Date: 20020725
Docket: 2000-3649-IT-G,
2000-3653-GST-I
BETWEEN:
BARRY ENRIGHT,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
Reasons for judgment
Lamarre, J.T.C.C.
[1] These are appeals from assessments made by the Minister of National Revenue ("Minister") under the Income Tax Act ("ITA") for the 1994, 1995, 1996 and 1997 taxation years and from an assessment under the Excise Tax Act ("ETA"), notice of which is numbered 00000001551 and dated April 6, 1999, for the quarterly reporting periods from January 1, 1995 to December 31, 1997.
[2] In computing his income for the 1994 through 1997 taxation years, the appellant deducted the amounts of $50,981, $68,206, $97,218 and $80,865 respectively as farm losses. The appellant also filed his goods and services tax ("GST") returns for the quarterly periods from January 1, 1995 to December 31, 1997 and claimed input tax credits ("ITCs") totalling $17,826.20.
[3] In assessing the appellant, the Minister disallowed expenses in the amounts of $2,256 for 1994, $3,083 for 1995, $11,250 for 1996 and $3,651 for 1997 as being personal in nature, and ITCs in the amount of $2,084.68 relating to those personal expenses. The appellant does not dispute this part of the assessments.
[4] However, the Minister also disallowed the balance of the appellant's farm losses (that is $48,725 in 1994, $65,123 in 1995, $85,968 in 1996 and $77,214 in 1997) and the ITCs relating thereto (that is, an amount of $15,741.52, being the balance of the total ITCs claimed), on the basis that the appellant had no reasonable expectation of profit ("REOP") from the farming activity and hence no source of income for the purpose of claiming income tax deductions under the ITA and no commercial activity for the purpose of claiming ITCs under the ETA[1].
[5] In an alternative argument, the respondent submitted that should this Court be satisfied as to the existence of a REOP, the appellant's losses should be restricted pursuant to section 31 of the ITA on the basis that he has not shown that his chief source of income was farming or a combination of farming and some other source of income during the 1994 through 1997 taxation years. However, the respondent has admitted that, in that case, the ITCs claimed under the ETA should be allowed, as section 31 has no equivalent in the ETA.
Facts
[6] The appellant was born and raised on a farm and his father and grandfather were full-time farmers. He lived on his father's farm until he was 35 years old, during which time he was actively involved in the operation of the farm, and so were all his brothers and sisters. Growing up, the appellant, as well as his siblings, was involved with the 4-H Club (a youth organization for the farming community), which taught its members about different aspects of the farming industry. The appellant was specifically active in the beef clubs component of the 4-H Club, through which he learned how to raise and show cattle.
[7] The appellant received title to his first farm property in 1975 from his father as compensation for the years of work he had put into the family farm. In 1978, the appellant purchased a second farm property for $55,860. He moved into the residence located on that property in Renfrew, Ontario in 1982 when he married Jane, who was also born and raised on a farm. The house was renovated and the land was tile drained before they moved in. The appellant also purchased a third farm in 1986 within walking distance of the other two farms. The three farms have a total area of approximately 500 acres, making Enright Farms one of the larger farms in that area of Eastern Ontario. The farm purchased in 1978 is located approximately one kilometer from the family farm and is also close to other family members' residences and farms. This was an important factor in the appellant's decision to purchase that farm because having family members close by allows for the sharing of equipment and of labour costs and for obtaining help in the appellant's absence.
[8] Over the years, from 1982 to 1998, all the properties were tile drained, the existing buildings were completely renovated and other structures were built to store hay and house cattle. One structure was built in 1996 to serve as a show barn and to house an office. It is now used for special events organized for the purpose of showing animals to potential buyers. This building was subsequently enlarged. Another structure put up by the appellant was a silo for the storage of grain.
[9] My understanding is that, in the period up until 1998, the appellant expended approximately $200,000 for the construction of those other structures and for the renovation of existing buildings. Altogether, the Enright farms can currently house 400 to 500 head of cattle on a year-round basis. They also produce grain, corn and hay for their own use and for other farms. In the appellant's view, there is now no need for further capital improvements.
[10] The appellant had an initial mortgage of $55,000 on the farm he purchased in 1978. His current debt on the farms is $220,000. A real estate appraisal in November 2001 put the value of his farms at $800,000, exclusive of equipment (that is, land and buildings only). Except for a tractor, the appellant did not own any equipment when he made his first purchase of a farm in 1978. In 1993, the total value of the equipment (including balers for the hay, instead of contracting the baling out) was $137,600; it went up to $190,200 in 1997 with the purchase of a new truck, a bigger cattle trailer and a new tractor. The appellant calculated that the purchase of adequate equipment would be profitable in the long run. For example, it was cheaper to purchase machinery so that he could bale the hay himself (a $10,000 investment) than to contract that work out at $5,000 per year.
