Date: 19980624
Docket: 96-2809-IT-G
BETWEEN:
HANSEN HOLDINGS LTD.,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
Reasons for Judgment
Mogan J.T.C.C.
[1] When filing its income tax returns for the 1993 and 1994 taxation years, the Appellant deducted the amounts of $169,866 and $154,357, respectively, as farming losses. When issuing reassessments to the Appellant for 1993 and 1994, the Minister of National Revenue disallowed as farming losses the amounts which had been deducted by the Appellant but, relying on section 31 of the Income Tax Act, the Minister allowed for each year the deduction of a restricted farm loss in the amount of $8,750. The relevant words of subsection 31(1) state:
31(1) Where a taxpayer’s chief source of income for a taxation year is neither farming nor a combination of farming and some other source of income, for the purposes of sections 3 and 111 his loss, if any, for the year from all farming businesses carried on by him shall be deemed to be the aggregate of
(a) ...
The remainder of subsection 31(1) contains a formula which permits a maximum deduction of $8,750 for a farming business if the taxpayer’s chief source of income is neither farming nor a combination of farming and some other source of income. The Appellant has appealed from those reassessments. Therefore, the only issue is whether, in the 1993 and 1994 taxation years, the Appellant’s chief source of income was farming or a combination of farming and some other source of income.
[2] Gerry Hansen is the sole shareholder of the Appellant and he has been in the mobile home business for about 30 years. During the 1980s, the Appellant was engaged in the business of developing mobile home parks. A related corporation, “Carefree Homes” is in the business of selling mobile homes and its sole shareholder is Diane Hansen, wife of Gerry Hansen. Part of the Appellant’s purpose in developing mobile home parks was to create an opportunity for Carefree Homes to sell mobile homes. Gerry Hansen testified in this appeal and described how the Appellant operated.
[3] In the 1980s, Mr. Hansen had a good relationship with certain native groups on Vancouver Island. The Appellant would offer to develop a mobile home park on a parcel of the natives’ land if they would share the development cost and then lease the various lots in the park to persons who needed a place to locate mobile homes. The development costs would be shared 45% by the Appellant and 55% by the natives who owned the land. In order to start the development, the Appellant would lend to the natives their 55% share of the cost. In other words, the Appellant would initially advance all of the development costs and obtain an exclusive right to sell the mobile homes which would be installed on the developed lots.
[4] When the development was complete (streets paved and lots serviced with water, sewer and electricity), the Appellant would transfer to Carefree Homes its exclusive right to sell mobile homes for the park. Upon the sale of each mobile home, Carefree Homes would reimburse the Appellant for part of its 45% share of the development costs; and the customer who purchased the mobile home would enter into a lease with the native group who owned the park to occupy a lot in the park over a term of 10 or more years. When the lease commenced, the natives would amortize their 55% share of the development costs of each lot and repay that amount to the Appellant over the term of the lease. It was the rental payments from the owners of the mobile homes which permitted the natives to pay their share of the development costs.
[5] When all of the lots had been leased and occupied with new mobile homes, the Appellant would have recovered from Carefree Homes its full 45% share of the development costs, and the Appellant would be receiving from the natives a stream of payments designed to reimburse the Appellant for the remaining 55% of the development costs. There was a profit element built into the recovery of the development costs.
[6] According to Mr. Hansen, the Appellant and Carefree Homes did about 20 separate parks like the one described above over the period from the mid-1980s to 1993. Each park would have about 25 to 30 lots. The Appellant did its last park in 1993 because, by that time, it had developed all of the good parcels of land owned by native groups friendly with Mr. Hansen. There was other land available in the interior of British Columbia but Mr. Hansen was not prepared to move away from the urban areas of Victoria or Vancouver.
[7] Mr. Hansen purchased his first horse in 1991. He was in partnership with Ted Dawes who knew something about owning and racing horses. Prior to 1991, Mr. Hansen had no experience in owning horses. As they acquired more horses, Mr. Dawes did not want to expand and so Mr. Hansen bought him out. Mr. Hansen was developing an interest in harness racing as opposed to thoroughbred racing. On April 1, 1992 (the first day of the Appellant’s 1993 fiscal period), Mr. Hansen transferred his horse-racing operation from himself as proprietor to the Appellant. At all relevant times thereafter, the Appellant corporation has had a horse-racing and horse-breeding operation. The maintaining of horses for racing is within the definition of “farming” in section 248 of the Income Tax Act.
