Gray v. The Queen, 86 DTC 6504, [1986] 2 CTC 382 (FCTD)

Reed, J.:—The plaintiff appeals from a decision of the Minister of National Revenue which restricted the farm losses the plaintiff could deduct for his 1978 taxation year to $5,000. While only the 1978 taxation year is in issue, a decision with respect to that year will obviously set guidelines for the ensuing years. The plaintiff appealed the Minister's assessment to the Tax Court. The assessment was upheld.

The taxpayer lived on a farm as a child. His parents were farmers engaged in the raising of sheep, cattle and horses. As so many children of farmers do, he acquired extensive farming experience working on his parents' farm. The plaintiff left the farm when he was 18 for employment at a service station. He worked at various jobs thereafter but by 1974 was working as a service manager for a G. M. dealer. He left that job in 1974 and commenced the operation of a service station owned by Turbo Resources. The terms of the “purchase" of the service station business by the plaintiff were: Turbo Resources continued to own, at all times, the land and buildings thereon (including fixtures such as gas pumps); the service station equipment such as tow trucks and tools together with the stock of the station were purchased by the plaintiff for $70,000. This purchase was accomplished by paying Turbo at the rate of one cent on every gallon of gasoline sold. No down payment or substantial initial capital outlay was made by the plaintiff. The service station, which was called Gray's Turbo Service Limited, comprised an auto repair shop, a restaurant (which the plaintiff leased out), a 24-hour towing service (subsequently discontinued in 1978) and what was referred to as the “up-front" business (eg: gasoline sales to motorists) as well as a bulk business (eg: the delivery of gasoline in bulk to farmers). The plaintiff received employment income from Turbo. In 1978 this amounted to $29,196.99. In 1979 the method of remuneration was changed and the plaintiff received a smaller sum as employment income but a more substantial amount as dividends.

During the years 1974 to 1976 the plaintiff spent considerable time operating the service station. No major farming operation was undertaken by the plaintiff at this time although two or three horses were owned for the family’s recreational purposes. These were stabled on what is referred to in the evidence as the homestead property, ie: what had been the plaintiff's parents' farm. The plaintiff's father had died in 1970. After that time each of the plaintiff, his brother and his sister owned an undivided one-third interest in the homestead property. The plaintiff during the years 1974 to 1976 did do some clearing of and work on the homestead property.

From 1976 to 1978 the plaintiff began becoming more interested in farming as a serious proposition, specifically the breeding and raising of horses. In 1977 two or three horses were owned for breeding purposes. In 1978 the plaintiff approached a neighbour who owned a 171-acre parcel adjoining the homestead property and asked whether the neighbour would sell that property. The neighbour agreed and originally offered terms which would have allowed the plaintiff to pay off the purchase price as and when money became available. Instead the plaintiff paid $1,000 as a down payment and financed the rest through a mortgage from the Alberta Treasury Branch. The purchase price was $80,000. The plaintiff then began extensive work on the property: old corrals which had become rotten were torn down and replaced; the road on the property was upgraded; a workable water system was installed; 70 acres were summer fallowed; repair work was started on fences. The above enumeration of the work undertaken is not exhaustive.

In 1979 the plaintiff purchased an additional 50 acres adjoining the 171- acre parcel. He paid a small down payment and financed the rest. The purchase price was $38,000. In 1979 he acquired additional acreage (400 acres) by way of a government grazing lease. More recently the division of the original homestead property between the plaintiff and his two siblings was accomplished. The plaintiff acquired his one-third of that property outright. His one-third adjoins the land he had purchased in 1978 and 1979.

It is clear from the evidence that the plaintiff’s operation of Gray's Turbo Service Limited and the remuneration he received therefrom as well as the fact that he was in control of his own working hours enabled him, in 1978, to commence the establishment of a farm business as a serious undertaking. Both the plaintiff and his wife come from farm backgrounds. They both gave evidence that their preferred lifestyle was that of the farmer. Counsel for the Minister noted in argument that the Minister did not dispute the fact that the Grays were committed to farming, that that is the life they want for themselves and the life they want for their children. The plaintiffs wife wrote in 1981 to the Department of National Revenue:

Our plans for the future are either are either to sell our interest in the service station or turn it over to our sons. (no time limits have been set). Dennis and I are both farmers at heart . . .

The taxation year under appeal is, of course, 1978, not 1981, but I think the pattern of the plaintiff’s actions and conduct in the years subsequent to 1978 are relevant to a determination of the plaintiff’s intention in 1978. They are relevant to a determination of whether the farming enterprise was in 1978 a chief source of income as that term is used in subsection 31(1) of the Income Tax Act.

The plaintiff gave evidence, as did his wife, that in 1978 he seriously considered selling his interest in the service station business in order to devote all his attention to farming. However, the family prevailed upon him not to do so. This is entirely consistent with his wife’s statements in 1981, that their intention was to eventually either sell that business or pass it on to their sons.