[11] The appellant testified that he did not draft a business plan when he purchased his farm in 1978. He started out with a commercial cow-calf operation (selling from the offspring of the herd solely for beef) because he had been raised on a cow-calf farm. He decided to change over to a seed stock operation (production of animals to enhance the beef industry in various genetic pools) when he determined that, in order to make the cow-calf operation viable, he would require at least 1,000 acres of land whereas he had only 500 acres. The appellant explained that in a cow-calf operation, the size of the herd is important while in a seed stock operation, it is the quality rather than the quantity of the herd that is important. The appellant first saw the opportunity to enter the seed stock business with the purchase of his first Limousin cattle (one of the major beef breeds) in 1988. In fact, there was a need for a seed stock operation in the area where the appellant's farm was located. The appellant officially began to change from a cow-calf operation to a Limousin seed stock operation in 1992. This is why, in 1996, he built a show barn to display his cattle. A building was also required for eventual production sales (in which a portion of the quality herd is sold off).
[12] He and his wife further researched the different genetic lines of Limousin cattle, visited farms in the United States and Canada to find genetics that would fit their breeding program and acquired quality seed stock cattle. They mostly bought female animals in order to enhance the herd. According to the appellant, a seed stock animal can be sold for anywhere from $2,000 to $100,000 depending on the animal's genetics whereas a beef cow would sell for no more than $800 to $1,200 at any local sale barn. The appellant filed as evidence magazine articles (Limousin World, November 1999) showing that a Limousin open heifer had sold for US$20,000 and that a Limousin bull had fetched US$80,000. Having consulted with different farmers who were involved in the Limousin seed stock industry, the appellant estimated when starting out that it would take approximately 10 years to develop a high quality herd. From their research, the appellant and his wife concluded that they would require a herd of 200 head of Limousin cattle in order for their operation to be profitable. As a matter of fact, their herd grew from a total of 172 head in 1992 (with 65 crossbred cows to be sold for meat and 25 purebred cows) to a total of 250 head in 1996 (with 60 crossbred cows and 65 purebred). By 1997, more of the cattle were purebred and the value of the herd had increased from $180,500 in 1992 to $327,510 in 1997. Today, Enright Farms no longer has any crossbred cattle; it has 230 head of purebred animals of which 20 to 30 are available to be sold at a high price at a production sale. Mrs. Enright stated that the herd's growth is on track to enable them to meet their 1992 projection of breaking even in 2002. The appellant believes that currently his herd is competitive with all other herds in Canada and the United States. The appellant has advertised his successful show results. For example, one of his cows has won several awards by virtue of its very high quality. This cow is on a special breeding program under which she is fertilized and the embryos are collected and sold. Over the past two years, she has produced 19 embryos. At a recent show and sale in Regina, a year-old heifer of the appellant's fetched the best price at $12,000 and another animal came in third at $8,500. The appellant's goal for his operation is to sell very high quality animals, which he advertises in Limousin World, a magazine with international distribution, and by showing them at various fairs where they have won a number of awards.
[13] The appellant has also set his sights on a production sale. Last year, he visited Top Meadow Farms' production sale, at which $650,000 was brought in by the sale of 100 head of cattle. With approximately 200-300 head, Top Meadow Farms is, according to the appellant, the only seed stock operation in Ontario that is on the same scale as his own. Top Meadow has been in the seed stock business for 8 to 10 years. The appellant believes that his operation will be ready for its first production sale in about one year from now. He explained that you need to have between 30 and 50 animals in a production sale (he now has 20 to 30 available) to make it worthwhile for people to incur the expense of travelling to your farm. He has already had requests to host a production sale at which half of the cattle for sale would be his own and the other half would be brought in by other farmers.
[14] With respect to the farming statements, the appellant knew his operating expenses were going to be significant when he first changed from a cow-calf to a seed stock operation. The chart in Schedule A to these reasons show the evolution of income and losses.
[15] The appellant stated that cattle sales were lower in 1996 and 1997 - as can be seen from the chart in Schedule A - because they were building infrastructure in those years and therefore retained cattle in order to increase the herd. He explained that increasing the herd would enable them to improve sales in subsequent years. At present, he sells 75 to 80 head of cattle a year, of which 25 to 30 would be of high enough quality to be part of a production sale where they could be sold at a minimum price of $5,000 each.
