J R Zavitz v. Minister of National Revenue, [1978] CTC 3021, [1978] DTC 1730

Delmer E Taylor:—This is an appeal against an income tax assessment in which the Minister of National Revenue disallowed the taxpayer’s claim of $3,586.15 for a restricted farming loss for the year 1974. The respondent relied, inter alia, upon paragraphs 18(1)(a), 18(1 )(h) and subsection 248(1) of the Income Tax Act, SC 1970-71-72, c 63 as amended.

Facts

The appellant is‘a Justice of the Peace, acting in that capacity on a full-time basis. His address is RR #2, llderton, Ontario, the farm property on which he resides and which enters into this matter.

Contentions

The Notice of Appeal read in part as follows:

My appeal is based on the fact that I was a farmer in that year (1974). In 1974 I had expenses directly attributable to taxes, hydro power, fence repairs, seed, fertilizer and custom work. I needed a new well to provide water for the beef cattle, fence repairs to contain them, and incurred expenses in tilling 6 acres to ’sow winter wheat for the 1975 crop (which was harvested and included in my 1975 income). The balance of the 1974 loss was a carryover from previous years and on the allowable portion of the expenses in relation to my buildings and car.

At the time I extended to purchase cattle in the spring of 1974 the outlook was worse than usual so I decided against it (later events proved it a sound judgement). I am very conscious of my profit and loss picture and rather than go ahead and lose more money with cattle, I adjusted my program to change to a fresh seeding of pasture in the winter wheat. Naturally this cut into my overall cash turnover drastically.

The letter dated June 8, 1976 from the London Office Audit . . . states that because I inherited the farm, work only a limited acreage and have a full-time occupation that I am not farming with any reasonable expectation for a profit. I admit to being happy'that my entire livelihood does not depend on the present agricultural situation, but those factors are well beyond my control. I am trying to do the best I can with what I have, no price can be placed on the hours and sweat I have devoted to this farm.

The money I am spending on the farm is an investment intended to make it a productive, paying proposition. Unfortunately I see some heavy capital expenditures before this goal will be accomplished. Pasture raising is uneconomical, I must switch to a cold confinement system with solid manure disposal, but it has to be extended over a period of time as my time and finances will allow.

The respondent contended that:

— the appellant was not, in 1973 or 1974, carrying on the farm Operation as a business or with a reasonable expectation of profit;

— the amounts expended, if any, were not incurred to produce income but were personal or living expenditures of the appellant.

Evidence

The financial statement upon which the claim was based is reproduced for assistance:

Income

Hay		$ 360.00
Gas Tax Refund		34.77
		394.77
Expenses
Automobile Expense	$1,230.08
Less: Personal Use 30%	369.02	861.06
House Repairs	459.47
Power, Fuel, Telephone & Insurance	875.61
Property Taxes	499.28
	1.834.36
Less: Personal Use 30%	550.31	1,284.05
Accounting and Legal		240.05
Supplies and Material		171.10
Tools		358.14
Machinery Expense		326.72
Repairs and Maintenance — Barn		280.20
Repairs and Maintenance —_— Fences		296.71
Seeds and Plants		67.70
Fertilizers		315.78
Custom Work		60.00
		4,261.51
Farm Loss for the Year		$3,866.74
Total Loss in 1974	3,866.74
Add Loss Carried Forward	805.56
	4,672.30
Allowable	2,500.00	2,500.00
	2,172.30
Allowable /2	1,086.15	1,086.15
Loss Carried Forward to 1975	1,086.15
Farm Loss for Tax Purposes in 1974		$3,586.15

The appellant described the circumstances to the Board in this manner:

The reasons for ruling me not a farmer given to me by the income tax people are that I inherited the farm in 1969 and the only cattle purchased in 1973 were retained for approximately two (2) weeks. (I quote)

. After considering the low gross income, small acreage and the fact that Mr Zavitz is employed full time, it is our conclusion that he cannot be considered to be farming with any reasonable expectation of a profit.”

Now. I did inherit the farm. It’s been in the family for over 100 years and I’m proud to have it. I spent the first two years trying to get ready to contain some cattle. Now, the farm had not been farmed since my father stopped farming in 1957 so there were 13 years that the farm was just maintained.

