: one thing the appellant told him, in reference to his activities as an engineer for various companies from 1988 to 1992, was that he had no diary for this. According to the appellant, however, Mr. Charpentier did not ask him questions relating to specific days spent on each activity and it was not until later, with the help of his diaries, that he was able to establish in greater detail how he used his time, and he now estimates that he spent an average of two days a week on engineering and five days a week on the farm.

Counsel for the appellant cited a number of decisions, and argued that despite certain weaknesses the situation in the instant cases should be considered favourably in light of the tests applied by the courts, in particular as regards the time spent on farm activities and the energy the appellant put into ensuring that his facilities were of exceptional quality. The size and quality of the herd, the market price situation and the fact that infrastructure expenditures are now decreasing steadily were all, in his submission, factors going to show that the break-even point is already a certainty. According to counsel for the appellant, this is confirmed by Mr. Boutet’s testi- mony, which indicated that the approach taken by the appellant to developing his farm during the years at issue was fully justified. For exam- ple, the appellant could not be blamed for not developing his operation quickly enough or for spending too much money on it, because on the one hand, he had to start up his operation on wasteland, and on the other, he had to manage to operate a livestock farm with a superior breed of animals. In the submission of counsel for the appellant, the quality of the facilities was a sort of long-term guarantee that stemmed from a business decision, even though some might think that certain expenses were too high. Thus, accord- ing to counsel for the appellant, what had been a source of losses in the past has now quite certainly demonstrated that the appellant had a reasonable expectation of profit, which according to the assessment made will become his chief source of income when combined with his other sources of income.

Counsel for the appellant relied inter alia on the decisions in the follow- ing cases: Moldowan v. R. (1977), [1978] 1 S.C.R. 480, 77 D.T.C. 5213, [1977] C.T.C. 310 (S.C.C.); Monette c. Ministre du Revenu national (1987), 88 D.T.C. 1467, [1988] 2 C.T.C. 2089 (T.C.C.); Ganci v. Minister of Namai Revenue (1990), 90 D.T.C. 1317, [1990] 1 C.T.C. 2354 (T.C.C.); R. v. Wylie (1992), 92 D.T.C. 6294, [1992] 1 C.T.C. 236 (Fed. T.D.); Hover v. Minister of National Revenue (1992), 93 D.T.C. 98, [1993] 1 C.T.C. 2585 (T.C.C.); ); Mott-Trille v. R. (1993), 94 D.T.C. 1013, [1994] I C.T.C. 2159

(T.C.C.); À. v. ICHI Canada Ltd. (1995), 95 D.T.C. 5384, [1995] 2 C.T.C. 120 (Fed. T.D.); Phillips v. Minister of National Revenue (1996), 96 D.T.C.

81, [1997] I C.T.C. 59 (Fed. T.D.); R & W Such Holdings Ltd. v. R. (1996), 96 D.T.C. 6455, [1996] 3 C.T.C. 221 (Fed. T.D.).

Counsel for the respondent, who also referred to a number of judgments, including the decision of the Supreme Court of Canada in Moldowan , supra, first pointed out that determining whether a source of income is a taxpayer’s chief source of income presupposes a test that is both a relative and objective one, based on the reasonable expectation of income from vari- ous sources and a taxpayer’s habits and usual manner of working. As well, it has been held that analysis of these factors presupposes that the time spent, capital committed and present and future profitability will be ex- amined for each source. Counsel for the respondent also pointed out that these tests must be examined as a whole and not disjunctively, to determine whether farming can be compared favourably with other sources of income.

Further, in the submission of counsel for the respondent, concluding that farming is a taxpayer’s primary concern or his or her chief source of income depends on showing not only a substantial commitment in time and money but also a reasonable expectation of a large or significant profit.