[16] The appellant was also employed with a road construction company, Armbro Construction ("Armbro"), that operates throughout Ontario. He began working for them in 1967. During the period from 1994 to 1997, he was a superintendent for Armbro's various work sites. He was involved in particular with the construction of Highway 416 between Ottawa and Highway 401. The appellant commuted between his home and the portable office set up on the Highway 416 site. The distance between the two locations was 65 to 70 kilometers, a 45-minute drive. The appellant stated that he was home almost every evening, on weekends and on several weekdays. He was also required to travel throughout Ontario for other projects. When travelling, the appellant was in frequent contact with his wife via cellular telephone to keep informed about activities on the farm. The appellant explained as well that he took the opportunity of visiting other Limousin breeders in Ontario when travelling for Armbro.
[17] The following breakdown was given of the time devoted by the appellant to Armbro and to the farm. From November through February, Armbro was closed down and the appellant could spend all his time on the farm. In November, the cattle were brought in from the fields for the winter, pregnancy checks were performed and vaccinations given. In December the cattle were placed on a feeding program and things were made ready for the calving season.
[18] In March and April, the appellant worked two or three days a week for Armbro preparing project bids, and the remainder of his time was spent working on the farm. In May and June, road construction began again and the appellant worked five days a week for Armbro. The remainder of his time was spent on the farm, where the crops were put in. By July and August, the Armbro projects had been organized and the appellant was able to spend more time on the farm by compressing his work days at Armbro, which allowed him to get involved in such activities as haying. In September and October, the appellant was working five days a week for Armbro, finishing up jobs in preparation for the winter shutdown. The appellant's activities on the farm in those months revolved around the show season.
[19] Overall, the appellant calculated that he spent 140 days a year working for Armbro and 225 days a year on the farm.
[20] The appellant stated that he chose to work at Armbro because it was seasonal work and as a full-time farmer he required supplemental income to keep the farm going.
[21] The appellant earned the following amounts at Armbro from 1994 to 1997:
1994 $ 63,413
1995 $ 87,900
1996 $138,220
1997 $123,352
[22] The appellant has three sons, one daughter, and siblings who can help his wife on the farm when he is away. According to him, the seed stock operation was more compatible with his work with Armbro than the cow-calf operation because it required a smaller herd of cattle and therefore less time had to be spent at the farm. Furthermore, he was able to do promotional work for the farm when he was on the road for Armbro.
[23] The appellant also stated that all his salary from Armbro went into the farming operation with the exception of what he invested in his Registered Retirement Savings Plan ("RRSP"). The appellant is no longer with Armbro. He retired in 1999 because in 1997 he had been promoted manager at Armbro and he found that the added responsibilities of that position were too much to handle along with the farming. He now devotes almost all of his time to the farm.
Appellant's Argument
[24] Counsel for the appellant argued first that the appellant operated Enright Farms in a manner that allowed him to have a REOP. He then submitted that farming or a combination of farming and another source of income was the appellant's chief source of income.
[25] On the first point (REOP), counsel reviewed the criteria referred to in Moldowan v. The Queen, [1978] 1 S.C.R. 480, for determining whether there is a REOP. He submitted that the appellant had the necessary training, being a third generation farmer who had worked on his father's farm for 35 years before he purchased his own. With respect to the appellant's intended course of action, counsel argued that the appellant always knew he wanted to be a farmer. He purchased his farm close to other members of his family so that help would be available if necessary. The appellant realized that in order to support his farm, he would have to engage in seasonal work. His employment with Armbro was perfect for that purpose. Initially, the appellant had a cow-calf operation but later changed his focus when he determined that the seed stock industry was more profitable. This was a carefully considered decision taken after he and his wife had researched the matter. They were sufficiently involved in the beef industry to have an idea of the value of Limousin cattle and also of the desirability of getting into the seed stock industry. Top Meadow Farms provided them with a successful business model to follow. In order to attain their goal, they first had to invest in the purchase of cattle to improve the quality of their herd. They took their cattle to various shows and fairs in order to advertise their inventory, which made it necessary to invest in a new truck and a bigger trailer. Also, the farm's infrastructure needed to be improved in order to showcase the cattle and give the operation credibility. So they invested all their capital in the farm. By 1992, improvements made to the land, buildings and equipment allowed the farm to function as a seed stock operation.
[26] With respect to the history of profits and losses, counsel for the appellant did not dispute that the appellant experienced many years of losses, but in his view, there is a valid explanation for those losses and they should not prevent this Court from concluding that there was a REOP. Counsel submitted that although the appellant started running his own farm in 1982, he changed direction in 1992: Enright Farms began investing in the quality of its herd and held animals back in order to improve the herd. Therefore, there was a dip in revenue in the years at issue. The years 1999 and 2000 and the first half of 2001 show a profit.
