Diner (J.B.) v. Canada, [1994] 1 CTC 2724

Beaubier, J.T.C.C. (orally):— These appeals, pursuant to the General Procedure of this Court, were heard at Winnipeg, Manitoba on December 9 and 10, 1993.

The appellant testified and called Michael Nozick as a witness. The Crown called the auditor on the file, Karram Bayney.

The appellant was reassessed respecting his 1985, 1986, 1987 and 1988 taxation years and disallowed the deduction of farming losses respecting a thoroughbred horse breeding and horse racing operation. He appealed.

During the years under appeal the appellant was employed as a licensed real estate agent in the province of Manitoba. Assumptions 8(b) and 8(c) of the Crown's reply read as follows:

8. In so reassessing the appellant for the 1985, 1986, 1987 and 1988 taxation years, the Minister made the following assumptions of fact:

(b) The appellant earned the following amounts from his employment as a real estate agent during the 1985, 1986, 1987 and 1988 taxation years:

TAXATION YEAR	EMPLOYMENT INCOME
1985	$111,964
1986	$155,219
1987	$ 83,102
1988	$238,645

(c) The appellant reported farming income (losses) during the 1985, 1986, 1987 and 1988 taxation years as follows:

TAXATION	CROSS		NET NET INCOME
YEAR	INCOME	EXPENSES	(LOSS) (LOSS)
1985	Nil	$22,391	($22,391)
1986	Nil	$26,983	($26,983)
1987	Nil	$36,210	($36,210)
1988	Nil	$26,514	($26,514)

The appellant is 51 years old. In 1968 he obtained his B.A. in political science and went to Louisiana State University in New Orleans to obtain his M.A. in political science. Due to a mix-up in records and administration he was not allowed to enter the program that fall. So he obtained work and because he lived near the race track, he started attending the races in New Orleans. By the summer of 1969 he had become a jockey's agent and he continued that work while he did his academic work in the winter of 1969-70.

In the summer of 1970 he made a deal with a jockey and trainer, each of whom had an earnings contract, and took a very promising thoroughbred to Mexico to train and race in the All American Futurity. There was an accident in the seventh heat and this came to naught. The appellant returned to Winnipeg and then went to Louisiana again where he obtained a contract to do various work for a Mr. Mekin of Texas —:— at the beginning respecting horses, and then on other matters, for about a year. He then returned again to Louisiana.

In Louisiana the appellant became an entry clerk and then a placing judge and then an assistant racing secretary at a race track. There he lived the horse industry”, learned handicapping and assisted the racing secretary in handicapping. In the course of that time he walked horses, rubbed them down, cleaned stalls and read the thoroughbred journals and records constantly.

In 1973 or 1974 he returned to Manitoba, and worked at various jobs until the spring of 1977 when he became the assistant racing secretary at Assiniboia Downs in Winnipeg. In 1979, the appellant became a real estate agent.

In 1977 the appellant saw what he considered to be a very promising mare for breeding purposes, "Jemarjo Princess” ("J.P."). The appellant did not have training as a breeder. But he had knowledge of bloodlines and handicapping. He spoke to his friend Michael Nozick about her. Michael bought her in a claiming race for breeding purposes for $3,200. He and Michael entered into a contract whereby the appellant in essence owned 1/2 of "J.P.". The details are in Exhibit A-3. “J.P.” was then seven years old.

They bred "J.P." In 1979 she had "Jekimjo", a colt, and in 1980 she had "Synchronist", a filly, in Manitoba. In October, 1981, “J.P.” died and paid approximately $43,000 in insurance. Both owners regarded this death as a major setback. The owners had planned to race the first two foals so as to prove "J.P."'s line and increase the value of her offspring. Since they were both born in Manitoba of Good lineage and raised in Kentucky, the owners had high expectations for good purses.

Mr. Nozick testified that he believes that "J.P."'s insurance proceeds yielded the owners a profit for their 1980 year. If so, that was the only profitable year.

