Gunn v. Canada

Gunn v. Canada
Court (s) Database
Federal Court of Appeal Decisions
Date
2006-08-21
Neutral citation
2006 FCA 281
File numbers
A-424-05
Notes
Reported Decision
Decision Content
Date: 20060821
Docket: A-424-05
Citation: 2006 FCA 281
CORAM: SEXTON J.A.
SHARLOW J.A.
MALONE J.A.
BETWEEN:
DOUGLAS G. GUNN
Appellant
and
HER MAJESTY THE QUEEN
Respondent
Heard at Toronto, Ontario, on April 4, 2006.
Judgment delivered at Ottawa, Ontario, on August 21, 2006.
REASONS FOR JUDGMENT BY: SHARLOW J.A.
CONCURRED IN BY: SEXTON J.A.
MALONE J.A.
Date: 20060821
Docket: A-424-05
Citation: 2006 FCA 281
CORAM: SEXTON J.A.
SHARLOW J.A.
MALONE J.A.
BETWEEN:
DOUGLAS G. GUNN
Appellant
and
HER MAJESTY THE QUEEN
Respondent
REASONS FOR JUDGMENT
SHARLOW J.A.
[1] This is an appeal from a judgment of the Tax Court of Canada (2005 TCC 437) dismissing Mr. Gunn’s appeal from reassessments made under the Income Tax Act, R.S.C. 1985, c. 1 (5th supp.), for the years 1997, 1998 and 1999. The only issue is whether the Judge was correct in concluding that section 31 of the Income Tax Act applied in each of those years to limit Mr. Gunn’s farm loss deduction to $8,750.
FACTS
[2] The facts are undisputed. For over thirty years, Mr. Gunn has built up a law practice and a farming business through the investment of capital and the application of skill, knowledge and hard work. His law practice required a relatively modest investment of capital and it has been profitable. His farming business required a greater capital investment, but it has resulted mostly in operating losses. Despite Mr. Gunn’s record of farming losses, it is undisputed that his farming operations comprise a business, a commercial activity undertaken for profit and with a reasonable expectation of profit.
[3] Mr. Gunn grew up near St. Thomas, Ontario, on a farm settled by his grandfather. His father raised cattle, sheep and cash crops on the farm. Mr. Gunn worked on his father’s farm during the summers when he was attending the University of Western Ontario. That is how he earned the money for his education. In 1962, Mr. Gun acquired a 25% interest in a farm. His parents and his brother were the other owners. The property was sold some years later.
[4] In 1965, Mr. Gunn graduated from the faculty of law of the University of Western Ontario. He was admitted to the bar of Ontario in 1967, and has practiced law ever since. In 1984 he formed his own firm, Gunn and Associates, in St. Thomas. At the time of the Tax Court hearing, Mr. Gunn had four lawyers working for him.
[5] In 1972, Mr. Gunn bought the property that he now calls his home farm. It is located near St. Thomas, a short distance from his law office. At that time the buildings were run down, and over the next several years Mr. Gunn and his wife together built the home that they still live in, and replaced the farm buildings on the property. The property now has five barns, in which Mr. Gunn has been raising pure-bred Hereford cattle for the past 30 years. By 2005, Mr. Gunn had an established herd of approximately 50 breeding cows.
[6] The breeding of cattle requires a considerable amount of time, attention and expertise. Mr. Gunn does most of the work involved in the cattle breeding operation himself, with the help of his wife. Until September 2004 he had a hired hand as well. He makes all of the decisions in connection with the livestock breeding. In the calving season he checks and feeds the cattle, visiting the barns twice daily, in the early morning and in the evening. His wife checks them during the day, and he is available to return home on short notice if needed. He is never away from home for more than a few days at any time. He also works on the farm during weekends, and some week days in the summer, doing much of the manual work of seeding and haying, with the assistance of people hired on a casual basis. He also does all of the paper work and record-keeping required in connection with the breeding and registration of his cattle.
[7] Between 1990 and 1997, Mr. Gunn acquired six additional farm properties in the vicinity of St. Thomas, where he grows rye, hay and his major cash crop, tobacco. Many of those properties were in very poor condition when purchased, both in relation to the soil, and the buildings and equipment. During that period Mr. Gunn invested considerable time and money to bring those properties up to the high standards that he has established for his farming operations. That work included improving the soil by adding large amounts of fertilizer that had to be trucked long distances. He also spent a lot of time and money on improvements to the buildings, and on repair of equipment that had been much neglected.
