Section 31

The taxpayer, who earned approximately $700,000 per year from his law practice in addition to realizing substantial stock option benefits from serving as a director, was able to deduct over $200,000 per annum from his horse racing operation for the two years in question given that he invested substantial capital in the operation in addition to spending a significant part of his daily work routine on supervising the operation.

The Supreme Court of Canada affirmed that the taxpayer's losses were not limited under s. 31(1). The Court reversed its prior decision in Moldowan on the basis that Moldowan effectively read the combination test out of s. 31(1). Rothstein J. stated (at para. 30):

[Subsection 31(1)] is clear that two distinct exceptions to the loss deduction limitation can be identified. A judge-made rule that reads one of the exceptions out of the provision is not consistent with the words used by Parliament.

Having dispensed with Moldowan, the Court affirmed the trial judge's finding that the taxpayer's chief source of income was from a combination of farming and his law practice. Rothstein J. stated (at para. 41):

I do not think that characterization of farming changes under the combination test. The provision still contemplates that the taxpayer will devote significant time and resources to the farming business, even if he or she will also devote significant time and possibly resources to another business or employment. It seems to me that, as long as the taxpayer devotes considerable time and resources to the farming business, the fact that another source of income produces greater income than the farm does not mean that such a combination is not a chief source of income for the taxpayer.

The trial judge had erred in rejecting a submission that the taxpayer's cattle farm in "combination" with his law practice was his chief source of income, on the ground that it was necessary, in order to find a "combination" that the farming and other operations were integrally connected in that his farm was a major contributor to the success of his law practice, and his law practice owed its existence or its success to the farm. There was evidence that the taxpayer's farming operations resulted in connections that enhanced the profitability of his law practice and that "his day to day life involved both, and the contacts he made in farming became valuable to his law practice". This represented a "combination" in the most ordinary meaning of that word. Furthermore, his farm and his law practice together comprised virtually all his income and represented most, if not all, of his investment of capital. Accordingly, s. 31 did not apply to his farm losses.

The Tax Court had correctly concluded that the taxpayer, who was a practising dermatologist and who was pursuing a strategy of planting the largest possible number of trees in the most efficient way possible but without apparently having a view to harvest the wood even when he reached retirement, was subject to the loss restriction rule in s. 31(1).

Although the taxpayer was part of a traditional farming family, had a deep commitment to the land, invested substantial capital in his farm and spent perhaps more time working on his farm than he spent earning his employment income, the Tax Court Judge had erroneously concluded that the taxpayer was a Class 2 farmer because of the taxpayer's failure to establish that the farm could reasonably be expected to produce substantial income in the future. Moreover, in the final year under review the farm would have showed a profit but for the elective deduction of capital cost allowance and, in fact, over the entire twelve-year period for which there was evidence, the farm would have been profitable in at least six years if no capital cost allowance had been claimed.

The taxpayer, who together with her husband had a farming background and who in partnership with him operated a mixed farming business (both grain farming and a cow-calf operation) worked full-time as a controller but with flexibility to take time off when the firm operations required it. She was entitled to deduct losses without limit since her capital, time and labour were focussed on the farm, whose potential profitability was such that in a subsequent year it was profitable. The statement in the Donnelly decision that there should be demonstration of a reasonable expectation of "substantial" profits should be viewed as having been stated in the context of a case where the activity in question (raising horses for racing) might potentially be a hobby.

The Court deferred to the finding of the Tax Court Judge that the taxpayer's dental practice remained the focus of his occupational life and his farming operation was subordinate to his dentistry practice. Accordingly, the deductibility of farming losses sustained by the taxpayer was restricted by s. 31(1).

Before going on to find that substantial losses from a mink ranch were not limited by s. 13(1) of the pre-1972 Act, Collier J. indicated (at p. 6134) that the words "source of income" in s. 13(1) were "used in the sense of a business, employment, or property from which a net profit might reasonably be expected to come" and that, for there to be a "combination of farming and some other source of income", there need not be any relationship between the sources of income.