"Jekimjo" started four races in Manitoba as a two-year-old and came first once, second twice and third once. When he was three years old he won approximately $40,000 and was named the champion three-year-old of Manitoba in 1982. In 1984 he was badly hurt in a van accident and was given away.

In 1984 "Synchronist" was placed for sale at a reserve auction with a reserve bid of either $35,000 or $40,000. The bidding fell approximately $1,000 short of the reserve and the partners kept "Synchronist". Mr. Nozick testified that after that he ceased taking an active interest in "Synchronist" and left matters to the appellant. Mr. Nozick and the appellant are good friends, trust each other and have been friends since their teens when they lived in the same general neighbourhood in Winnipeg. Mr. Nozick is a well-to-do lawyer and real estate developer.

"Synchronist" had hoof problems as a yearling in Kentucky and foundered. Nonetheless, she became the partners' broodmare. She was bred and in 1983 produced "Out of Sync".

“Out of Sync" trained in Toronto, had no success as a racer and was given to the trainer for unpaid training bills.

In 1985 "Synchronist" was barren. In 1986, she had "Pedestrian" which earned $12,000 as a three-year-old, bowed a tendon two years in a row and was given to the trainer for unpaid bills.

In 1987 "Synchronist" was barren. In 1988 she had “Salt Spring". ‘Salt Spring" cast as a yearling and foundered during her first try-out run under a jockey on the track in Winnipeg. The owners made a ten per cent deal with a breeder; there is no evidence that “Salt Spring" has ever returned any money.

In 1989 "Synchronist" had “Palm Island” in Ontario. “Palm Island” was not allowed to be listed in a select sale in Ontario because of the family experience of the line which the appellant described as "just bad luck”. Eventually she was given to her trainer to satisfy the training bill.

In 1991 "Synchronist" had "Deputy Speaker" which is now awaiting training as a three-year-old after having had some shin problems.

In 1981 the appellant bought a 20 per cent interest in "Naskra Bay” with a group of fellow real estate agents and developers. The price of the horse was 10,000. “Naskra Bay" was a yearling. Within a few months the appellant purchased another 20 per cent from a fellow investor. The horse had been British Columbia bred and was shipped to British Columbia where it eventually ran in seven races — it ran eighth in its first, came second in four and won two. The appellant flew “Naskra Bay” to Winnipeg in 1984 where it encountered a malathion cloud in its first warm up on the track, had a serious allergic reaction and"tied up". It never fully recovered.

"Naskra Bay” ran once more in Chicago, won, and went into breeding. Its first foal, "Lona the Great", was born in 1985 and couldn't run. The second was born in 1989 and died on the operating table at a few months of age. The third is now two years old. "Naskra Bay” was sold for the board bill. Over the years the appellant acquired an 80 per cent interest in "Naskra Bay” and Michael Nozick has the other 20 per cent. The appellant managed the horse and acquired his shares after the first two 20 per cent interests as the other partners failed to pay their shares of the costs incurred.

From 1983 to 1986 "Naskra Bay” won $14,600 in purses and the appellant had either 60 per cent or 80 per cent of the purses from 1988 to 1990. "Out of Sync" won $8,508 in purses, and the appellant’s share was 50 per cent.

The appellant’s breeding sources in the years in question were "Naskra Bay”, which had a serious malathion reaction in 1984 and "Synchronist" which was barren in 1985.

From 1985 until 1990 inclusive the appellant had only one year — 1987 — when his gross real estate income was less than $100,000. At times he employed a secretary and an assistant. He testified that during racing season when he had horses running at Assiniboia Downs, the majority of his day was spent at the track. However, during the years in question an analysis of the evidence indicates that the appellant's horses were not running at Assiniboia Downs that often. Approximately half the time they were running in Toronto. Furthermore a number of his horses were not running at all or were not running very much.

