The Queen v. Wylie, 92 DTC 6294, [1992] 1 CTC 236 (FCTD)

The Associate Chief Justice:—This appeal by way of trial de novo from a decision of the Tax Court of Canada dated September 25, 1986 came on for hearing at London, Ontario on October 1, 1991. The plaintiff appeals the decision of Brulé, T.C.C.J., which allowed the defendant's appeal against reassessments by the Minister of National Revenue (the "Minister") of his income tax for the 1979, 1980, 1981 and 1982 taxation years. The Minister had, pursuant to subsection 31(1) [formerly subsection 13(1)] of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the "Act"), restricted farm losses claims by the defendant taxpayer to $5,000 in each of the taxation years at issue. For reasons given orally from the bench on October 1, 1991, I dismissed this appeal with costs to the defendant and I indicated that these written reasons would follow.

Facts

In computing his income for the 1979, 1980, 1981 and 1982 taxation years, the defendant deducted the amounts of $13,441.66, $14,883.38, $16,698.14 and $16,662.43 respectively, as losses from a farming business carried on by him in each of those years. By notices of reassessment dated April 17, 1984 the Minister disallowed the losses in excess of $5,000 in each of the defendant's 1979, 1980, 1981 and 1982 taxation years in accordance with subsection 31(1) of the Income Tax Act, R.S.C. 1952, c. 148 as amended (the "Act").

The Deputy Attorney General of Canada, on behalf of the plaintiff, states that the farming losses claimed in the 1979, 1980, 1981 and 1982 taxation years by the defendant were properly restricted in accordance with subsection 31(1) of the Act because the defendant's chief source of income for these taxation years was neither farming nor a combination of farming and some other source of income. The defendant, however, states that his major preoccupation is farming and that his chief source of income during the relevant taxation years was a combination of farming and some other source of income—namely, teaching.

It is admitted that at all material times the defendant was engaged in full- time employment as a teacher with the Oxford County Board of Education and that his wife was also engaged in full-time employment as a teacher. Farming, however, is not a new pursuit for the defendant but rather a well-established tradition in both the defendant's and his wife's families. The defendant, an only child, was raised on the farm which he now operates. The land was originally purchased in 1917 by his grandfather and it was subsequently operated as a dairy farm by the defendant's father until he died when the defendant was 18 years old.

Prior to his father’s death, the defendant had been actively involved in the farm and had considerable experience in tractor work, field work and the dairy operation. After his father died, the defendant obtained a university degree and in 1973 he began teaching school in the area. Four years later he accepted a full-time teaching position closer to the farm and in 1979 he and his family moved back to the farm and leased it from his mother. In 1983 he purchased the farm. The defendant states that it had always been his intention to return to the farm and, for that reason, the farm had not been sold after his father's death but simply rented until the defendant was able to do so.

During the relevant period, 1979 through 1982, the defendant and his wife resided on the farm. His farming activities included the raising of pigs and a beef operation from which he sold butchered calves. He phased out the pig operation by 1981 and began purchasing purebred Holstein cows. During the years 1979 through 1983 the defendant worked on, improved and repaired the farm equipment and made additions to the property. In addition, he built up his herd of purebred Holsteins. The defendant states that he completed all of this work by himself and that during the period at issue he had spent, on a yearly basis, approximately 25 per cent of his time working on the farm as compared with 14 per cent of his time teaching. He states that his earnings from teaching were used to finance the farming operation and to reduce the amount of money borrowed for this purpose until such time as the farm could be self-supporting and until he could take up farming on a full-time basis.

In his amended statement of defence, dated December 19, 1989, the defendant provided the following figures representing his teaching and farm income and expenses and capital expenditures for the farm for the period 1979 through 1987:

Issue

At issue in this appeal is the defendant's right to deduct for tax purposes the entire amount of his farming losses suffered during the 1979, 1980, 1981 and 1982 taxation years.

Relevant statutory provisions

The statutory provision relevant to this appeal is subsection 31(1) [formerly subsection 13(1)] of the Income Tax Act*:

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) [1] /2 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.

