Roney (C.H.) v. M.N.R., [1991] 1 CTC 280

Desjardins, J.A. (Stone and Heald, JJ.A., concurring):—This appeal from a judgment of the Trial Division ([1988] 2 C.T.C. 357; 88 D.T.C. 6489) is concerned with the application of subsection 31(1) of the Income Tax Act, R.S.C. 1952,

c. 148 (am. S.C. 1970-71-72, c. 63) (the "Act").1 [1] At issue is whether the chief source of income of the respondent in the taxation year 1975 was a combination of farming with another source. If the answer is in the affirmative, the respondent can claim the full amount of the farming losses of $73,238 incurred that year. If the answer is in the negative, he is subject to the limitation imposed by subsection 31(1) of the Act and entitled to a deduction of $5,000 only.

The Minister of National Revenue, in its notice of reassessment dated September 26, 1977, allowed for a deduction of $5,000.

The Facts

The respondent, born on September 15, 1922, was at all material times the president and sole shareholder of Universal Investigation Service Ltd ("Universal Investigation”) which he established in 1946 and which is one of Ottawa's largest and most experienced security firms. He was also, since 1962, vice- president of Universal Alarms Ltd (“ Universal Alarms") of which he held 50 per cent of the shares. In his taxation year 1975, his interest in Universal Investigation was estimated at $800,000 to $900,000 while his interest in Universal Alarms was worth approximately $500,000. In that same year 1975, Universal Investigation had approximately four hundred full and part-time employees. Universal Alarms had about thirty employees.

The respondent taxpayer planned to carry on a cattle breeding business on a full-time basis at the time of his retirement. He intended to develop a business that could, on his retirement, produce an amount of income that would allow him to live the way he had become accustomed to. With this in mind, he assembled, in 1968 and subsequent years, several pieces of property for a total of seven hundred and eleven acres of farm land on which ne could operate a cattle breeding business. The first property was located in the Township of West Carleton on the 7th Line (transcript at 68). He hired a farm manager and a herdsman so as to operate the farm efficiently and established them on the farm properties. He committed over $486,000 of capital to buy land, buildings and equipment. The cattle were purchased at a cost of $55,151 with the full expectation that his cattle breeding business would generate substantial profits. The market value of the cattle was over $141,000 in 1975. The respondent had no previous experience in farming except for general work he had done on dairy farms, for three or four years during the summer months, when he was a boy (transcript at 96). Before launching himself in this new business, he consulted a number of persons knowledgeable in the business of breeding and selling cattle. He became convinced that he could make large sums of money, between $150,000 and $200,000 per year, on the crossbreeding and on the importation of European cattle, mainly Charolais and Simmental. Around 1972, he decided to supervise the operation from a closer point. He and his family moved from Ottawa to a recently purchased farm property about a mile away from his first purchase (transcript at 69).

In 1975, the taxpayer was in the process of slowing down his activities with his companies so as to devote more time to his farm. He had two vice- presidents and a secretary-treasurer who, more or less, operated his business at Universal Investigation. He, in turn, had a very small part to play at Universal Alarms which he eventually sold in 1987. He would spend 30 hours per week working with his companies. In addition, he was actively involved in a service club and was a board member for the Better Business Bureau (transcript at 92). Fifteen to 16 hours per week were spent on the farm. Wednesdays, in full, and the evenings of other days, he was on the properties, checking the cattle in the fields, the fencing, and ” going over the general operation with the farm manager". In addition, he would spend 150 to 200 hours a year attending sales and conventions. His wife took care of the bookkeeping, the breeding record and the registration of cattle.