[27] In counsel's view, this is not a case of a professional moving from the city to the country to lose there the income earned in the city. This is not a case where the revenues are insignificant compared to the losses. In 1998, 1999 and 2000, revenues were over $100,000 per year. According to counsel, it has been demonstrated that Enright Farms exhibited in the years at issue the potential to show a profit. It had the requisite cattle and equipment to carry on the operation. The value of the cattle, barns and machinery altogether jumped from $498,350 in 1993 to $824,834 in 1997 (as per Exhibit A-1, Tab 31, which is uncontradicted). The herd growth plan prepared by the appellant shows that they are achieving their original goal and objectives and that the inventory is now at a level where it can produce a profit.
[28] While the herd may not have increased in number, it has however appreciated in value. An animal having been sold last year for $12,000, it is reasonable to expect that other animals from the herd, with similar genetics, would likewise command high prices on the market. Furthermore, two other revenue streams, namely embryo and semen straw sales, have been introduced.
[29] Based on the above, the appellant submitted that Enright Farms did have a REOP.
[30] On the second issue, that of the chief source of income, counsel for the appellant reviewed the three criteria established in the case law for determining a taxpayer's chief source of income, namely: capital committed, time spent on the activity and profitability, both actual and potential (see Canada v. Donnelly (C.A.), [1998] 1 F.C. 513).
[31] Counsel relied on The Queen v. Poirier, 92 DTC 6335 (F.C.A.), where it was stated that when a court considers the three factors listed above, they must be considered cumulatively and not disjunctively. He also relied on Hover v. M.N.R., 93 DTC 98 (T.C.C.), a decision in which the concept of adjunct income in cases involving farmers was recognized. In other words, without the off-farm income, the farming operation could not have been commenced nor could the substantial capital expenditures and start-up costs have been made or incurred. In this sense, the off-farm income formed an integral part of the combination of farming and some other source of income. Here, the income from Armbro was an essential element in the business plan for the farm.
[32] Counsel also submitted that having a farming background is an important consideration in the determination of a taxpayer's chief source of income. There is a distinction to be drawn between a country person who goes to the city and a city person who goes to the country (see Donnelly, supra).
[33] Counsel relied as well on cases in which the courts did not apply the section 31 restriction to taxpayers who had been raised on farms and who had been incurring losses for periods ranging from 12 to 19 years (see Miller v. The Queen, 2000 DTC 1502 (T.C.C.); Rich v. Canada, [1995] T.C.J. No. 1623 (Q.L.); Paquette v. Canada, [2000] T.C.J. No. 412 (Q.L.)).
[34] In counsel's view, the appellant's seasonal off-farm job did not interfere with the significant time he spent on his farm. As for the capital committed, almost all of the appellant's income was invested in the farm and he had sufficient buildings and equipment to succeed with his business plan. With regard to profitability, the appellant expected during the period from 1994 to 1997 that the bulk of his income would be from farming by 2002, that is, once they reached the production sale stage. This is shown by the financial projections they made at the time, which, according to the appellant's wife's testimony, are on the verge of being borne out (as per the non-reconciled financial statements filed for the first six months of 2002). In counsel's view, there is evidence of potential profitability in the relevant years and confirmed evidence that the farm was in fact profitable in subsequent years.
[35] Counsel finally submitted that if not convinced that, in the years in question, the potential profitability of Enright Farms exceeded the income from Armbro, the Court should consider the fact that no one factor, such as profitability, should be determinative in a chief source of income analysis. The lack of profitability in the relevant years cannot be ignored but it should not overshadow the other relevant facts of this case.
Respondent's Argument
[36] Counsel for the respondent did not dispute the sufficiency of the appellant's knowledge and expertise with regard to the farming operation. Counsel relied mainly on the size of the losses incurred over a period of 20 years in submitting that the appellant did not have a REOP in the taxation years at issue. In counsel's view, that is too many years for those losses to be able to be considered as start-up costs. He submitted that the losses over the 20 years are to be seen as a continuum and that the change in business from a cow-calf operation to a seed stock operation is not significant enough for the Court to close its eyes to the losses in the years prior to that change. Basically, counsel did not accept the appellant's submission that a new start-up period began in 1992. In his view, the appellant has not shown that there was a REOP in the years at issue.
[37] With respect to the chief source of income argument, counsel for the respondent did not dispute that the appellant invested all his capital in the farming operation. He submitted, however, that the evidence discloses that the appellant spent half his time on the farm and the other half on his employment with Armbro, and that he did not devote more time to the farm than to Armbro. Counsel relied on the case of Sartori v. The Queen, 2002 DTC 1252, [2001] T.C.J. No. 855 (Q.L.), in which Judge Bowman stated that the determination of chief source of income is not a pure quantum measurement, however, the fact that a source of income besides farming provides a taxpayer's livelihood while farming consistently yields a loss cannot be ignored. Counsel said that the Minister believed the average price that could be obtained for the Limousin cattle owned by the appellant to be more in the vicinity of the $3,000 per head indicated in the documents adduced in evidence than the $5,000 to $10,000 claimed by the appellant and his wife in their testimony. Using a $3,000 value for the cattle, counsel submitted that the potential profitability of the farm is much less than the appellant testified that it is. Therefore, the potential income from the farm was not comparable to the income received from Armbro. Counsel was accordingly of the view that farming was not, either alone or in combination with the income from Armbro, the appellant's chief source of income. He therefore asks that the losses be restricted pursuant to section 31 of the ITA.