I did get the cattle in 1973 and I grossly underestimated the fencing requirements and I had to get rid of them after only two weeks because the cattle simply kept sifting through the fences.

Of course, in my 1973 gross income they talk about there was roughly $2,600.00 incurred in the sale of the cattle I had even though I only had them for the two weeks, so, of course, in 1974 then, with the price of cattle to purchase, I decided it would be a bad move. My experience the year before, the price of the cattle and the projected selling price. I thought I! would have much more of a farm loss if I went ahead and bought the cattle so in that year, of course, not having any $2,800 of cattle to sell (in 1974), my gross income was considerably lower from 1973 and ensuing years.

I only worked 20 acres and I have a total of 43 acres which may be an uneconomical package and I am fortunate that my complete livelihood does not depend on the agricultural situation. But the expenses that were incurred in 1974 which have been disallowed were to improve the fences. I had to put up some extra repairs on the buildings, I had seed, fertilizer, so on like this because I seeded or I worked up and seeded six acres to winter wheat. The winter wheat was harvested in 1975 and that did become part of my 1975 income. The amount of work that I have expended on this farm to try to make it profitable has been considerable and while an accountant may be able to look at a bunch of figures and say, “He’s not farming with a reasonable expectation of profit”. I maintain unless he can look in my mind and see what I am doing, then it's quite logical to look at the overall operation of the piace.

In summary, he worked about 2 /2 hours per day on the farm, part of this time on the /4 acre of lawn around his own residence on the property; he could sell the property, but kept it for personal family reasons as well as his desire to farm: he believed the farm could support a cattle feeding operation of about ten head, all year round, if winter protection facilities could be made adequate; he was also considering the freezer beef business, and looking at the potential for specialty stone ground flour from wheat he would grow himself. Although Mr Zavitz had considered himself to be farming in the years after inheriting the farm, in the earlier years he had not claimed the farm loss due to advice he had received then. But he had done so consistently from at least 1973 forward through 1977 after having received different advice. Copies of the financial statements for those years were filed with the Board, and they showed respectively the following loss amounts:

1973 — $3,305.56

1974 — $3,586.15 (amount in issue)

1975 — $3,727.29

1976 — $3,571.20

1977 — $3,576.68

Particulars of the details on these statements were readily and candidly supplied by the appellant to the Board. A major point of contention with the taxpayer was that the years 1975, 1976 and 1977, according to his records, had been assessed by the Minister as filed, but 1974 had been disallowed—he wanted some explanation for that, since his tax returns were all generally consistent in content and result.

Mr Reginald Swartz, an auditor with the Department of National Revenue, in evidence for the respondent pointed out that he had visited the farm in question, and compared it to others of which he had knowledge. He had decided there was no reasonable expectation of profit. Swartz had a substantial background in farming himself and in dealing with similar income tax returns. He recognized the complexity of interpreting the section of the Act under review, and believed he gave the taxpayer in each case the full benefit of any doubt. In the instant case. he informed the Board that the 1975. 1976 and 1977 tax returns would probably be subject to reexamination after this decision in the 1974 appeal. and pointed out that there was no assurance from the Minister’s side that the restricted farming losses for those years would remain as allowed to the taxpayer. The following is a quotation from Mr Swartz’ evidence:

Mr Fulcher:

Q. Was it your opinion that there were possibilities of that kind of operation being profitable?

A. I could never see a profit being realized from such an operation.

Q. Can you tell us how you distinguish between the person to whom you allow restricted farm loss or general farm loss and the person to whom you disallow? How do you draw the line?

A. Well, there are a lot of factors and one of the basic things is the acreage involved and whether the individual—what time he has to work on the farm. the number of head that can be sustained on this acreage. It varies a little bit with that, the type of land . . .

THE CHAIRMAN: If we can interrupt, Mr Fulcher. so we can save asking questions later on. Is Mr Swartz saying that the distinction which he sees between a restricted farm loss operation and a general farm loss operation, to use your terminology, does have its base at least in the factors of acreage. time available to the individual, particularly in a cattle operation. where the cattle would be sustained—the distinction between restrictive and general was made on those factors or some other factors?

THE WITNESS: Those are some of the factors; there are a number of factors.