A urologist was unable to deduct losses from his operation of breeding and racing horses without limitation given that his medical practice continued to be a major part of his work routine and given the lack of evidence as to what profits his farming operation would have generated but for the unforseen setback that had produced continued lack of profitability. In referring to the earlier Graham decision (85 DTC 5256), Robertson J.A. stated (at p. 5503) that "the second generation farmer who was unable to adequately support a family may well turn to other employment to offset persistent annual losses" and that "it may well be that in tax law a distinction is to be drawn between the country person who goes to the city and the city person who goes to the country".

A full-time teacher was entitled to unrestricted deductions not withstanding that his teaching income was far greater than his income from a sheep-farming operation, given a finding (at p. 6587) that "the centre of Mr. Phillips' psychological, physical, and professional activity was farming not teaching".

The taxpayer was unsuccessful in his contention that his chief source of income was a combination of farming and accountancy. Although he spent approximately 60% of his time at his farm and had significantly more capital invested in his farm than in his accountancy practice, in all the years in question, the farm generated a loss whereas the accountancy practice was a consistent source of income.

Although the Crown was successful, Wetston J. rejected a submission of the Crown that two businesses cannot be a combined chief source of income if there is no connection between those two revenue sources.

The taxpayer, which also operated a building rental business, was found to have farming as its chief source of income given that its major preoccupation was its farming operation, and the losses initially suffered by the farming operation were start-up losses that could reasonably be expected.

The taxpayer, which had acted as a Canadian distributor for the paper-roll covering fabrics of a Japanese company, commenced operating a horse breeding and racing farm around the time that the distributorship agreement was cancelled. In finding that the significant losses incurred in the first year of operations were fully deductible, Joyal J. referred to management skills and knowledge of horse-breeding and horse-racing of the principal owner of the taxpayer, the high proportion of his time devoted to the operation, the significant amount of capital expended during the year in question, and the significant revenues derived even in the first year.

An orthopaedic surgeon who devoted approximately 60 to 80 hours per week to his medical practice, and 20 hours per week to his vineyard operation and whose income from the vineyard operation would have been substantially exceeded by the income from his medical practice even if his farming income projections had been achieved, was found not to have made farming his chief occupation notwithstanding the very substantial capital that he had committed to the vineyard.

Although the taxpayer spent at least as much time on his equestrian horse farm as on his consulting practice and committed all of his capital and his credit to the farm, the evidence did not establish that the taxpayer had a realistic expectation of profit from the farm for the years in question or for those within a reasonable time thereafter. Accordingly, he failed to establish that farming might reasonably be expected to provide the bulk of income or the centre of work routine for the taxpayer.

A full-time teacher was not able to deduct his losses from his cattle farm without limit for his 1978 to 1981 taxation years given that: his farm did not generate any net income until 1993, throughout the period the farm generated lower revenues than his teaching position; and his daily teaching schedule took up "his daily quality time".

The horse farm of a practising lawyer was found not to be her chief source of income, given her admission that in the taxation years in question she spent more time doing legal work than she did in respect of the farm and the magnitude of her professional income.

Although the taxpayer spent more time on his farming business (which entailed the purchase of mature horses and their training for equestrian jumping and show competitions) than on his land assembly business, his farming losses were restricted given the lack of profitability of the farm (revenues were only a small fraction of expenses), his failure to present any evidence to corroborate his statements concerning his expectations of profit, and his failure to establish that his major preoccupation throughout the taxation years in question was the farm.

A full-time doctor who also devoted about 35 to 40 hours per week to the business of raising purebred cattle for breeding purposes was not able to deduct losses of $36,695 and $43,477 in 1977 and 1978 without limitation. The case was found to be on all fours with the Poirier decision.