[8] More recently, Mr. Gunn has moved from the production of flue-cured tobacco to the production of air-cured burley tobacco, with a view to making his tobacco operation less labour intensive and more profitable. Air cured burley tobacco is less expensive to produce and, unlike flue-cured tobacco, it is not subject to provincial production quotas. Mr. Gunn testified at trial that, having completed the transition to burley tobacco, his tobacco production will come within the top ten percent of all producers in Ontario, in terms of yield and quality.
[9] Mr. Gunn’s usual daily routine is to work on the farm from about 6:00 a.m., and then in his law office from about 9:00 a.m. until about 4:00 p.m., returning to the farm to do more work in the late afternoon and evening. He estimated that he normally spends about 50 hours per week working at his law practice, and about 20 hours on farm work.
[10] Mr. Gunn has acted as the Chairman of the Ontario Crop Insurance Arbitration Board, and has been involved in the work of other bodies connected with agriculture and the cattle industry. He testified that many clients of his law firm are people Mr. Gunn has met through his farming connections. Clients are encouraged to contact him by telephone or in person at the farm, and often do so. His analysis of files opened in his law firm in the years under appeal shows that between 10% and 15% of them were for clients he met through his farming activities. He suggested that many more files could be attributed indirectly to his farming contacts.
[11] Mr. Gunn’s net farming assets amount to approximately $2 million, the greatest part being land and buildings. The capital invested in his law practice is about $62,000 (before taking into account unbilled accounts and goodwill). He spends approximately 30% to 35% of his working time on the farming operations, and the balance on his law practice. Mr. Gunn’s net income from farming and his net income from his law practice since 1987 are as follows:
Year
Net professional
income ($)
Farm Income
Gross ($)
Expenses ($)
Net ($)
1987
165,663
66,719
126,156
(59,437)
1988
152,682
59,481
84,575
(25,094)
1989
268,770
30,139
88,726
(58,587)
1990
280,017
32,307
82,142
(49,835)
1991
235,854
44,873
98,645
(53,772)
1992
428,077
82,451
130,360
(47,909)
1993
256,723
105,226
191,241
(86,015)
1994
270,818
321,246
377,862
(56,616)
1995
277,869
162,554
222,011
(59,457)
1996
221,013
295,364
426,683
(131,319)
1997
308,686
217,560
272,013
(54,453)
1998
204,865
366,877
474,383
(107,506)
1999
308,447
258,489
417,417
(158,928)
2000
428,189
395,585
429,213
(33,628)
2001
331,419
225,572
272,246
(46,674)
2002
305,890
231,452
192,293
39,159
2003
369,356
148,406
235,390
(85,024)
2004
247,031
326,109
229,997
96,112
[12] Mr. Gunn testified that without the financial support provided by his law practice, he could not have financed the expenditures required to improve his farming operations. He also testified that his farm losses during the 1990s and later years were greater than they might otherwise have been because of a number of nonrecurring expenditures and unforeseen events. First, Mr. Gunn spent considerable amounts of money on the rehabilitation of the farm properties he bought during that period. As of the date of trial, Mr. Gunn believed that he would have no further obligations in that respect. Second, it took Mr. Gunn some years to change the tobacco operation from flue-dried tobacco to the more profitable air-dried burley tobacco. Third, for 2003 and subsequent years, the profitability of Mr. Gunn’s cattle operation, like those of practically every cattle farmer in Canada, was adversely affected by the discovery of bovine spongiform encephalopathy (mad cow disease) in some Canadian cattle. Fourth, had Mr. Gunn not claimed elective deductions for capital cost allowance in the years 2000 to 2004, his farm profits for those years would have increased (and losses would have decreased).
[13] Counsel for the Crown agreed, in his submissions at the end of the hearing in the Tax Court, that Mr. Gunn’s farming business had a potential for income in the years in issue as well as in later years, but he argued that the farm income potential would never match the potential for income from Mr. Gunn’s law practice. The Judge accepted that Mr. Gunn has been seriously committed to farming as a business for more than 35 years, that during the years under appeal he remained as committed to it as ever, that he remains fully committed to it, and that he intends to continue both practicing law and farming for the foreseeable future.