THE CHAIRMAN: If you were looking at an operation and setting aside for the moment this one—presuming you had concluded it was a farming operation. what would this distinction be?

THE WITNESS: The first decision you must make is whether the individual is in the business of farming.

THE CHAIRMAN: So, having done that, now for the distinction between restrictive or general, what are some of the factors which you take into account? I want to make sure of that. Continue counsel.

BY MR FULCHER:

Q. The distinction between the person who you feel qualifies for restricted farm loss and the person who you feel doesn’t qualify for any loss at all; what are the distinctions? How do you draw that distinction?

A. I don’t know. That's a difficult question.

THE CHAIRMAN: It’s just as difficult for me. That's why I need your help.

THE WITNESS: Well, there’s the matter of reviewing the whole farm picture, the land available for the operation, number of cattle in this case that can be sustained on this land, whether you can develop a successful cow/calf operation over a period of time, whether an acreage is such that you have no expectation of a profit or developing the operation.

Argument’.

The appellant presented no specific argument in summary of his case.

Counsel for the respondent made reference to several recent judgments on this complex matter. and noted the variation which might be read into them between any expectation of profit” and a “reasonable expectation of profit . In counsel's view, there were two problems here: first, that there was no indication of a reasonable expectation of profit. so no loss of any kind from the operation could be allowed: and second, that in any event. a very substantial portion of the expenses claimed as farming losses were personal and related to the Provision of a residence for the appellant (albeit the farm), rather than running a farming operation.

Findings

The Board as background information refers to two recent decisions: Fred L Johnson v MNR, [1978] CTC 2122: 78 DTC 1109, and Ernest Radies v MNR, [1978] CTC 2601: 78 DTC 1448, and notes the comments contained therein from other judgments. I would repeat the comment made on pages 2126 and 1112 respectively of the Johnson decision:

There can be no doubt that the analysis and interpretation of section 31 of the Act is difficult. as is evidenced by the detail provided in the Moldowan decision by the Supreme Court. On the other hand, it is just as clear from the judgment that there is a niche in such interpretation to allow for such restricted losses. That niche seems most appropiately defined on page 315 [5216] of the judgment:

”(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." (Italics mine).

It appears to me that the conflict pointed out by this appeal arises from the perspective taken of the operation in question when assessing the import of the word reasonable". The question is—reasonable to whom, and by what standards? In Johnson (supra), the Board outlined the position that “reasonable expectation” to the taxpayer as a businessman might involve a risk which, when viewed by others using more conservative standards, might be regarded as not only unreasonable but non-existent. I would suspect that many of the successful business operations in Canada today, at their inception, might well have been similarly judged as hopeless, by all but the entrepreneur himself.

The allure and promise of return often perceived in a pastoral existence may sometimes be illusory. In placing limitations on the indirect support through tax benefits permitted to budding farmers, the Parliament of Canada has properly protected the general tax-paying public against excesses which could result from any over-enthusiasm and over-optimism. Parliament, however. did not take away from those individuals themselves the fundamental right to decide that they could see therein a "reasonable expectation of profit’’. The time. effort and expense put forward by taxpayers in a rural environment can not always be written off as merely the choice of a different way of life, carrying with it the total economic burden as a personal expense. It is comprehensible to me that some of these individuals would hold in their own minds "a reasonable expectation of profit". I am satisfied they hold fast to "some expectation of profit", and until events have proven them completely wrong, and also shown their desire to continue a losing venture in opposition to all the evidence. it is not consistent with my reading of the Act and the judgments given on it that their opinion that ‘.‘some" (any) is "reasonable" should be completely discarded. If “reasonable” is to be a conclusion reached in the affirmative only by an outside party, then it would seem logical to allow the full farming loss rather than any restricted amount. As I understand it, that would be the determination basis for loss deductibility in any other business venture—‘‘a reasonable expectation of profit —and I do not read anything in the specific sections of the Act dealing with farmers which would allow them less benefit. In my view. the "restricted” portion comes into play when the facts indicate that the taxpayer was farming as a business, or more often started farming with a business purpose in mind. but these facts and the results of the operation could not support a conclusion to anyone but himself that his expectation of a profit was reasonable in the year under review. I can think of no other reason why such a “notch" provision for farmers would have been included in the tegisaltion if it were not to encourage just such ventures.