The plaintiff carried on both the service station business and the farm business in 1978. He did so by putting in long hours and working extremely hard. The fact that his role at the service station was in part, at least, managerial gave him a certain flexibility with respect to the use of his time. Also, his eldest son, Dennis, by 1978, despite his youthful age of 18, had been working around the service station for four years (since the purchase of the franchise in 1974). He was able to take considerable responsibility for the operation of the station. There were also other employees who had more experience than Dennis who could be called upon in running the station. In addition, the plaintiff had the assistance of his wife in both the operation of the farm and the operation of the service station.

The evidence indicates that as of 1981 the plaintiff was spending approximately an equal number of working hours on the farm and on the service station. The exact proportion would vary seasonally. More time was spent on the farm in the summer, more time at the service station in the winter. It is reasonable to conclude from the evidence that this same pattern was followed in the earlier years, from 1978 onwards.

In 1978 the plaintiff invested almost all of his employment income in the farm. As noted above his salary for that year was $29,196.99. The farm expenses were $21,380. The farm income was $150. The expenses arose from the purchase of, among other things, fencing, equipment, tools and tack; approximately $7,500 was spent purchasing breeding horses. This pattern of putting much of the income which arose from the service station business into building up the farm continued over the years which followed. In 1980 the plaintiff sold the family residence in town and built a home on the farm property to which the family moved. The proceeds of the sale of the house in town paid for the new home at the farm.

In 1983 the plaintiff gave up the Turbo franchise. He did not sell the equipment and stock of the business he owned; market conditions were bad. A small building in town was rented and the stock and equipment were moved to it. The stock and equipment not required for an auto repair business were sold. The rest was kept and Gray's Auto Repair Shop was opened. For the years 1983, 1984 and 1985 the plaintiff took a salary of approximately $12,380 per year from this business. The plaintiff's son has a high degree of involvement in this business. He is not interested in farm work. The plaintiff continues to be involved in the auto repair business. The amount of time he spends at it, still varies with the season of the year; in the winter months when the demands of the farm are less more time is spent on the repair business. The evidence is clear that the plaintiff did not extricate himself from the auto repair business in either 1978 or 1983, in part, because he could not afford to do so — the money made from employment in those businesses was being used by him to help establish his farm.

The farming business has still not made a profit. Counsel for the Minister argues that this demonstrates that it was unprofitable from conception and therefore there was no reasonable expectation of it making a profit. I do not agree. While a profit has not yet been made the farm income has been rising each year and the losses falling.

The plaintiff’s intention was and is, clearly, to operate a profitable farm business. He is working towards that goal and achieving it. The failure to be profitable before now is not only the result of the heavy start-up costs involved in establishing a farm business but also the result of unexpected factors outside the plaintiff's control: the downturn in the economy in 1980-81 and drought conditions during the summers of 1984 and 1985.

The plaintiff’s original intention had been to establish a horse breeding and raising operation. With the downturn in the economy in 1980 and 1981 the bottom dropped out of the horse market. Horses are a luxury item; when the economy is not buoyant, the demand for horses falls. The plaintiff and his wife, in response to this situation, decided they had to change their farming operation from horses to cattle. Thus in 1980 they acquired 14 head of cattle; they had 19 horses at the time. In 1986 they have 93 head of cattle and three horses.

The second unexpected factor was the drought situations of 1984 and 1985. This meant there was less pasture available than anticipated and con- sequently fewer cattle could be raised. The plaintiff and his wife received drought assistance from the government. The plaintiff's wife would add one further factor as a cause of their present unprofitability: the Revenue Canada assessment which disentitled them to full farm losses. This resulted in the plaintiff and his wife having to borrow funds to pay the reassessed amounts at a time when interest rates were very high.

The dispute in this case is caused (and I use that word intentionally) by subsection 31(1) of the Income Tax Act. Subsection 31(1) provides:

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 business 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) Z> 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 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.

The starting point for the application of subsection 31(1) is the Supreme Court decision in Moldowan v. The Queen, [1977] C.T.C. 310; 77 D.T.C. 5213. The factors to be considered in determining chief source of income were discussed at 314 (D.T.C. 5215-56):

Whether a source of income is a taxpayer's “chief source" of income is both a relative and objective test. It is decidely 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. [Emphasis added.]

and at 315 (D.T.C. 5216):

... 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.

It is clear that a determination of “chief source" involves a consideration, in each case, of a variety of factors. These factor will differ from case to case and the weight each carries will also differ. Chief Justice Dickson, in the Moldowan case, as noted above, gave as an illustration of relevant factors: time spent; capital committed; profitability both actual and potential. This last was expressed in slightly different words with reference to the requirement of reasonable expectation of profit as: the profit and loss experience of the past years; and, the capability of the venture capitalized to show a profit after charging capital cost allowance. Also relevant to a determination of reasonable expectation of profit and consequently also relevant to "chief source” are the taxpayer's training and the taxpayer’s intended course of action. The factors listed are expressly stated by the Chief Justice not to be exhaustive: "The factors will differ with the nature and extent of the undertaking.”* [1]

In assessing the particular position of the taxpayer, in the Moldowan case, Chief Justice Dickson at 315 (D.T.C. 5216-17) considered: the nature of the other ventures the taxpayer was engaged in; the amount of time the taxpayer spent on the business (several hours a day for part of the year only); the taxpayer’s commitment of capital (cautious); the nature of the enterprise (risky); the nature of the losses (constant and increasing). He then concluded:

Although none of the above is alone determinative, together they suggest . . . [Emphasis added.]