Section 31 of the Income Tax Act
[14] Section 31 of the Income Tax Act reads as follows:
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 the taxpayer's loss, if any, for the year from all farming businesses carried on by the taxpayer shall be deemed to be the total of
31. (1) Lorsque le revenu d'un contribuable, pour une année d'imposition, ne provient principalement ni de l'agriculture ni d'une combinaison de l'agriculture et de quelque autre source, pour l'application des articles 3 et 111, ses pertes pour l'année, provenant de toutes les entreprises agricoles exploitées par lui, sont réputées être le total des montants suivants:
(a) the lesser of
a) la moins élevée des sommes suivantes:
(i) the amount by which the total of the taxpayer's losses for the year, determined without reference to this section and before making any deduction under section 37 or 37.1, from all farming businesses carried on by the taxpayer exceeds the total of the taxpayer's incomes for the year, so determined from all such businesses, and
(i) l'excédent du total de ses pertes pour l'année, déterminées compte non tenu du présent article et avant toute déduction prévue aux articles 37 ou 37.1 et provenant de toutes les entreprises agricoles exploitées par lui, sur le total des revenus, ainsi déterminés, qu'il a tirés pour l'année de ces entreprises,
(ii) $2,500 plus the lesser of
(A) 1/2 of the amount by which the amount determined under subparagraph 31(1)(a)(i) exceeds $2,500, and
(B) $6,250, and
(ii) 2 500 $ plus la moins élevée des sommes suivantes:
(A) 1/2 de l'excédent du montant visé au sous-alinéa (i) sur 2 500 $,
(B) 6 250 $;
(b) the amount, if any, by which
b) l'excédent éventuel de la somme visée au sous-alinéa (i) sur la somme visée au sous-alinéa (ii):
(i) the amount that would be determined under subparagraph 31(1)(a)(i) if it were read as though the words "and before making any deduction under section 37 or 37.1" were deleted,
exceeds
(ii) the amount determined under subparagraph 31(1)(a)(i).
(i) la somme qui serait déterminée en vertu du sous-alinéa a)(i) compte non tenu du passage "et avant toute déduction prévue aux articles 37 ou 37.1",
(ii) la somme déterminée en vertu du sous-alinéa a)(i).
Discussion
[15] The legal issues raised in this case require a determination of the meaning of the opening words of section 31 of the Income Tax Act. The interpretation of section 31 requires a textual, contextual and purposive analysis to find a meaning that is harmonious with the Income Tax Act as a whole, and that achieves consistency, predictability and fairness so that taxpayers may manage their affairs intelligently: Canada Trustco Mortgage Co. v. Canada, [2005] 2 S.C.R. 610, at paragraphs 10-12.
(a) Textual analysis
[16] The opening words of section 31 set out the test for its application. The test asks two questions. I refer to these as the “principal question” (Is farming the taxpayer’s chief source of income?) and the “combination question” (Is the taxpayer’s chief source of income a combination of farming and some other source of income?). Section 31 applies only if the answer to both questions is no.
[17] The remainder of section 31 states its effect (an issue which in the current case is not controversial).
[18] A straightforward textual analysis leaves two important questions unanswered. First, what is the meaning of the phrase “chief source of income” (which is not defined in the Income Tax Act)? Second, does a positive answer to the combination question require farming to be predominant?
(b) Statutory context
[19] The relevant statutory context includes the regime in the Income Tax Act for the determination and tax treatment of business profits and business losses, and the special rules applicable to the determination and tax treatment of the profit and loss of a farming business. For the purposes of the Income Tax Act, the word “farming” is defined as follows:
“farming” includes tillage of the soil, livestock raising or exhibiting, maintaining of horses for racing, raising of poultry, fur farming, dairy farming, fruit growing and the keeping of bees, but does not include an office or employment under a person engaged in the business of farming;
Sont compris dans l'agriculture la culture du sol, l'élevage ou l'exposition d'animaux de ferme, l'entretien de chevaux de course, l'élevage de la volaille, l'élevage des animaux à fourrure, la production laitière, la pomoculture et l'apiculture. Ne sont toutefois pas visés par la présente définition la charge ou l'emploi auprès d'une personne exploitant une entreprise agricole.