That having been said, it would appear from the nature of the appellant's testimony that he frequents the track and follows the horses.

There is no doubt from his testimony, which lasted over a day, that the appellant is a student of thoroughbreds and that in the years in question he was engrossed in horse racing and devoted to his horses. He did not own facilities because he and his various partners realized that they couldn't afford them. The horses were boarded and trained by others, frequently outside of Manitoba. He always had partners because he realized that he couldn't afford to carry a horse by himself. In these ways he exercised limitations on his investments which may have been due to his partner’s control, or to his own pocketbook's limits.

In 1984 the appellant’s horses were "Jekimjo", "Synchronist", "Naskra Bay" and "Out of Sync". In 1985 they were "Synchronist", "Naskra Bay" and "Out of Sync". Two disasters occurred in 1984 — one to “Jekimjo” and one to “Naskra Bay". They were very serious even in the eyes of a layman and they occurred to 50 per cent of his horses and to what were his two best horses. At the same time, the appellant viewed himself as engaged in a breeding program with "Synchronist" which was barren in 1985. "Out of Sync” was still a youngster and not able to run in 1985. 1986, 1987 and 1988 were also encumbered with a substantial and constant overhead of expenses, with no horses in a position to carry it and none developed which would carry it. In those years, past experience was indicating losses.

Upon examining the appellant’s real estate commission income and the expenses of the horse operation it is clear that the appellant did not plunge into farming without reservation. Farming was a sideline. The appellant admitted in cross-examination that he was “immersed in the life of the track" and the evidence is clear that he was. But the appellant was not that immersed in farming. He and his financial partners were, together, careful and controlled in their investment in the horse operation.

That having been said, it is clear from his testimony that the appellant is completely and emotionally caught up in the life and lore of the track and the bloodlines of successful horses and, for that matter, in the bloodlines of the horses in which he had an interest. He was almost unable to answer a question respecting his horses without giving a dissertation on bloodlines and an analysis of where successful strains lay.

Mr. Nozick, an experienced and successful businessman, made it apparent in his manner of testimony, that by his abandonment of management of "Synchronise in 1984 after the failed reserve bid sale that he had abandoned that breeding project as a practical business exercise and left it to the appellant to do what he could or would with it. There is no doubt that the rest of the original investors in "Naskra Bay" made the correct decision when they got out, and they did it based on their experience, an assessment of their means and prospects and some foresight. This is stated by this Court because hindsight is correct and easy, and it is for this Court to determine if the appellant had a reasonable expectation of profit in 1985, 1986, 1987 and 1988.

In 1985, the appellant was still in the same business he had started out in when he and Michael Nozick first bought "J.P.". But there was no prospect of an income at all in 1985 from carrying on as he had in the past or as he in fact did. Furthermore, the Court finds that there was no reasonable expectation of profit in 1986, 1987, 1988 and 1989 either from farming or from farming combined with some other source, based upon his expenses and the potential crop of colts and earnings in each year, given the overhead and the previous history.

That having been said, there are two considerations to note:

First, the appellant had a business and some horses that should have yielded a profit if they had been sold in 1985.

Second, it is not easy or quick to assess a situation and get out of a business involving property, whether that property is horses or anything else.

The result is that the Court shares the Minister’s view that the going business was finished in 1984. However, the Court is of the view that a reasonable man would have taken time to assess the prospects during and after 1984 and could have wound it up in 1985 with a prospect of a profit in that year if expenses had been limited to the cost of winding up and selling the saleable stock within a reasonable time. Given the Court's view, the 1985 expenses deducted are larger than they should have been. Moreover, in 1985 the appellant’s chief source of income was neither farming nor a combination of farming nor a combination of farming and some other source. In these circumstances, the appellant is allowed a restricted loss within the provisions of section 31 of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the "Act") for his 1985 taxation year and the appeals are dismissed for the remaining years.

The Crown is awarded its costs.