(2) For the purpose of this section, the Minister may determine that 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 effect of section 31 then is to place a limit on the amount by which a taxpayer's farming losses may reduce his income from all other sources if his chief source of income is not farming or a combination of farming and some other source of income. Between the taxation years 1951 through 1987, a taxpayer's chief source of income could be reduced only by $5,000 with respect to farming losses under subsection 31(1). It should be noted, however, that if the taxpayer is simply engaged in a farming operation for personal enjoyment, recreation or as a hobby, then his expenditures in this light are considered to be personal or living expenses and, according to paragraph 18(1)(h), are disallowed in full.

Analysis

It is self-evident that the legislation which governs this dispute is most complex. Mr. Justice Marceau, in his comprehensive dissent in The Queen v. Paul E. Graham, [1985] 1 C.T.C. 380, 85 D.T.C. 5256, at page 394, (D.T.C. 5267-68) (F.C.A.) clearly recognized this:

The limit placed by section 31 on the deductibility of farming losses is extremely difficult to explain as it is obviously meant to apply not only to "hobby farmers", who in any event would have difficulty in establishing that farming is for them a source of income, but also and even primarily to some serious and dedicated farmers engaged in farming as a business. Of course one must assume that the goal is to prevent abuses which in this area could be difficult to detect. But it remains that no such limit appears to have been placed on the deductibility of any other type of business.

He is critical of the section, stating (at page 393, (D.T.C. 5266)) that [a] determination that requires the consideration of so many factors is bound to be difficult at times.” In his opinion, however, the determination remains a basic one having to be made in relation to two quite disparate groups, that is to say those who farm as a pastime and for their leisure and those who do it seriously with a view to gain from it a profit." He notes that" It is obviously the second determination required by section 31 that raises the real problem, not so much because it concerns a further division, but for the obvious reason that the criteria given by Parliament is ill-defined”, particularly that concerning the terms "chief source of income" and the word "combination."

The Supreme Court of Canada in Moldowan v. The Queen, [1978] 1 S.C.R. 480, [1977] C.T.C. 310, 77 D.T.C. 5213, has established the guiding principles with respect to s. 31(1) of the Act. Dickson, J. [as he then was] determined that the Income Tax Act envisaged three classes of farmers (at page 315 (D.T.C. 5216)):

(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) [now subsection 31(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 other subordinate source of income, for his livelihood but carries on farming as a sideline business. Such a taxpayer is entitled to the deductions spelled out in subsection 13(1) in respect of his farming losses.

(3) the taxpayer who does not look to farming, or to farming and some other subordinate source of income, for his livelihood and who carries 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.

In considering whether a source of income is a taxpayer's "chief source of income", Mr. Justice Dickson remarked (at page 315 (D.T.C. 5215-5216)):

Whether a source of income is a taxpayer's "chief source" of income is both a relative and objective test. It is decidedly not a pure quantum measurement. A man who has farmed all of his life does not cease to have his chief source of income from farming because he unexpectedly wins a lottery. 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.

It is clear that "combination" in section 13 cannot mean simple addition of two sources of income for any taxpayer.

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

(1) 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.

[Emphasis added.]

Subsequently in The Queen v. Graham, supra (at C.T.C. 391, D.T.C. 5263), Urie, J., for the majority of the Court, elaborating on the decision in Moldowan, referred to a two-step process in the determination of "chief source of income.” This process consists of first, a consideration of the taxpayer's reasonable expectation of profit from the farming operation and, second, a consideration of the taxpayer's ordinary mode and habit of work employing the tests established in Moldowan, i.e., time spent, capital contributed and the profitability both actual and potential. Here, the Minister does not dispute that the taxpayer has a reasonable expectation of profit, so the first step is not at issue.

In Moldowan, the Court found that while the taxpayer devoted a considerable amount of time to his other business ventures, his horse-raising activities consumed only a few hours per day for only a part of the year and his capital commitment was cautious. The Court confirmed the lower court's findings that farming was not his chief source of income so the taxpayer thus was entitled only to the restrictive farm loss deduction. Unlike the circumstances relating to Mr. Moldowan's operation however, there is no doubt that this taxpayer can be described as a serious farmer.