[20] Generally, a taxpayer who operates a business is subject to tax on the profit earned from that business in a particular year. If the operation of the business results in a loss for a particular year, that loss may be deducted from the taxpayer’s other income for that year. The annual profit or loss of a business may be determined by any method that produces an accurate picture of the financial result of the operation of the business for the year, and is consistent with the provisions of the Income Tax Act, established case law principles, and well accepted business principles: Canderel Ltd. v. Canada, [1998] 1 S.C.R. 147, at paragraph 53.
[21] The Income Tax Act provides a number of special rules for the determination of the profit or loss of a farming business. They are found in sections 28 to 31.
[22] Pursuant to section 28, the profit or loss of a farming business may be determined by a special method of cash basis accounting (that method also may be used to determine the profit or loss of a fishing business). Most business are required to use accrual accounting (that is, they must record as revenue all amounts that are receivable, and record as expenses all amounts for which a liability has been incurred). Accrual accounting generally is considered to produce a more accurate picture of income than the cash method, but the statutory cash basis method of accounting for farmers is simpler to use than accrual accounting, and it may result in a better matching of the cash flow of the business to the tax liability for any profit, or tax relief for any loss, as the case may be. A taxpayer who chooses to use the cash method of computing the profit or loss of a farming business may treat the cost of inventory as an expense (up to its fair market value). However, a mandatory inventory adjustment precludes a taxpayer from using inventory purchases to create or increase a farming loss (paragraph 28(1)(c) of the Income Tax Act).
[23] Section 29 establishes the tax consequences of the disposition of an animal that forms part of a “basic herd”. This provision was enacted in 1972 as a transition from the pre-1972 tax regime (in which a herd of animals could be treated as a capital asset, the disposition of which would result in tax-free gains), to the current regime in which a herd is treated as inventory.
[24] Section 30 permits the cost of clearing land, levelling land or installing a land drainage system to be deducted as a current expense of a farming business. For most other businesses, expenditures on improvements to land would not be deductible, but would be treated as capital expenditures comprising part of the cost of the land.
[25] Section 31 limits the entitlement of certain farmers to claim a deduction for the losses of a farming business. As mentioned above, a taxpayer who incurs a loss from the operation of a business in a year is entitled to deduct that loss from other income of the year. Section 31 provides an exception to this general rule in the case of certain farming losses. If section 31 applies, the maximum deduction is $8,750 for a loss from a farming business.
[26] I see nothing in the scheme of the Income Tax Act relating to the determination and tax treatment of farm profits and losses that sheds light on the meaning of the phrase “chief source of income” in section 31, or the manner in which the combination question should be addressed. I have been able to find no provision of the current Income Tax Act that is analogous to the “chief source of income” test or the combination question in section 31.
[27] I turn now to the legislative history to see if it provides any clues. Section 31 has its roots in Canada’s first income tax legislation, the Income War Tax Act, S.C. 1917, c. 28. Section 4 of that statute imposed an income tax on “income”, which was defined in section 3 to include, among other things, the profit of any “profession or calling, or from any trade, manufacture or business”.
[28] A number of paragraphs within section 3 of the Income War Tax Act set out specific rules for the computation of profit. In 1919, paragraph 3(f) was added by S.C. 1919, c. 55, to prevent the income from a taxpayer’s chief source of income from being reduced by a loss transaction that was not connected with the taxpayer’s chief source of income.
[29] In 1920, a further amendment was made to empower the Minister to determine whether a transaction resulting in a loss was connected with a taxpayer’s chief source of income. The Minister’s determination was stated to be “final and conclusive”. That was one of a number of provisions in the Income War Tax Act that gave the Minister very wide discretionary powers with respect to the determination of profits and losses for income tax purposes.
[30] By S.C. 1923, c. 52, paragraph 3(f) was replaced with a rule that deemed the income of a taxpayer to be not less than the income derived from the taxpayer’s chief source of income. The Minister was given the discretion to determine, finally and conclusively, which one or more sources of income, or which combination of sources, constituted a taxpayer’s chief source of income. It is worth noting that after the 1923 amendment, the word “connected” no longer appears in paragraph 4(f), suggesting that a combination of sources of income could include unrelated sources.
[31] In the 1927 consolidation of federal statutes, the Income War Tax Act was amended in a number of minor respects (R.S.C. 1927, c. 97). Paragraph 3(f) became section 10. The two provisions are substantially the same.