Appeal allowed in part.

Avrum Schwam Holdings Inc. v. Her Majesty The Queen (informal

[Indexed as: Avrum Schwam Holdings Inc. v. Canada]

Tax Court of Canada (Archambault, J.T.C.C.), January 11, 1994 (Court File No. 91-1019).

Income tax—Federal—Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72,

The appellant was an investment corporation which began its farming activity during the 1983 taxation year. The appellant’s farming activity was in the field of horse racing. The appellant acquired all its horses with other partners. The appellant’s sole shareholder, S, spent five or six hours a week on the horse racin business while he only spent at most two hours a month on the investment activities of the appellant. The appellant had no other employees involved in the horse racing business. The training and the keeping of the horses were subcontracted to the appellant’s co-partners. During the taxation years under appeal, 1987 and 1988, the appellant had an interest in 12 horses. The appellant made its money only from race winnings and never sold horses at a profit. Neither S nor his family was doing horse riding and the appellant did not have any farm property that S or his family could enjoy. Horse racing was therefore strictly a business. From 1985 to 1990, the appellant suffered losses from its horse racing business ranging from a low of $2,413 in 1985 to a high of $45,652 in 1989. In 1984, the appellant earned a profit of $12,595 from horse racing. During the 1985 to 1990 taxation years, the appellant earned income from its investment business and that income often exceeded $100,000 annually. For the 1987 and 1988 taxation years, the Minister disallowed the appellant’s claim for full farming losses and restricted those losses pursuant to section 31.

HELD:

Since horse racing is a very risky business, the profitability of the investment business was much better. The amount of capital committed to the investment activities was significantly more substantial than that committed to the horse racing activities. Accordingly, the investment activities of the appellant, not the horse racing business, were its chief source of income. Furthermore, since the horse racing activities had no connection with the other activities of the appellant, it could not be concluded that the appellant’s chief source of income was a combination of farming and another source. In the result, only the restricted amount of losses permitted by subsection 31(1) were deductible by the appellant. Appeal dismissed.

Diane Tsonos, agent for the appellant.

Christopher Mostovak for the respondent.

Cases referred to:

Moldowan v. The Queen, [1978] 1 S.C.R. 480, [1977] C.T.C. 310, 77 D.T.C.

5213:

Gestion S.A.P. v. M.N.R., [1994] 1 2450:

Hover v. M.N.R., [1993] 1 C.T.C. 2585; 93 D.T.C. 98.

Archambault, J.T.C.C.:— These are income tax appeals for the 1987 and 1988 taxation years heard under the informal procedure in Montréal. The Minister of National Revenue (the "Minister") has disallowed farming losses of $24,888 for the 1987 taxation year and $31,159 for the 1988 taxation year pursuant to section 31 of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the "Act"). Counsel for the respondent conceded that there was no issue whether the appellant was carrying on a farming business. The only issue is whether the amounts of farming losses are to be restricted pursuant to section 31 of the Act.

Facts

The facts on which the Minister made his reassessments were the following:

(a) at all material times the appellant was an investment corporation;

(b) the appellant apparently began its farming activity during the 1983 taxation year;

(c) the appellant's farming activity was in the field of horse racing;

(d) the appellant paid a jockey to train the horses;

(e) the appellant had no place of business for the horse racing activity;

(f) the expenses that the appellant sought to deduct dealt with the keeping of the horses;

(g) the appellant’s receipts from farming were very low because they were dependent on winnings from horse racing;

(h) the appellant reported the following amounts:

(i) the appellant’s chief source of income during the 1987 and 1988 taxation years was neither farming nor a combination of farming and some other source of income.