These rules follow from the following cases, inter alia; Morrissey v. R. (1988), 89 D.T.C. 5080, [1989] 1 C.T.C. 235 (Fed. C.A.); Mohl v. R. (1989), 89 D.T.C. 5236, [1989] 1 C.T.C. 425 (Fed. T.D.); Roney v. Minister of National Revenue (1991), 91 D.T.C. 5148, [1991] 1 C.T.C. 280 (Fed. C.A.); Connell v. Minister of National Revenue (1992), 92 D.T.C. 6134, [1992] 1 C.T.C. 182 (Fed. C.A.); Poirier (Trustee of) v. Canada (1992), 92 D.T.C. 6335, [1992] 2 C.T.C. 9 (Fed. C.A.); Timpson v. Minister of National Revenue (1993), 93 D.T.C. 5281, [1993] 2 C.T.C. 55 (Fed. C.A.).

Applying these rules to the facts of the instant case, counsel for the respondent argued that consideration of the various tests leads to the conclusion that farming cannot be favourably compared with the appellant’s other sources of income. First, on the question of the time spent on farming as compared with the time spent on his activities as an engineer, she noted the stability of the appellant’s income, which remains stable despite his statements that he had extensive professional activities which he had tried to cut back on during the years at issue. Despite the fact that the appellant began living on the farm in 1985, those activities have always continued to produce substantial income, before, during and after the years at issue, and there is no evidence to suggest that any imminent change is likely in this regard. As well, noting that there were no animals on the farm until 1990 and that the first stable was built in that year, counsel for the respondent considered that the time the appellant spent working on his land was exaggerated. The limited activity was also observed by Mr. Charpentier in 1993.

With respect to the capital invested, counsel for the respondent stressed the colossal amounts spent to construct what were certainly the very top quality, but also very expensive, facilities, which made it correspondingly less possible that the operation would quickly become the appellant’s chief source of income.

On the question of profitability, counsel for the respondent stressed the fact that even now, after 13 years, actual and potential profitability has not been established, since even in 1996 there was a $50,000 operating loss before adjustments for inventory. She also noted that the appellant began his work on the farm without any real operating plan and subsequently modified his projections several times in an attempt to establish that his operation was profitable. She also noted that the appellant delayed purchas- ing livestock and did not try to increase their reproduction rate or to obtain financing which would have made speedier progress possible.

After the hearing, counsel for the parties had an opportunity to make further submissions regarding the judgment rendered by the Federal Court of Appeal on October 15, 1997 in À. v. Donnelly (1997), [1998] 1 F.C. 513, 97 D.T.C. 5499 (Fed. C.A.). Counsel commented on that judgment and dis- tinguished it as required by the facts of the instant case, and for the most part reiterated their respective positions as to the application of s. 31 of the Act for the years at issue. Counsel for the appellant added that the facts of the instant case were even more favourable to the appellant than the facts in Graham v. R. (1985), 85 D.T.C. 5256, [1985] 1 C.T.C. 380 (Fed. C.A.), to which the Federal Court of Appeal referred and in which it found for the taxpayer.

At the outset, I would say that applying well-defined rules is likely to produce a more satisfactory conclusion than simply comparing the appel- lant’s situation with that of other taxpayers, since it is always possible to find inconsistencies which make comparisons awkward.

In Donnelly , Robertson J.A., speaking for the Federal Court of Appeal, succinctly summarized the analytical principles developed in earlier cases and referred to by counsel for the respondent. At pp. 520 and 521 of the Federal Court of Canada Reports, he said the following:

A determination as to whether farming is a taxpayer’s chief source of income requires a favourable comparison of that occupational endeavour with the taxpayer’s other income source in terms of capital committed, time spent and profitability, actual or potential. The test is both a relative and objective one. It is not a pure quantum measurement. All three factors must be weighed with no one factor being decisive. Yet there can be no doubt that the profitability factor poses the greatest obstacle to taxpayers seeking to persuade the courts that farming is their chief source of income. This is so because the evidential burden is on taxpayers to establish that the net income that could reasonably be expected to be earned from farming is substantial in relation to their other income source: invariably, employment or professional income. Were the law otherwise there would be no basis on which the Tax Court could make a comparison between the relative amounts expected to be earned from farming and the other income source, as required by section 31 of the Act. The extent to which the evidential burden regarding the profitability factor or test differs from the one governing the reasonable expectation of profit requirement is a matter which I will address more fully below.