From 1968 on, the respondent went through three different designs for breeding. He initially tried to develop the so-called" Hayes Converter". He then imported Charolais cattle in 1972, and later changed to Simmental animals. He expected the farm would yield interim profits that would reach the break-even point seven to eight years after 1968. [2] Unfortunately, the market which was peaking in 1973, started to slip in 1974 and slipped badly in 1975 due to circumstances which were explained by Mr. John Douglas Baird, a retired farmer and former employee of the Federal Department of Agriculture, Livestock Division. According to Mr. Baird, it was only around 1965 that Canada opened its borders to cattle being imported from Europe. Because of a rigorous health program prior to importation, the animals being held in quarantine for six months, very few animals were imported in that first year. Those imported were Charolais. The semen produced by the bulls went for sale mainly to the United States because at the time the U.S. health requirements did not recognize importation from Europe. Imported animals to Canada could not be re-exported to the United States. In 1975, the American commercial cattle market went into a cyclical slump and, because the American breeders had been able, through ten years of semen production importation from Canada, to build up a herd of purebred animals, the demand for semen from Canada was drastically reduced. Realizing that the cattle industry would not meet his expectations, the respondent decided to reduce his farming business and completely disposed of his herd in 1979.

During all these years, the farm never yielded a profit.

The Judgment under Appeal

The trial judge gave a summary of the respondent's net employment earnings, other income apart from losses, gross farm revenue and farm losses for the fiscal years 1972 to 1980 inclusively:

The trial judge said the following about the respondent at 358-59 (D.T.C. 6490):

He did not consider cattle raising as a sideline business and he fully expected, when first assembling the land in 1968 and subsequent years, that his income from that source would be very substantial and that it would be his sole occupation in future years.

His chief source of income at all material times was that derived as an employee of Universal and his farming operation did not earn a profit prior to 1975. The farming operation also lost money from 1976 to 1979 when it was terminated.

He then stated the issue before him in the following manner (at 361 (D.T.C. 6492)):

. . . there is no issue here about the defendant being regarded as a so-called ” hobby-farmer"; if so, he would have been disallowed the entire loss. The issue is whether the defendant is entitled to deduct for tax purposes the entire amount of farm losses incurred by him in the 1975 taxation year or whether the deductibility should be limited to $5,000, per subsection 31(1) of the Act.

He concluded that the respondent, who had the onus to establish on the balance of probability that the minister's assessment was wrong, had met the test set forward in Moldowan v. The Queen, [1978] 1 S.C.R. 480; [1977] C.T.C. 310; 77 D.T.C. 5213. He said at 363-64 (D.T.C. 6493):

The evidence adduced shows that the defendant changed his occupational direction from that of an executive to farming as a main expectation of income. In fact, in 1975, the defendant was "a taxpayer, for whom farming may reasonably be expected to provide the bulk of income or the centre of work routine".

He explained at 364 (D.T.C. 6494):

In the present case, the following facts have to be retained in favour of a deduction of full farm losses. Firstly, the size of the farming operation, some 711 acres, is one that is commensurate with an ability to generate large profits over a period of time. Secondly, the evidence showed that the farm was a well equipped operation with a good number of purebred and half-bred cattle and that this was a viable ongoing business. Thirdly, there was a large amount of capital injected by the defendant. Fourthly, the defendant moved his family on the farm where he had a view over the general operation of the farm and he obtained the services of a farm manager and a herdsman to help operate the farm and to make it a successful business enterprise. Fifthly, the defendant applied his considerable business experience to his farming business with a view to deriving substantial income therefrom. He later had to close down the operations due to special circumstances which were out of his control.

He added:

Had the Court not come to the conclusion that the farming activities of the defendant might reasonably be expected to provide the bulk of income or the center of his work routine, the incurred losses could be characterized as start-up costs, and even then, the taxpayer would be allowed the full deduction of same. In the Moldowan case (at 315 (D.T.C. 5216)), Mr. Justice Dickson, as he then was, stated that:

. . . 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.

He dismissed the action against the taxpayer, thus confirming a judgment of the Tax Court of Canada, dated June 1, 1984, allowing the defendant's appeal in respect of his 1975 taxation year.