[8] Right from the start, the Appellant’s horse operation has lost money. The amount of the loss cannot be discerned from the Appellant’s financial statements because there is not a separate statement of profit and loss for the horse operation as distinct from the Appellant’s business of developing mobile home parks. The Appellant did, however, introduce Exhibit A-9 which shows the financial results of the horse operation for the years 1996, 1997 and 1998. Also, Mr. Hansen reviewed in his testimony the facts assumed by the Minister of National Revenue in paragraph 7 of the Reply to the Notice of Appeal and confirmed the truth of paragraphs 7(f), 7(g) and 7(n). Considering that the Appellant acquired the horse operation only at the beginning of its 1993 fiscal period, the results of its horse operation in the years 1993, 1994, 1996, 1997 and 1998 are as follows (1995 is missing):
|
1993 |
1994 |
1996 |
1997 |
1998 |
|
|
Revenue |
57,523 |
58,986 |
22,892 |
54,361 |
83,685 |
|
Expenses |
227,390 |
213,343 |
175,044 |
223,987 |
158,391 |
|
Loss |
169,867 |
154,357 |
152,152 |
169,626 |
74,706 |
[9] According to Exhibits A-1 and A-2 (the Appellant’s income tax returns for the fiscal periods ending March 31, 1993 and 1994), the Appellant’s gross revenue in 1993 was $917,795 and in 1994 was $224,894. If the revenue each year from the horse operation alone was approximately $58,000 as shown in the table above, the Appellant had gross revenue from its development business of approximately $860,000 in 1993 and $166,000 in 1994. In other words, for both 1993 and 1994, the revenue from the Appellant’s horse operation was significantly less than the revenue from its development business.
[10] Having regard to the Appellant’s horse operation in 1993 and 1994 (the only two years under appeal), it is difficult to see that operation as a source of income by any standard let alone the Appellant’s chief source of income. On the contrary, it was a significant drain on income from the development business which the Appellant might otherwise have retained. Counsel for the Appellant urged me in argument to regard the losses in the horse operation in 1993 and 1994 as part of the normal start-up losses which could be expected in any new enterprise. I might have been inclined to regard the losses in that manner if the Respondent had disallowed all of the losses from the horse operation on the basis that it did not have a reasonable expectation of profit; it was not a business; and therefore, it was not a source of income. The Respondent has, however, allowed the deduction of a restricted farm loss under section 31. Therefore, we start these appeals for 1993 and 1994 accepting the proposition that the Appellant’s horse operation had a reasonable expectation of profit; it was a business and, therefore, a source of income. See Moldowan v. The Queen, 77 DTC 5213 at 5215 and 5216. In my view, the consideration of start-up losses is a relevant factor to weigh in the overall determination of whether a new commercial operation has a reasonable expectation of profit (see Tonn, et al v. The Queen, 96 DTC 6001), but it is not a relevant factor in the determination of “chief source of income” under section 31.
[11] A long line of cases commencing with Moldowan which has been explained and applied many times in the Federal Court of Appeal has established the proposition that, when determining whether a farming business is a chief source of income, the most relevant factors to weigh are time spent, capital committed and profitability, both actual and potential. In The Queen v. Donnelly, 97 DTC 5499, Robertson J.A. delivered the judgment of a unanimous Court and stated at pages 5500-5501:
A determination as to whether farming is a taxpayer's chief source of income requires a favourable comparison of that occupational endeavour with the taxpayer's other income source in terms of capital committed, time spent and profitability, actual or potential. The test is both a relative and objective one. It is not a pure quantum measurement. All three factors must be weighed with no one factor being decisive. Yet there can be no doubt that the profitability factor poses the greatest obstacle to taxpayers seeking to persuade the courts that farming is their chief source of income. This is so because the evidential burden is on taxpayers to establish that the net income that could reasonably be expected to be earned from farming is substantial in relation to their other income source: invariably, employment or professional income.