In finding that an operation of raising Charolais cattle was not the taxpayer's chief source of income, MacGuigan J.A. stated:

"... it is patent to us that farming was in a subordinate position to the respondent's employment occupation. Farming comes closest to a rough equality on the time factor, but it lags far behind on the capital and income tests."

A full-time farmer was able to deduct his farming losses without limit given the "enormous" commitment of time made by him and his family and the substantial amounts invested in the farm. Jerome A.C.J. also noted that "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" (p. 6298).

The taxpayer, who devoted more time to his full-blood simmental cattle breeding farm than to his medical practice, had more capital invested in his farm than his medical practice, was highly regarded for the excellent quality animals he bred, and forecast that his farm profits would exceed his medical income, nonetheless realized substantial losses because of a plunge in cattle prices, high interest costs, expansion of his farm, and an inability to properly finance further cattle purchases due to his dispute with Revenue Canada. He was able to deduct his losses without limitation.

The evidence did not support a finding that there was a reasonable expectation that the farming operations of the taxpayer, who had a good position at the Board of Education, would be significantly profitable within a reasonable time frame. Accordingly, the taxpayer was subject to the loss limitation.

The taxpayer's chief source of income was not farming in light of the fact that most of its employees and most of the time of its principal shareholder were devoted to the provision of management services business and in light of the continuing profitability of the management services business compared to the substantial and continuing losses from the farming business. Rouleau J. also rejected (at p. 5205) the submission of taxpayer's counsel that "for a taxpayer to deduct all his losses resulting from farming operations, those operations must simply be part of a combination of businesses and its combination must itself be the taxpayer's chief source of income".

The president and part-owner of a very successful security services firm, who spent 30 hours per week working with that firm and 15 hours per week on his cattle-breeding farm which had thrown up losses of over $30,000 per annum (and generated revenues less than 1/10 of his net employment earnings) for most of the eight years (from 1972 to 1979) that he operated it following an initial investment of $0.5 million, was only able to deduct $5,000 of his loss of $73,238 for his 1975 taxation year. Desjardins J.A. stated (p. 5154):

"A quantum measurement of farming income, although not alone decisive, is relevant and cannot be ignored."

S.31(1) restricted the deduction by a corporation and its successor ("AJDL" and "DAPL") which operated a Canadian Tire associate store generating a profit of over $1 million annually, of substantial losses from a 640-acre horse breeding farm in light of the absence of a business plan showing when the farm would become profitable and the continued substantial losses which it generated.

In rejecting a submission that the taxpayer's involvement in a race horse syndicate was passive and that the farming business therefore was not "carried on by him", Rouleau, J. stated:

"The jurisprudence is clear that business may be said to be 'carried on' by a taxpayer, even though the actual work is undertaken by another, when the taxpayer invests capital only with a view to sharing the proceeds ..."

In 1978, the taxpayer disposed of his city homes, changed his lifestyle and commenced spending 60 hours a week working farmland which initially was in wretched condition, in addition to spending 35 to 40 hours in a trucking business. Revenues from the farm initially were minimal in relation to his income from trucking. Pinard J. held that it was not until 1983, when the farm had been drained and 15 acres had been planted with blueberries, that the farm could be said to have become a probable chief source of income in combination with his profitable trucking activities.

The taxpayer, who left a secure position with the Saskatchewan Wheat Pool to work 30-hours per week on flexible hours as the Manager of the Canada Farm Labour Pool Program, in order to help fund losses at his sheep farm, was found to have "truly changed his mode and habit of work and centred the bulk of his energy on sheep farming." Accordingly, his farm losses were deductible without limit notwithstanding that in the years in question his farm was not successful due to severe economic and weather conditions.

A full-time miner was able to deduct losses from his farm without limit (with the exception of 1977, when he first acquired the farm in run-down condition) in light of his obvious dedication (including long hours) to the farm, and the steadily increasing revenues from the farm. (In 1982 and 1983, years for which he did not claim CCA, he enjoyed cash profits of $1,944 and $5,737.)