The Appellant's Contention

The appellant submits that the trial judge erred in his appreciation of what the taxpayer's chief source of income was during the taxation year 1975. More specifically, says the appellant, the trial judge could not arrive at the conclusion he did in view of the finding he made that the respondent's ”. . . chief source of income at all material times was that derived as an employee of Universal . . .” He erred in reading disjunctively the various tests by the Supreme Court of Canada in Moldowan, supra, contrary to the way it was interpreted by this Court in Morrissey v. Canada, [1989] 1 C.T.C. 235; 89 D.T.C. 5080 (F.C.A.). He erred in stating that the incurred losses could be characterized as start-up costs. And finally, says the appellant, the trial judge erred in failing to consider the appellant's alternative argument that the respondent had no reasonable expectation of profit from his farm operation.

The Respondent's Contention

The respondent submits that the evidence adduced clearly shows that the respondent changed his occupational direction from that of an executive to farming as a main expectation of income. He was, in 1975, "a taxpayer, for whom farming may reasonably be expected to provide the bulk of income or the center of work routine"—or was "a man whose major preoccupation is farming" but had some "income from a sideline employment or business”. He was, in fact, phasing out of Universal Investigation and Universal Alarms and was going into farming on a full-time basis. The tests set out in Moldowan, supra, were met; both in terms of time spent on farm work, capital committed, change in his mode or habit of work and reasonable expectation of profit. The respondent contends that the profits that were expected were large and warranted the time spent and capital committed by the respondent to this business venture. The potential of the farming operation was significant and would have been capable of providing between $150,000 to $200,000 per year. The tria! judge was correct in also treating the expenditures as start-up costs. Whether the expenses incurred in 1975 were start-up costs or ordinary expenses or a combination of both, they were properly deductible. And, says the respondent, the trial judge did not read the statute disjunctively as the farm was found to have a large profit potential.

Analysis

There is no dispute that the proper test to be applied is to be found in the Moldowan case, supra, [3] particularly where Dickson, J. states at 313-14 (D.T.C. 5215-16; S.C.R. 485):

Although originally disputed, it is now accepted that in order to have a" source of income” the taxpayer must have a profit or a reasonable expectation of profit. Source of income, thus, is an equivalent term to business . . .

There is a vast case literature on what reasonable expectation of profit means and it is by no means entirely consistent. In my view, whether a taxpayer has a reasonable expectation of profit is an objective determination to be made from all of the facts. The following criteria should be considered: the profit and loss experience in past years, the taxpayer's training, the taxpayer's intended course of action, the capability of the venture as capitalized to show a profit after charging capital cost allowance. The list is not intended to be exhaustive. The factors will differ with the nature and extent of the undertaking: The Queen v Matthews, [1974] CTC 230; 74 DTC 6193. One would not expect a farmer who purchased a productive going operation to suffer the same start-up losses as the man who begins a tree farm on raw land.

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. That would lead to the result that a taxpayer could combine his farming loss with his most important other source of income, thereby constituting his chief source. I do not think subsection 13(1) can be properly so construed. Such a construction would mean that the limitation of the section would never apply and, in every case, the taxpayer could deduct the full amount of farming losses.

In my opinion, the Income Tax Act as a whole envisages three classes of farmers:

(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) in those years in which he sustains a farming loss.

(2) The taxpayer who does not look to farming, or to farming and some 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 farming losses.

(3) The taxpayer who does not look to farming, or to farming and some 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.

The reference in subsection 13(1) to a taxpayer whose source of income is a combination of farming and some other source of income is a reference to class (1). It contemplates a man whose major preoccupation is farming, but it recognizes that such a man may have other pecuniary interests as well, such as income from investments, or income from a sideline employment or business. The section provides that these subsidiary interests will not place the taxpayer in class (2) and thereby limit the deductibility of any loss which may be suffered to $5,000. 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.