[12] When considering “time spent”, I direct my attention to Mr. Hansen because the Appellant is a corporation and he was the only officer or employee of the Appellant to testify. He is not a “hands-on” person with respect to the horses. There is no evidence that he grooms them or rides in a sulky behind them while they train as trotters or pacers. The Appellant does not own any farm or barn or other facility for housing horses; and so Mr. Hansen has no need to maintain such a facility. Exhibit A-9 indicates that all of the horses are boarded with a stranger because there are expenses for “rent and board”. In 1993, the Appellant was completing its last development of a mobile home park and had revenues of approximately $1,000,000 from that source. See Exhibits A-1 and R-1. Although the Appellant did not start another park after 1993, it made a serious attempt to start one at Tsawwassen just south of Vancouver. In its fiscal period ending March 31, 1996 (Exhibit A-4), the Appellant spent $164,000 on that attempted development and it was stopped only because of difficulties with the municipality. That attempted development must have been a drain on Mr. Hansen’s time because he appears to be the only employee of the Appellant with the experience to develop a mobile home park.
[13] Mr. Hansen belongs to certain breeding and trotting associations. He reads books on the bloodlines of horses and is involved in the purchase and sale of each horse. He has two trainers and tries to attend the races in which his horses are running. On balance, however, I conclude that, in the years under appeal, Mr. Hansen spent at least as much time on his park development business as on his horse business. It must be remembered that even after 1993 when the Appellant did not actually start a new park, the Appellant had significant loans outstanding with respect to the 55% owners’ share of development costs of parks which had been previously developed, and the Appellant could recover those loans only over a period of years from the owners’ leases. The recovery of those loans was essential to the Appellant’s survival. The Appellant’s balance sheet at March 31, 1994 (Exhibit A-2) and the accompanying Note 2 show that the loans receivable of $945,000 are almost equal to the retained earnings of $959,000. I draw the inference that Mr. Hansen was concerned with the collection of those significant loans receivable and that they absorbed some of his time.
[14] There is no doubt that the Appellant had more capital committed to its park development business than to its horse business. Exhibit A-10 is a list of the horses owned each year from 1993 through to 1997. At the end of each year, the Appellant never had more than $127,000 invested in horses. For 1993 and 1994, the amounts were $124,600 and $89,600, respectively. In those same years, the Appellant had loans receivable of $1,063,588 and $945,028 in connection with the development of its mobile home parks in prior years. See Exhibits A-1 and A-2. With no farm, no barn, no stable and no training track, the Appellant’s capital committed to the horse business was almost all in the horses themselves; and it was not significant in relation to the capital in its other long-term business.
[15] The Appellant’s profitability from the horse business has yet to be proven. The table above (in paragraph number 8) is a very clear indication that there were substantial losses in 1993, 1994, 1996, 1997 and 1998. In Donnelly, Robertson J.A. refers to the test to be applied when determining chief source of income and the test for reasonable expectation of profit and states at page 5499:
... As is explained below, the legal test for establishing farming as a chief source of income is, on an evidential level, a more onerous one.
and further at page 5501:
Any doubt as to whether the taxpayer's chief source of income is farming is resolved once consideration is given to the element of profitability. There is a difference between the type of evidence the taxpayer must adduce concerning profitability under section 31 of the Act, as opposed to that relevant to the reasonable expectation of profit test. In the latter case the taxpayer need only show that there is or was an expectation of profit, be it $1 or $1 million. It is well recognized in tax law that a "reasonable expectation of profit" is not synonymous with an "expectation of reasonable profits". With respect to the section 31 profitability factor, however, quantum is relevant because it provides a basis on which to compare potential farm income with that actually received by the taxpayer from the competing occupation. In other words, we are looking for evidence to support a finding of reasonable expectation of "substantial" profits from farming.
[16] In these appeals, there was no evidence to support a finding that the Appellant could or would have a reasonable expectation of profits, substantial or otherwise, from its adventure in harness racing. At all relevant times, the Appellant’s chief source of income was its business of developing mobile home parks. The appeals for 1993 and 1994 are dismissed, with costs.
Signed at Ottawa, Canada, this 24th day of June, 1998.
"M.A. Mogan"
J.T.C.C.