A retired businessman with significant income from other sources could not demonstrate that he had a reasonable expectation of a horse breeding and racing operation being significantly profitable.

An RCMP officer, who had been carrying on a farming operation since 1973 without making a profit in any year, was unable to bring himself within the test of potential profitability established in the Morrissey case.

A freighter engineer who devoted almost all his employment income to a cow-calf operation that generated revenues equal to about 1/4 of expenses was subject to the monetary limit in light of the trial judge's finding that the farm was not likely to be profitable. The chief source requirement does not "merely require that farming be the taxpayer's major preoccupation in terms of available time and capital." [There is an excellent discussion of the legislative history of s. 31(1), suggesting that the Moldowan decision was at variance with Parliament's intention.]

A practising accountant, whose billable hours were reduced from 1645 hours in 1977 to 1270 in 1978 when in the summer of 1978 he and a partner purchased two farms which commenced generating losses approximately equal to their accounting income, and whose role in the farm venture consisted mostly in keeping the books and completing the financial arrangements, was found not to have established a change of occupational direction, notwithstanding his desire for a more relaxed lifestyle.

The taxpayer who operated a highly successfully dental practice at which he worked four and a half days a week, was subject to the numerical limit in deducting losses from a cow/calf operation whose revenues were roughly 1/10 of those of his dental practice. The fact that the capital committed to the ranch exceeded that committed to the dental practice was not sufficient for a finding that his chief source of income was the farm. The high cost structure for the farm indicated that it would remain unprofitable for at least seven more years.

The taxpayer, who was the president and sole shareholder of an automotive tubing manufacturer was able to deduct 1976 and 1977 losses of $136,415 and $105,619 from his race horse farm without limit against his other income, notwithstanding that the 1976 and 1977 net incomes of the company were $453,000 and $540,000. There was "abundant evidence to show that from the beginning of the farm operation, the plaintiff had changed his ordinary work habits so as to center it equally between the farm and the manufacturing business", and for a period during the early 1980's, the farm became more profitable than the manufacturing business.

A full-time school teacher who suffered continued losses during the 1978 to 1981 taxation years and thereafter from the cultivation of strawberries on 5 to 15 acres of a 100 acre property which was not being used as a farm at the time of its acquisition by him in 1977, was subject to the loss limitation notwithstanding that he devoted considerable time and effort to the farm in the spring and summer months, and notwithstanding his plans to retire to the farm in 1991.

On a realistic analysis, the income-producing potential of the taxpayer's orchard was about $40,000 to $50,000 per annum even without taking full account of substantial annual interest charges of as much as $50,000 whereas in fact the orchard produced recurring losses and the taxpayer's law practice earned him about $100,000 per annum. Farming in the taxation years in question accordingly was not his chief source of income.

The Deputy Minister of National Revenue (Customs and Excise), who operated a cattle farm for the period from 1972 to date, had consistently incurred losses, including losses in the taxation years in question (1979 and 1980) of $19,637 and $41,035, respectively. He was subject to the $5,000 limitation because he had no reasonable expectation of farm income exceeding his employment income, and because his position of Deputy Minister could not be characterized as an employment side-line.

The taxpayer, who devoted approximately equal time to his farm and his service station business, was held to be entitled to deduct losses from the farm without limitation. He committed a great deal of capital to his farm, and he and his wife had the experience and training to operate the type of farm business they were embarked upon. Although the farm had not become profitable even at the date of the trial, this was explicable by a number of factors beyond the tax- payer's control and there was no reason to doubt the farm's potential profitability.

Farm losses from a cow-calf operation ranging from $45,286 to $87,273 per year over a 4 year period, that were sustained by a construction superintendent earning from $67,479 to $169,560 per year in employment income, were subject to the $5,000 limitation. Although he devoted approximately equal time to the cow-calf operation and earning employment income, he was unable to establish that the farm would become highly profitable relative to his employment earnings, and that his acquisition and development of the farm entailed a fundamental shift rather than merely creating an option for his future.