Analysis
[38] As mentioned at the beginning of these reasons, the parties argued this case before the decisions of the Supreme Court of Canada in Stewart, supra,and Walls, supra, were rendered.
[39] In those decisions, the Supreme Court of Canada considers the appropriate use of the REOP test under the ITA and, in Stewart, summarizes as follows how that test has been broadly used over the years, in paragraph 47:
47. To summarize, in recent years the Moldowan REOP test has become a broad-based tool used by both the Minister and courts in any manner of situation where the view is taken that the taxpayer does not have a reasonable expectation of profiting from the activity in question. From this it is inferred that the taxpayer has no source of income, and thus no basis from which to deduct losses and expenses relating to the activity. The REOP test has been applied independently of provisions of the Act to second-guess bona fide commercial decisions of the taxpayer and therefore runs afoul of the principle that courts should avoid judicial rule-making in tax law: see Ludco, supra; Royal Bank of Canada v. Sparrow Electric Corp., [1997] 1 S.C.R. 411; Canderel, supra; Shell Canada Ltd. v. Canada, [1999] 3 S.C.R. 622. As well, the REOP test is problematic owing to its vagueness and uncertainty of application; this results in unfair and arbitrary treatment of taxpayers. As a result, "reasonable expectation of profit" should not be accepted as the test to determine whether a taxpayer's activities constitute a source of income.
[40] The Supreme Court of Canada concludes in the following terms at paragraph 60:
60. In summary, the issue of whether or not a taxpayer has a source of income is to be determined by looking at the commerciality of the activity in question. Where the activity contains no personal element and is clearly commercial, no further inquiry is necessary. Where the activity could be classified as a personal pursuit, then it must be determined whether or not the activity is being carried on in a sufficiently commercial manner to constitute a source of income. However, to deny the deduction of losses on the simple ground that the losses signify that no business (or property) source exists is contrary to the words and scheme of the Act. Whether or not a business exists is a separate question from the deductibility of expenses. As suggested by the appellant, to disallow deductions based on a reasonable expectation of profit analysis would amount to a case law stop-loss rule which would be contrary to established principles of interpretation, mentioned above, which are applicable to the Act. As well, unlike many statutory stop-loss rules, once deductions are disallowed under the REOP test, the taxpayer cannot carry forward such losses to apply to future income in the event the activity becomes profitable.
[41] In the present case, it is obvious that the respondent initially denied the deductibility of the losses under the ITA based on a REOP analysis.
[42] It is clear now that sole reliance on such a restricted analysis is no longer valid. However, where a personal element is present, the REOP test is one objective factor, although not a conclusive one, to be considered in determining whether the taxpayer is carrying on the activity in a commercial manner.
[43] With respect to the right to claim ITCs under the ETA, these may only be claimed on tax paid on property or services acquired in the course of a commercial activity. Commercial activity is defined as follows in subsection 123(1) of the ETA:
"commercial activity" of a person means
(a) a business carried on by the person (other than a business carried on without a reasonable expectation of profit by an individual, a personal trust or a partnership, all of the members of which are individuals), except to the extent to which the business involves the making of exempt supplies by the person,
(b) an adventure or concern of the person in the nature of trade (other than an adventure or concern engaged in without a reasonable expectation of profit by an individual, a personal trust or a partnership, all of the members of which are individuals), except to the extent to which the adventure or concern involves the making of exempt supplies by the person, and
(c) the making of a supply (other than an exempt supply) by the person of real property of the person, including anything done by the person in the course of or in connection with the making of the supply.
[44] Thus, the REOP test is specifically included in the legislative provision which defines commercial activity. A taxpayer must therefore demonstrate that he or she is carrying on a business other than a business carried on without a REOP if that taxpayer is to be able to claim that he or she is engaged in a commercial activity.
[45] In the present case, the appellant is claiming ITCs under the ETA. It should be added that he lives on his farm with his family and, although the scale of his farming activities is quite large, it cannot be denied that there is a personal element involved here. Consequently, an analysis of the REOP test in the context of the facts of this case is not superfluous in the circumstances, and I will deal with this aspect first.