[My emphasis. I

and further on, at 522:

Any doubt as to whether the taxpayer's chief source of income is farming is resolved once consideration is given to the element of profitability. There is a difference between the type of evidence the taxpayer must adduce concerning profitability under section 31 of the Act, as opposed to that relevant to the reasonable expectation of profit test. In the latter case the taxpayer need only show that there is or was an expectation of profit, be it $1 or $1 million. It is well recognized in tax law that a “reasonable expectation of profit” is not synonymous with an “expectation of reasonable profits”. With respect to the section 31] profitability factor, however, quantum is relevant because it provides a basis on which to compare potential arm income with that actually received b the taxpayer from the competing occupation. In other words, we are looking for evidence to support a finding of reasonable expectation of “substantial” profits from farming.

[My emphasis. I

Of course, there is no question here as to whether the appellant had a reasonable expectation of profit in 1989 to 1993, as this point was conceded by the respondent at the outset despite the significant losses incurred by the appellant not only in those years but also in the years both before and after the years at issue.

Since what must actually be decided is whether farming became the appellant’s chief source of income in 1989 to 1993 pursuant to the tests applied by the Federal Court of Appeal in Donnelly , supra, I consider the evidence submitted to be entirely insufficient to support such a conclusion.

The appellant, who in 1984 decided to establish a permanent residence in the country, undoubtedly did make considerable effort and, without a shadow of a doubt, spent a lot of time setting up an operation which might be described as a “model” one in various respects, especially as regards the quality of the buildings and facilities. The extent of the losses, which now exceed $900,000, also indicates the level of the investment made over the years. However, two points are unavoidable: first, the relative stability of the appellant’s income from his profession over the years, and second, the method of calculating his use of his time, to establish the percentage spent on farm work, which seems generous to say the least.

I have to say that the appellant demonstrated exceptional energy. cHowever, the fact remains that, to take what is admittedly an extreme situation, spending 187 days in a year on engineering, which was the case in 1990, to my mind corresponds to a percentage that is significantly greater than 50 percent of the time available. While it is understandable that there is always something to do on a farm, it may also be thought to be somewhat extreme to do the calculations based on a 365-day year. Accordingly, al- though the appellant said he spent an average of two days a week on engi- neering alone in the years at issue, in view of his frequent trips and often prolonged absences it is difficult to conclude that he spent only 25 to 30 percent of his time on that and that he actually spent an average of nearly 70 to 75 percent of the available time on farm work.

In any case, it is really on the crucial question of potential profitability that, here again, as in many other cases, the evidence is below the critical threshold. Bearing in mind the amount of money invested by the appellant, which I repeat exceeded $900,000, one cannot help being surprised to find that in 1993 the appellant himself was hoping to get a gross annual income of $50,000 from his operation when it reached maturity. At the hearing, he said several times that his objective was an annual net income of $30,000. This is where farming cannot be favourably compared with the appellant’s other sources of income, in particular engineering, as his chief source of income. Anticipating or hoping for a net income of $30,000 after investing over $900,000 amounts to anticipating a return of less than three percent on the capital invested, and this could never be regarded as what was referred to as “substantial” or even “reasonable” profits from farming, contrary to what counsel for the appellant argued. Moreover, this $30,000 net income was not even anticipated in 1993. Although Mr. Boutet’s testimony was favourable to the appellant, it must be noted that he did not suggest a figure on the question of profitability. It should also be noted that he was not con- sulted until 1996, for the specific purpose of helping the appellant make raising livestock his chief source of income and attempting to make the op- eration profitable. In any case, this is not exactly what could be called relent evidence in establishing the situation in 1989 to 1993.

In the circumstances, I cannot conclude that farming was the appellant’s chief source of income during the years at issue in the sense that it became or could have become his “living”, as it is expressed in Moldowan , supra. In my opinion, farming was actually a secondary source which could at most have produced supplementary income.

The appeals are dismissed with costs to the respondent.

Appeal dismissed.