In Morrissey v. Canada, supra, this Court rejected a disjunctive reading of the various criteria Dickson, J. mentioned: time spent, capital committed and profitability. Mahoney, J.A., for the majority, commented at 241-42 (D.T.C. 5084):

With respect, I do not agree that Moldowan suggests disjunctive consideration of pertinent factors in quite the way the learned trial judge has dealt with them. The discussion in Moldowan begins as follows:

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.

Moldowan also says, dealing with the difference between classes 1 and 2, "while a quantum measurement of farming income is relevant, it is not alone decisive”. While the determination that farming is a chief source of income is not a pure quantum measurement, it is equally not a determination in which quantum can be ignored.

The Morrissey decision, supra, was rendered after the decision under appeal and could not, for that reason, be cited by the trial judge.

Contrary to what is claimed by the appellant, when the trial judge says, at the beginning of his reasons for judgment, that the taxpayer's " chief source of income at all material times was that derived as an employee of Universal. . .”,

his statement, in my view, is not meant to be conclusive of the matter. I understand these words as a simple recognition of the fact that the bulk of the respondent's income for the taxation year 1975 was derived from employment.

I however encounter difficulty with the assessment made by the trial judge considering the factors he relied on in favour of a full deduction. The ability of the farm to provide large profits, the viability of the ongoing business, the capital injected, the moving of the family, the retaining of employees, and the business experience accumulated by the respondent with his companies do not constitute a complete list of the relevant factors enumerated by Dickson, J. in Moldowan, supra. While I recognize the difficulty in applying the test, which is both a relative and objective one, and the fact that the criteria mentioned by Dickson J. are by no means exhaustive, I am far from being convinced that, in the circumstances of this case, a proper assessment was made in light of the proper criteria.

The ratio in Moldowan, supra, is that the reference, in subsection 31(1) of the Act, to a taxpayer whose source of income is a combination of farming and some other source, contemplates a man whose major preoccupation is farming. It recognizes that such an individual may have other pecuniary interests such as income from investments or income from a sideline employment or business. These however remain auxiliary or subsidiary to his chief source of income. A quantum measurement of farming income, although not alone decisive, is relevant and cannot be ignored. The distinguishing features of "chief source of income", i.e., the taxpayer's reasonable expectation of income from his various revenue sources and his ordinary mode and habit of work, are to be analyzed in the light of considerations such as the time spent, the capital committed and the profitability both actual and potential.

With regard to the potential profitability of the farm, the respondent tendered, at trial, the testimony of Mr. John Douglas Baird whom the respondent retained in 1977 at the time of his discussion with Revenue Canada. The trial judge treated Mr. Baird as an expert witness and summed up his evidence in the following manner at 363 (D.T.C. 6493):

Mr. Baird’s report, based on his own experience as a renowned breeder, shows that there was a reasonable expectation of profit in 1975. It particularly shows that for an investment of $4,000 to $5,000 on an imported Simmental cow arriving in Canada in 1971, one could expect an anticipated inventory value, based on 1972-73 prices of $115,500. His report concludes that "therefore it was reasonable to conclude in 1972 using an expected level of production in current prices that an excellent opportunity for profit existed.” His report also shows that for the purpose of his study, he divided the defendant's cattle into four groups, the Charolais group, the Hereford and Hereford X Charolais group, the half-Simmental group and the full-blood Simmental group. For each of these groups, the expert stressed the number of heads, the problems encountered and his conclusions. Despite the fact that the defendant was not a knowledgeable breeder, that he did not have time to establish his reputation as a breeder, that he had no established market outlet or program for merchandising the production of the breeding herd, the expert still maintained that the defendant very definitely had a reasonable expectation of profit.

The appellant has attacked before us the report of Mr. Baird on the basis that, in his testimony, Mr. Baird recognized that he did not make any analysis of the costs that were occasioned by the respondent in the course of his operation but, instead, considered his own experience and what had been his own costs when he was running his own farm (transcript at 55-56). With regard to the projection on breeding, Mr. Baird indicated he used the results of his own herd instead of those of the respondent (transcript at 57). In re-examination, Mr. Baird reiterated however, on the basis of all the observations he had made, that the respondent very definitely had a reasonable expectation of profit (transcript at 63). His conclusion was accepted by the trial judge who had the advantage of hearing the witness and appreciating the whole of his testimony.