Mr. Avrum Schwam, the sole shareholder of the appellant, stated in his testimony that the company held several investments. It had an interest in two operating companies: 75 per cent in Louben Sportswear Inc. ("Louben") and 140 shares in Paradox. The appellant sold the latter shares in 1987 at a profit of $254,000. It also owned term deposits and shares in publicly traded companies such as Royal Trust and Toronto-Dominion Bank. The financial statements for 1985 to 1990 reveal the following information with respect to the capital of the appellant:

These statements do not show any asset for the horse racing business. The cost of the horses was fully written off by the company in the years of acquisition.

Three schedules were filed as exhibits by the appellant showing the farm loss history, the expenses and the gross income:

Mr. Schwam also testified that the appellant received from Louben a $410,000 dividend in 1984 and a $375,000 dividend in 1988.

With respect to the horse racing activities, he stated that the appellant acquired all its horses with other partners. The horses were generally one year old. Mr. Schwam spent five or six hours a week on the horse racing business while he only spent at most two hours a month on the investment activities of the appellant. The company had no other employees involved in the horse racing business. The training and the keeping of the horses were subcontracted to its co-partners. During the 1987 and 1988 taxation years, the company had an interest in 12 horses. The horses could only race when they were two years old. The company made its money only from race winnings and never sold horses at a profit. The shareholder nor his family was doing horse riding. The company did not have any farm property that the shareholder or his family could enjoy. Horse racing was therefore strictly a business. The witness indicated that the average prize for a first place was between $2,500 and $3,000, for second place, $1,500. The first five places would earn some money. He estimated that the company could make up to $225,000 with its 12 horses if they participated in all races.

Analysis

The leading case on farming losses is a decision of 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. Mr. Justice Dickson outlined the task of the Court in dealing with such issues at page 486 (C.T.C. 314, D.T.C. 5215-16):

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 a reasonable expectation may signify a change in the chief source, but that is a question of fact in the circumstances.

It is also well known that the onus to show that the assessment of the Minister is erroneous lies on the taxpayer. In this instance, the burden was to show that the horse racing constituted in the 1987 and 1988 taxation years the chief source of income for the company. There is absolutely no problem with the fact that the taxpayer carried on its horse racing activities with a view of making a profit. Its activities amounted to the carrying on of a business. This case did not have the features that we often see in farming losses cases where a taxpayer derives personal enjoyment from the facilities used for the farming business. This was strictly a business activity.

However, the law is very clear that in order to deduct the full amount of its losses, the taxpayer must show that the farming business was its chief source of income. I should review the three criteria developed by the Moldowan case. The Court should not appraise the profitability of a particular business venture with the benefit of hindsight. The two taxation years in issue are 1987 and 1988. It is with respect to these two years that the determination of a chief source of income has to be made. Could it be said that the taxpayer had at the beginning of each of these two taxation years an expectation that its horse racing activities would constitute its chief source of income? This determination has also to consider the intentions of the taxpayer when it started the horse racing activities in 1983. Whether the determination is made in 1983 or in 1987 and 1988, I do not think that one could expect the horse racing activities to be the chief source of income for the company. Horse racing is a very risky business. The potential to make more money is higher but, as with any such type of business, the risk of losing is also very present. The substantial amount of dividend paid in 1984, which was the first full year of operation of the horse racing business, further confirms my view that the profitability of the investments was much better than the risky business of horse racing. Clearly the amount of capital committed to the investment activities of the company are significantly more substantial than to the horse racing activities. It is true that the time spent on the horse racing activities was greater than on the investment activities. However, this is not a very significant factor in these circumstances. It is only one factor to be taken into account in determining what was the chief source of income of the appellant during these two taxation years. A fair appreciation of the facts put forward before the Court leads me to the conclusion that the investment activities of the company, not the horse racing business, were its chief source of income.

Finally, although this was not argued by the appellant, I find that the horse racing activities had no connection with the other activities of the company and the resources devoted by the appellant to the farming were not that substantial. I could not therefore conclude that the appellant’s chief source of income was a combination of farming and another source. [1] For these reasons, the appeals will be disallowed.

Claim allowed.