REOP
[46] The Supreme Court of Canada noted in Stewart, supra, that in order for an activity to be classified as being commercial in nature, a variety of objective factors should also be looked at. The Court states at paragraphs 54, 55 and 58:
54. It should also be noted that the source of income assessment is not a purely subjective inquiry. Although in order for an activity to be classified as commercial in nature, the taxpayer must have the subjective intention to profit, in addition, as stated in Moldowan, this determination should be made by looking at a variety of objective factors. Thus, in expanded form, the first stage of the above test can be restated as follows: "Does the taxpayer intend to carry on an activity for profit and is there evidence to support that intention?" This requires the taxpayer to establish that his or her predominant intention is to make a profit from the activity and that the activity has been carried out in accordance with objective standards of businesslike behaviour.
55. The objective factors listed by Dickson J. in Moldowan at p. 486 were: (1) the profit and loss experience in past years; (2) the taxpayer's training; (3) the taxpayer's intended course of action; and (4) the capability of the venture to show a profit. As we conclude below, it is not necessary for the purposes of this appeal to expand on this list of factors. As such, we decline to do so; however, we would reiterate Dickson J.'s caution that this list is not intended to be exhaustive, and that the factors will differ with the nature and extent of the undertaking. We would also emphasize that although the reasonable expectation of profit is a factor to be considered at this stage, it is not the only factor, nor is it conclusive. The overall assessment to be made is whether or not the taxpayer is carrying on the activity in a commercial manner. However, this assessment should not be used to second-guess the business judgment of the taxpayer. It is the commercial nature of the taxpayer's activity which must be evaluated, not his or her business acumen.
. . .
58. In addition to the fact that the deductibility, or otherwise, of an expense is a separate question from the existence of the underlying source of income, it is also true that the profitability of the activity to which the expense relates does not affect the deductibility of the expense. In particular, there have been a number of cases where a taxpayer's large interest expenses have resulted in net losses, which in turn have caused the Minister to conclude that there is no reasonable expectation of profit, and therefore no source of income from which the interest expenses can be deducted. However, as stated above, reasonable expectation of profit is but one factor to consider in determining whether an activity has a sufficient degree of commerciality to be considered a source of income. . . .
[47] The criteria set out in Moldowan, supra, are the taxpayer's training, the taxpayer's intended course of action, the history of profits and losses and the capability of the venture to show a profit. Those objective criteria are not disputed by the Supreme Court of Canada in Stewart, supra, for cases where the REOP test may be a useful tool in the determination of the commerciality of a venture. Each counsel, in his argument, has analyzed those criteria in light of the facts in the present case.
[48] The respondent did not challenge the fact that the appellant and his wife had the required training to operate a farming business.
[49] With respect to the appellant's intended course of action, it is true that he did not have a formal business plan. However, when he determined that the cow-calf operation was unstable and that he would require another 500 acres in order to make it profitable, he decided to look for other options. He and his wife did research in magazines and spoke with various breeders before determining that a seed stock operation with Limousin cattle would be a good investment. The appellant followed the model used at Top Meadow Farms - a now profitable enterprise as I understand it - in bringing along his operation. First, he invested in his herd in order to improve its quality. Second, he invested in the physical infrastructure required to operate a seed stock farm. Third, he sought to develop a strong reputation in the industry by showing his animals at fairs. Finally, the appellant is now focusing on the sale of his cattle through a production sale that he intends to hold in the near future. The appellant has also opened up new avenues of revenue such as embryo and semen straw sales.
[50] With respect to the history of profits and losses, it is understandable that the respondent would challenge the existence of a REOP when the appellant has shown losses for 20 years. However, I also agree with counsel for the appellant that the gross farming revenue was significant in the years in question and much of it was from cattle sales. The appellant's losses between 1994 and 1997 were large but not excessive compared to gross income. In 1996 and 1997, revenues were lower due to the appellant's decision to retain cattle in order to increase the herd with a view to improved sales in the future. Furthermore, expenses were greater in those years because of the addition of a show barn and the purchase of new equipment to transport animals to shows and fairs. The appellant testified that all the required physical infrastructure is now in place and that yearly expenses will consequently decrease. The appellant further testified that he will soon be in a position to hold a production sale that he expects should be quite profitable. As well, one must be careful in reading the farm expenses chart. The greatest expenses consist of the purchase of cattle. A mandatory inventory adjustment has to be taken into account in the computation of farm expenses. This adjustment is designed to decrease or eliminate cash method losses resulting from purchased inventory (see Interpretation Bulletin IT-526, Farming - Cash Method Inventory Adjustments, May 28, 1993). If we take into account the mandatory adjustment, the appellant's losses are far lower than they appear to be on the chart.
[51] Finally, although the appellant lives on the farm with his family, this is not a case where a professional from the city sets up a hobby farm in the country and incurs substantial losses in doing so.
[52] I therefore conclude that the operation of the farm has shown numerous indicia of commerciality, and I am satisfied that the appellant did have a REOP in the taxation years at issue.