The challenge made by the appellant on the testimony of Mr. Baird goes to credibility or reliability of the opinion evidence of the witness. In such a case, the finding made by the trial judge about Mr. Baird’s testimony should remain undisturbed. Where the evidence does not go to the issue of credibility or reliability of a witness, an appellate court is in as good a position as the trial judge to appreciate the evidence. [4] But this is not the case with regard to Mr. Baird's testimony.

With regard to the other criteria, the point in dispute deals with the proper inference to be drawn from proven facts. Consequently, an appellate court is in as good a position as the trier of facts to make a proper assessment of the situation.

In the taxation year 1975, two-thirds of the respondent's time was still spent with his companies and one-third only was spent on farming activities. The Capital invested was no doubt a sizeable one. “An entrepreneur" said the respondent in his testimony "doesn't go into to invest the type of money I committed to this operation, unless he intended to make a rofit” (transcript at 81). His investment into the farm business amounted roughly to about a fourth of his capital. The potential profitability of his farm was however starting to look bleak in the face of the hard reality. On the eve of the taxation year 1975, the respondent had already lost $133,676.64, i.e., approximately a third of his investment. His situation was precarious. The year 1975, where he suffered a drastic market reversal, was the year he expected he would be close to break even. [5] Therefore, except for the potential profitability, all the other criteria are adverse to the position taken by the respondent.

I do not consider the case at bar to be comparable in any way to the circumstances set out in The Queen v. Graham, [1985] 1 C.T.C. 380; 85 D.T.C. 5256 (F.C.A.). In Graham, the taxpayer was precluded from becoming a farmer in his youth by adverse circumstances and became employed by Ontario Hydro where, by application and dedication, he achieved a position of responsibility, but his ambition to farm was never forsaken. He had changed his occupational direction when, in 1968, with the ultimate objective of farming in view, he applied for transfer, and was transferred to a rural area. He then invested all of his available capital in farm land, building and residence. He was in the habit of sleeping five hours, working eight hours at Ontario Hydro and spending the remaining eleven hours on the farm with minimal time off for breakfast, supper and personal needs. He was able to adjust his working days with his employer so as to meet the needs of his hog farming operation. It was established at trial that he was a progressive and innovative farmer. During the relevant taxation years, the acreage and facilities he owned were capable of providing a reasonable standard of living, but the taxpayer was not satisfied with that standard and his ultimate objective was an increased holding in his animal farm. The salary from his employment was utilized to supplement his standard of living and to achieve his ultimate goal. The trial judge made the finding that the taxpayer might reasonably expect his farming operation to "'provide the bulk of income”, and that it was most certainly “the center of work routine" and allowed his losses in full. He was sustained on appeal.

In the light of the evidence before us, I do not think that the respondent, in the taxation year 1975, was a person whose major preoccupation was farming. He was someone who was testing the water, so to speak. For him, farming was a sideline.

Start-up costs, contrary to what the trial judge said, cannot be considered as the basis for an alternative ground of decision. The permissible amount to be deducted depends on the class the taxpayer finds himself in. Indeed, Dickson, J., as quoted by the trial judge, said the following in Moldowan, supra: “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.]

Read in context however it is clear that Dickson, J. is referring to the class (1) taxpayer. This, in turn, brings us back to the issue I first dealt with. For the reasons given there, I have concluded that the respondent is not a class (1) taxpayer.

For all the above reasons, I would allow the appeal, I would set aside the decision of the trial judge dated October 6, 1988, and I would reinstate the reassessment made by the Minister of National Revenue dated September 26, 1977. The whole with costs both here and in the Trial Division.

Appeal allowed.