As indicated in Johnson (supra), a point could be reached at which the evidence would no longer lend any support to such an ambition, but the utmost care should be taken to avoid that decision being taken prematurely. It is in this light that one should read from Johnson (supra) the statement on pages 2127 and 1113 respectively that “Even the information that the immediately subsequent years continued to show losses would not of itself invalidate the proposition that the efforts and intentions of the taxpayer during the years in question were directed to making a profit.”

I would point out a recent case in which the Minister took a viewpoint quite opposite to that taken by him in the instant case—the matter of D A MacEachern v MNR, [1977] CTC 2139: 77 DTC 94. In that venture (deep sea-diving where treasure was discovered) which the appellant contended to be a hobby, the Minister argued successfully that although the risks were high and the possibility of return minimal, nevertheless the venture was not a hobby, but a business. The Minister did not make the the argument that there was a reasonable expectation of profit, even any expectation of profit. The facts would indicate if such expectation existed, it existed only in the minds of the participants. It may be concluded from that decision that in the opinion of the Minister, the state of mind of the entrepreneur him- self is very significant if not determinative, not the state of mind of a third party looking at the venture, where the question of “reasonableness” comes into play. I believe that is consistent with the approach taken in Johnson (supra) and support for that view may be seen in the signal Moldowan (supra) decision.

In the. present appeal, by the year 1973 the taxpayer had pursued for some three or four years his stated intention of bringing the family farm back into production. To fulfill that goal he had purchased some cattle with what turned cut to be rather disastrous results. His evidence was that in 1974 he did not purchase and run cattle because he needed and acquired additional fencing repairs and equipment. In the years 1975, 1976 and 1977, he returned to cattle farming in a limited way, but was learning by experience. He encountered some difficulty with local by-laws which have prohibited him from an all- year operation and he now is considering other options—both in cattle and wheat. Further and significantly, it is his general opinion that on the operation of the cattle business itself he was not losing money, but perhaps breaking even. I cannot determine that by the year 1974 this taxpayer had concluded that there was no reasonable expectation of profit for him in running the farm. He has not reached that conclusion even yet in 1978. and he may well be right—the only difficulty is that his claim to acceptance of his analysis of that possibility appears to have been eroded rather than strengthened, based on the results to date. But that does not affect his claim for 1974—in that year he was farming and entitled to the restricted farm loss.

However, the second question now faces the Board, and it is the fundamental one. In my view, the dilemma of this taxpayer results not from his entitlement in the year in question to the restricted farm loss, but from his method of calculating the amount of that entitlement. The fact that he did not run cattle that year (and I accept his reasons for not doing so as valid) does not deny the taxpayer the entitlement for continuation of the farm expenses as deductions—taxes, supplies, repairs, etc—since he did return to cattle farming the next year. It does not, however, give him entitlement to charge off in the farm statement for that year or any other year amounts which were primarily if not exclusively personal. I do point out there is not the slightest inference herein that the appellant filed financial statements believing these to represent an excessive allocation to the farming opration. The problem is that such an examination of the quantum and the nature of the total expense claim did not arise since all the expenses claimed were disallowed. I am sure from my observations that the appellant would have welcomed such a review. It is my opinion, from the limited evidence and cross-examination on this point, that the proportionate amounts of at least automobile expenses, house repairs, power, fuel, telephone and insurance, and property taxes (30% in each case) are quite inadequate considering the fact that a major use of the farm property was as a residence, even though a farming operation was conducted on it. It is the Board’s arbitrary decision that the percentages should be reversed—70% charged against the taxpayer and 30% against the farming operations. I am aware that the matter of losses carried forward by the taxpayer, as they may affect the 1974 year, may require reconsideration by the Department in the light of that determination.

Decision

The appeal is therefore allowed in part, in order that the taxpayer can claim a restricted farm loss for the year 1974 within the limits of all the provisions under the Act, including loss carry forward or back clauses. The basis for the calculation of such a claim where expenses have a dual applicability—to the farm and to the taxpayer— shall be in the ratio of 70% to the appellant personally, and 30% to the farming operation. The matter is referred back to the respondent for reassessment accordingly.

Appeal allowed in part.