Chief Source of Income
[53] The respondent is of the opinion that the farm losses should be restricted to $8,750 for each of the taxation years at issue in accordance with the formula set out in section 31 of the ITA. Losses will be restricted under section 31 if it is determined that the appellant's chief source of income was neither farming nor a combination of farming and some other source of income in the taxation years at issue.
[54] The cumulative factors of capital committed, time spent and profitability will determine whether farming will be regarded as a "sideline business" to which the restricted farm loss provisions apply. No one factor is decisive (see Donnelly, supra).
[55] In the present case, there is no doubt that the appellant has committed significant time and capital to his farm.
[56] With respect to profitability, both actual and potential, the appellant knew he would incur losses during the taxation years at issue because of the new orientation given to the farm. The appellant and his wife had, however, expected at that time that the seed stock operation would break even in 2000. Indeed, in 2000 and the first six months of 2001, the farm showed a profit after deduction of capital cost allowance.
[57] When the appellant's gross employment income from Armbro and gross farming income are compared, the farming income is greater in 1994 and 1995. In 1996 and 1997, the employment income is greater, but the appellant testified that his cattle sales were low in those years because he held animals over in order to better the quality of the herd. The proceeds from Top Meadow Farms' first production sale were between $650,000 and $700,000. It is therefore reasonable for the appellant to expect a substantial profit when he holds his first production sale (in a year or so). The evidence adduced by the appellant of the various awards that his cattle have won and which should provide a solid basis for a successful production sale strengthens the reasonableness of that expectation.
[58] In my view, the facts of this case more closely resemble those in The Queen v. Graham, [1985] 2 F.C. 107 (F.C.A.). In Graham, it was held that a taxpayer was entitled to the full deduction of farm losses despite the fact that he held full-time employment elsewhere. The taxpayer, who had been raised on a farm, arranged a flexible shift schedule around his hog-farming operation. He took his holidays, took days off without pay and traded shifts with co-workers to accommodate the demands of the farm at planting and harvest time. Robertson J.A. commented on the Graham case as follows in Donnelly, supra, at paragraph 19:
[19] In the end, Graham stands or falls on its unique facts. But there is at least one lesson that can be derived from the case. It seems to me that Graham comes closer to a case in which an otherwise full-time farmer is forced to seek additional income in the city to offset losses incurred in the country. The second generation farmer who is unable to adequately support a family may well turn to other employment to offset persistent annual losses. These are the types of cases which never make it to the courts. Presumably, the Minister of National Revenue has made a policy decision to concede the reasonable expectation of profit requirement in situations where a taxpayer's family has always looked to farming as a means of providing for their livelihood, albeit with limited financial success. The same policy considerations allow for greater weight to be placed on the capital and time factors under section 31 of the Act, while less weight is given to profitability. I have yet to see a case where the Minister denies such a taxpayer the right to deduct full farming losses because of a competing income source. Perhaps this is because it is unlikely a hog farmer such as Mr. Graham would pursue the activity as a hobby.
[59] Although the appellant has had 20 years of losses (including the years at issue), which - on this I agree with the respondent - should not be ignored, I do not, however, find that to be especially unreasonable in the circumstances of this case. The situation here is not much different from that in the Miller and Paquette cases referred to by the appellant, where 13 and 14 years of farm losses had been incurred prior to the years there in question. In the Hover case, also cited by the appellant, it was recognized that start-up periods for operations that are begun from scratch will be longer than those in cases where the taxpayer purchases a going concern. In the present case, the taxpayer acquired farms that required substantial investment in order to be viable. Furthermore, the appellant in the case at bar switched from a cow-calf to a seed stock operation. Although similar in nature, a seed stock operation does require different capital investments.
[60] In the circumstances, I do not find that the number of years of losses is detrimental to the appellant's claims. In my view, he has shown that his chief source of income was farming or a combination of farming and employment income from Armbro during the years in question.
[61] The appeals are allowed, with costs, and the assessments are referred back to the Minister for reconsideration and reassessment on the basis that the appellant may deduct the amounts of $48,725, $65,123, $85,968 and $77,214 as farm losses for the 1994 through 1997 taxation years respectively and is entitled to ITCs in the amount of $15,741 for the quarterly reporting periods from January 1, 1995 to December 31, 1997.
Signed at Ottawa, Canada, this 25th day of July 2002.
|
"Lucie Lamarre" |
J.T.C.C.