It was found respecting some losses from a partnership engaged in the breeding and racing of horses that s. 31(1) applies at the level of the individual partners to whom the farming losses have been flowed through rather than at the partnership level, i.e., a partnership is not the "taxpayer" for the purposes of s. 31(1).

A corporation which had a relatively successful logging business whose gross revenues rose from $1.2 million in 1972 to $9.2 million in 1977, purchased 4,000 acres of land in 1975 for $300,000 (or about 17% of its capital) and in 1977 sold the land after having failed to derive any gross revenues from the lands. It was held "that there was virtually nothing in the evidence to show me that Plaintiff would reasonably be expected to provide the bulk of its income from farming or that farming would become the center of its activity."

Between 1976 and 1980 the taxpayer, who had substantial investments in other businesses which he helped manage from an office on his cattle farm, invested about $800,000 in the farm and had personal involvement in various aspects of the farm's operations. The following results obtained in his 1977 and 1978 taxation years, for which the s. 31(1) limitation was found not to apply:

The taxpayer, who at all relevant times earned a substantial income from a car dealership and leasing business that was owned and supervised by him, nonetheless was able to deduct losses of $450,000 and $138,000 in 1976 and 1977 from a cow-calf and pure-bred cattle farm without numerical limit, in light of his substantial investment in the farm (which approximately equalled his existing investment in his car business), the intellectual direction and constant attention he gave to supervising his farming operations, and the fact that the substantial losses were attributable to market forces beyond his control.

Notwithstanding that the taxpayer was a full-time employee of Ontario Hydro, his losses from a pig farm were deductible without numerical limit in light of findings that: farming was his chief interest and virtually all his remaining efforts, resources and time were devoted to it; and he regarded his employment simply as a means of funding substantial start-up losses of what eventually became a productive operation.

A taxpayer who devoted about 40 hours a week to his accounting practice and between 25 and 40 hours a week to a race horse business, and who had no previous experience in raising horses for racing, could not be said to be looking primarily to farming for his livelihood, and thus was subject to the $5,000 limitation in the deduction of his farming losses.

By the taxation years in question, the taxpayer had shifted most of her time and energy and, to a somewhat lesser extent, her capital, from a truck-servicing business to a horse farm, and was able accordingly to deduct her farm losses without limit.

"Mr. Klie obtained his income from his farm operations, by working during the days, on week-ends and holidays, and his income from Chrysler of Canada Limited by working at Chrysler [nearby his farm] five days a week on the midnight to 8:00 a.m. shift." His farming operations were held to be a sideline business and thus subject to the $5,000 limitation.

The taxpayer's house was 300 yards from his 43 acre farm, and 16 miles from London where he worked five days a week as a Justice of the Peace. Farm losses in his 1974 taxation year were attributed, in part, to a shortage of machinery and equipment on the farm due to a shortage of funds to purchase such items, and to a change in the distribution of crops on his farm. It was held that he farmed with a reasonable expectation of profit, and he could deduct a restricted farm loss.

The taxpayer sold most of his dairy farm to a developer for $517,655, then sustained substantial losses in the ensuing taxation years while he converted the remaining lands to a beef cattle operation. The losses were deductible without limit because "it was to his farming operations that he looked for his livelihood" during this period.

Farming constitutes a taxpayer's chief source of income if it may reasonably be expected to provide the bulk of income or the centre of work routine. An operation of training, boarding and racing horses did not so qualify in light of the facts that horse-racing consumed only several hours of the taxpayer's day, and for part of the year only, his commitment of capital was limited and the nature of the enterprise was risky.

The Exchequer Court had the jurisdiction to determine the question whether the taxpayer's chief source of income for the taxation years in question was neither farming nor a combination of farming and some other source of income in the absence of a determination of the Minister under s. 13(2) of the pre-1972 Act.