I think the fact situation in The Queen v. Graham, supra, is much more helpful. In Graham, a majority of the Court found that a taxpayer who was employed full-time by Ontario Hydro but who devoted even more time and energy to farming, was not subject to the restricted farm loss deduction but was entitled to deduct his full farming losses from his employment income. The Court considered the arguments that although the taxpayer's activities were a way of life for him, they did not constitute a chief source of income because of (a) the absence of profit; (b) the comparison of employment income to farming losses; (c) the cash flow analysis over the years in issue; (d) the optimum capacity of the taxpayer's operations; and (e) the fact that the taxpayer made no change in his occupational direction to demonstrate that farming provided his main expectation of income. The Court nevertheless found that in the “ unusual circumstances of that case" the taxpayer fell within the first category set out in Moldowan.

As in Graham, this taxpayer has demonstrated that he has conducted his affairs in a manner that illustrates that farming is the centre of his work routine. He changed his work routine and that of his wife and family when he moved on to the farm property. He and his wife and children made an enormous commitment of their time, particularly at the outset, in an effort to resurrect the farm which was in a state of disrepair. The taxpayer's efforts were clearly not limited to week-ends, holidays and the summer months. His time commitment to the farm, therefore, does not fall within category two as was the case in Watson v. M.N.R., [1986] 2 C.T.C. 2009, 86 D.T.C. 1468 (T.C.C.) and Howes v. M.N.R., [1988] 1 C.T.C. 2407, 88 D.T.C. 1289 (T.C.C.).

In terms of a monetary commitment, it is difficult to measure the impact of the $15,000 initial cost since this was a family purchase. I cannot, however, overlook the fact that the taxpayer moved on to the farm property for four years to lease it and to attempt to improve it. I particularly note the capital improvements made to the farm property as set out in Exhibit P-1 at tab 11. It appears that the taxpayer's income from teaching has supported his farm operation, with substantial amounts having been invested. Therefore, while it may be valid to remark that the taxpayer's income from farming does not seriously rival his income from teaching, it is equally valid to observe that without the teaching income, the capital acquisitions and improvements could not have been made.

Counsel for the Crown stresses the difficulty this taxpayer faces in comparing the income or possibility of income from the farm with the income he derives from teaching. Recently, in The Queen v. Charles H. Roney, [1991] 1 C.T.C. 280, 91 D.T.C. 5148 (F.C.A.), Desjardins, J.A., for the Court, reiterated that a disjunctive reading of the criteria mentioned by Dickson, J. in Moldowan—time spent, capital committed and profitability—has been rejected by the Court of Appeal in The Queen v. Morrissey, [1989] 1 C.T.C. 235, 89 D.T.C. 5081. She nevertheless held (at page 286 (D.T.C. 5154)) that "a quantum measurement of farming income, although not alone decisive, is relevant and cannot be ignored”. I am also in agreement with the following comments of Madame Justice Reed in William C. Robinson v. The Queen, [1991] 1 C.T.C. 556, 91 D.T.C. 5302, at page 560 (D.T.C. 5305):

As noted, the Moldowan case classified farmers into three categories: those for whom farming constitutes a chief source of income; those for whom farming is a sideline business; those for whom farming is a hobby. The Supreme Court indicated that the test to be applied in distinguishing between these categories is an objective and relative one. It also indicated that it was "decidedly not a pure quantum measurement." This must be the case because if it were otherwise an individual with a large non-farm income could almost never fall into the first category while someone in essentially similar circumstances but with a more limited farm income would be able to do so.

Her comments illustrate the unfairness that could result if too much emphasis is placed upon the impact of other sources of income outstripping or rivalling the taxpayer's farm income. Such emphasis is particularly inappropriate today in the light of the taxpayer's evidence that the small farm operation combined with no other source of income has disappeared. It is virtually impossible to operate a small family farm unless there is at least one form of a non-farm income to supplement it, as is the case here.

Considering the taxpayer's reasonable expectation of income from his various revenue sources and his ordinary mode and habit of work, the time spent, the capital committed and the profitability both actual and potential, I find that the taxpayer's farming operation was a chief source of income.

Conclusion

Accordingly, for reasons given orally from the bench and as outlined above, I dismissed this appeal by the Minister with costs to the taxpayer.

Appeal dismissed.