In the Moldowan case, the taxpayer’s involvement in the horse-racing business was held not to be a chief source of income.

Mr. Justice Joyal in Hadley v. The Queen, [1985] 1 C.T.C. 62 at 68; 85 D.T.C. 5058 at 5063 has perhaps best described the approach to be taken. I quote only part of his comments in this regard:

I . . . find in the considerations and factors outlined in the Moldowan case that they do not need all to be of equal value. Their individual importance depends on all the circumstances of an individual case. One such factor which might predominate over the others is the amount of capital the plaintiff committed to his farming venture. If the plaintiff argues new direction, new orientation, or new commitments to bring himself within the first category defined in the Moldowan case, the quantum element alone of his capital investment provides the plaintiff with pretty good credibility . . .

It is a cumulative assessment of all the relevant factors which must be made. Applying this approach to the present facts my conclusion is that farming was a chief source of income for the plaintiff from 1978 forward and that he is entitled to deduct full farm losses therefor. The taxpayer was spending about equal amounts of time on the farm and on the service station (at least up until 1981) but, he was putting in 12 to 16 hour days. He committed a great deal of his available capital to the establishment of the farm. Certainly more was committed to the farm than to any other endeavour. There is no reason to doubt the farm’s potential profitability. The farm is not yet actually profitable but that can be explained, as I have noted above, by reference to a number of factors beyond the plaintiff’s control. The plaintiff and his wife obviously have the experience and training to operate the type of farm business they are embarked upon. Indeed the contribution his wife makes to the operation of the farm, as disclosed in the evidence, is truly impressive. No one has doubted the commitment of the plaintiff and his wife to farming or to their preference for a farm lifestyle. Their actions, for example, in changing to raising cattle when the market for horses turned sour are completely consistent with this expressed intention. In addition the evidence discloses that had the plaintiff wished to sell a portion of his land for development in 1979 and make a quick profit there- from, he could have done so. He did not make this choice. The plaintiff and his wife are not operating the farm as a mere incidental or sideline business. Nor do I think they were doing so in 1978.

The only factor in favour of the Minister’s position is the plaintiff’s operation of Gray’s Turbo Service Limited, prior to 1983, and of Gray’s Auto Repair after that time. The Minister does not dispute a reasonable expectation of profit existed in 1978, with respect to the plaintiff’s farming operation. This is so despite counsel’s argument to which I have referred on page 7 above. What is disputed, is whether the farm was a chief source of income as required by subsection 31(1).

While each case turns on its own facts, the facts in this case are strikingly similar to those which pertained in The Queen v. Graham, [1985] 1 C.T.C. 380; 85 D.T.C. 5256 (F.C.A.). In the Graham case the taxpayer worked full time for Ontario Hydro. At the same time, he began the establishment of a pig farming operation. During the whole period of time under dispute the taxpayer continued to work at Ontario Hydro. The Trial Division found that the taxpayer’s farming operation was, nevertheless, a chief source of income. Factors relevant in coming to this decision were the taxpayer’s expressed intention to eventually make farming his only full-time occupation; the fact that he worked long hours and was in every sense working at two full-time jobs; the fact that he was committing all his employment earnings to establishing the farm, instead of borrowing for this purpose. The Federal Court of Appeal upheld that decision. Mr. Justice Urie, speaking for a majority of the Federal Court of Appeal, said at 383 (D.T.C. 5259):

. . . one of the issues with which the Court must deal in this appeal is whether or not it is possible, in the rather unusual circumstances of this case, for a person to have employment in two full-time occupations at the same time, the existence of one of which would not, per se, lead to the conclusion that he fell within the restrictions imposed by subsection 31(1) . . .

At 388 (D.T.C. 5263), Mr. Justice Urie said:

It would appear that the reasonable expectation of profit from the farming operations having been conceded (and such a concession was a proper one having regard to the evidence objectively) the next step in the determination of the “chief source of income” is to consider the taxpayer’s “ordinary mode and habit of work” employing tests of the kind suggested by Mr. Justice Dickson . . . These of course, involve a weighing of the facts objectively and relatively . .. He [the trial judge] found that the cumulative effect of the rather unusual circumstances disclosed by the evidence in this case was to satisfy him that the main preoccupation of the respondent “is farming but he has income from a sideline employment”.* [2]

My interpretation of the facts in the present case lead me to a similar conclusion. One of the significant factors in this particular case, which leads to that conclusion, is the course of action followed by the plaintiff in the years subsequent to 1978.

For the reasons given the plaintiff’s claim is allowed. The plaintiff shall recover costs of his action.

Appeal allowed.