SCHEDULE A
|
Taxation years |
Total farm gross income |
Gross income from cattle sales |
Total farm expenses * |
Labour expenses |
Livestock purchased |
CCA |
Net income (loss) before adjustments |
Inventory adjustments |
Farm loss claimed |
Farm loss adjusted and now claimed (excluding personal expenses) |
|
1994 |
$ 95,468 |
$ 81,908 |
$ 291,449 |
$ 14,342 |
$ 25,520 |
$ 30,000 |
($195,981) |
$145,000 |
($50,981) |
($48,725) |
|
1995 |
$ 92,560 |
$ 80,295 |
$ 290,416 |
$ 9,672 |
$ 14,650 |
$ 27,252 |
($197,856) |
$129,650 |
($68,206) |
($65,123) |
|
1996 |
$ 65,320 |
$ 58,197 |
$ 329,588 |
$ 9,336 |
$ 43,392 |
$ 26,350 |
($264,268) |
$167,050 |
($97,218) |
($85,968) |
|
1997 |
$ 46,325 |
$ 33,609 |
$ 318,140 |
0 |
$ 30,572 |
0 |
($271,814) |
$190,950 |
($80,865) |
($77,214) |
|
1998 |
$108,848 |
$ 84,421 |
$ 351,930 |
0 |
$ 30,141 |
0 |
($243,082) |
$206,028 |
($37,054) |
0 |
|
1999 |
$126,152 |
$113,365 |
$347,180 |
0 |
$ 28,124 |
0 |
($221,027) |
$222,940 |
$ 1,912 |
0 |
|
2000 |
$117,649 |
$ 49,353 |
$381,101 |
0 |
$ 7,888 |
$ 51,861 |
($263,452) |
$264,328 |
$ 875 |
0 |
|
2001 (6 months) |
$115,371 |
$ 61,554 |
$101,048 |
$ 275 |
$ 18,602 |
$ 20,022 |
$ 14,323 |
0 |
0 |
0 |
*including mandatory inventory adjustment
COURT FILE NO.: 2000-3649(IT)G and 2000-3653(GST)I
STYLE OF CAUSE: Barry Enright v. The Queen
PLACE OF HEARING: Ottawa, Ontario
DATE OF HEARING: January 14 and 15, 2002
REASONS FOR JUDGMENT BY: The Honourable Judge Lucie Lamarre
DATE OF JUDGMENT: July 25, 2002
APPEARANCES:
Counsel for the Appellant: G. Boyd Aitken
Counsel for the Respondent: Charles M. Camirand
COUNSEL OF RECORD:
For the Appellant:
Name: G. Boyd Aitken
Firm: Borden Ladner Gervais, Ottawa, ON
For the Respondent: Morris Rosenberg
Deputy Attorney General of Canada
Ottawa, Canada
2000-3649(IT)G
BETWEEN:
BARRY ENRIGHT,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
Appeals heard on common evidence with the appeal of Barry Enright 2000-3653(GST)I on January 14 and 15, 2002, at Ottawa, Ontario, by
the Honourable Judge Lucie Lamarre
Appearances
Counsel for the Appellant: G. Boyd Aitken
Counsel for the Respondent: Charles M. Camirand
JUDGMENT
The appeals from the assessments made under the Income Tax Act for the 1994, 1995, 1996 and 1997 taxation years are allowed, with costs, and the assessments are referred back to the Minister of National Revenue for reconsideration and reassessment on the basis that the appellant may deduct the amounts of $48,725, $65,123, $85,968 and $77,214 as farm losses for the 1994 through 1997 taxation years respectively.
Signed at Ottawa, Canada, this 25th day of July 2002.
|
"Lucie Lamarre" |
J.T.C.C.
2000-3653(GST)I
BETWEEN:
BARRY ENRIGHT,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
Appeal heard on common evidence with the appeals of Barry Enright 2000-3649(IT)G, on January 14 and 15, 2002, at Ottawa, Ontario, by
the Honourable Judge Lucie Lamarre
Appearances
Counsel for the Appellant: G. Boyd Aitken
Counsel for the Respondent: Charles M. Camirand
JUDGMENT
The appeal from the assessment made under Part IX of the Excise Tax Act for the period from January 1, 1995 to December 31, 1997, notice of which is dated April 6, 1999 and bears number 00000001551, is allowed, with costs, and the assessment is referred back to the Minister of National Revenue for reconsideration and reassessment on the basis that the appellant is entitled to input tax credits totalling $15,741 for the quarterly reporting periods from January 1, 1995 to December 31, 1997.
Signed at Ottawa, Canada, this 25th day of July 2002.
|
"Lucie Lamarre" |
J.T.C.C.
[1] It must be said here that this case was argued before the recent decisions of the Supreme Court of Canada in Stewart v. The Queen, 2002 SCC 46 and The Queen v. Walls, 2002 SCC 47, where it was stated that REOP should not be the test for determining whether there is a source of income under the ITA. The REOP test, however, is specifically referred to in subsection 123(1) of the ETA in the definition of commercial activity.