[32] There is no jurisprudence on section 10 of the Income War Tax Act, perhaps because of the provision that the Minister’s determination would be final and conclusive. Generally, the Courts respected the finality of a Ministerial determination unless it could be shown that the Minister failed to exercise his discretion in good faith or to act upon proper principles (Pioneer Laundry and Dry Cleaners, Ltd. v. Minister of National Revenue, [1940] A.C. 127; D.R. Fraser and Company, Limited v. Minister of National Revenue, [1949] A.C. 24). There are no cases relating to the proper principles for the exercise of the Minister’s discretion under section 10 of the Income War Tax Act.
[33] In 1948, a new Income Tax Act (S.C. 1948, c. 52) was enacted to replace the Income War Tax Act. The 1948 Income Tax Act was similar in structure to the current Income Tax Act. Many of the provisions that gave the Minister discretionary authority in the matter of the determination of income and losses were omitted, or were amended so that a Ministerial determination would not be final and conclusive. Section 10 of the Income War Tax Act survived as subsections 13(1) and (2) of the 1948 Income Tax Act. Subsection 13(1) deemed the income of a person for a year to be “not less than his income for the year from his chief source of income.” Subsection 13(2) gave the Minister the discretion to determine “which source of income or sources of income combined is a taxpayer’s chief source of income”. As there was no provision making that determination final and conclusive, the determination of “chief source of income” became subject to appeal (Canada (Minister of National Revenue) v. Robertson, [1954] Ex. C.R. 321 at page 331). However, it remained the case that no statutory guidelines were provided for the application of section 13.
[34] By S.C. 1950-51, c. 51, section 4, the first statutory predecessor to the current section 31 was enacted as subsections 13(3) and (4) of the 1948 Income Tax Act, effective for the 1949 taxation year. Those provisions are substantially the same as the current section 31, except that the maximum amount of the restriction was $5,000.
[35] Read in the context of the 1948 Income Tax Act, the original version of the farm loss restriction was a relieving provision. Before the enactment of the original version of the farm loss restriction, a taxpayer who suffered a farming loss but whose chief source of income was not farming (or a combination of farming and something else) would be entitled to no tax relief for the farm losses because of the general loss restriction in subsection 13(1) and (2). However, once subsections 13(3) and (4) were enacted, that same taxpayer would be entitled to claim farming losses to a maximum of $5,000.
[36] The relieving nature of the original farm loss restriction was explained in a speech made in Parliament by the then Minister of Finance, The Honourable Douglas Abbott (House of Commons Debates, 4th session, 21st Parliament, Volume V, June 13, 1951, at page 4054; quoted in Morrissey v. Canada (C.A.), [1989] 2 F.C. 418 at page 423):
[T]his section is intended to give some measure of relief to those who may be colloquially known as gentlemen farmers, whose principal occupation is not farming. Again this confirms what was a practice over a great many years, during which the income tax branch allowed 50 per cent of the cash losses incurred in this type of farming; secondary income; and by cash losses it meant without charging depreciation. It was a rule which as it developed, probably was not strictly justified under the act. We had a great many representations that the practice which had existed for many years, I believe going back to the early twenties, should be maintained. It was felt that it would not be appropriate to do so without any limit, because some might run very elaborate farms with very large losses in fancy horses and that sort of thing. Probably it would not be fair to allow such losses without limit, so the present section was inserted fixing a limit of $5,000.
[37] The general loss restriction in subsections 13(1) and (2) was repealed by S.C. 1952, c. 29, section 4, effective for the 1952 taxation year. However, the farm loss restriction remained, and it remains still (except for the occasional change in the formula by which the amount of the restriction is determined).
[38] The only explanation I can find for the 1952 amendment is in an exchange in Parliament (House of Commons Debates, 6th session, 21st Parliament, Volume III, May 27, 1952, at page 2626ff; quoted in Morrissey, cited above, at page 424-5)). Mr. Abbott, the then Minister of Finance, said that the general loss restriction was no longer needed, but the more specific farm loss restriction was needed to deal with the problem of “gentleman farmers” who never make money from their farms, but claim their losses for tax purposes. The meaning of the term “gentleman farmers” is not clear, but one Member of Parliament referred to them as people who “make their money in the city and lose it in the country.” In my view, it remains unclear why the farmers who had been singled out for special relief in 1949 were subjected, in 1952, to a more onerous tax burden than the operators of other kinds of business.
[39] In 1966, The Royal Commission on Taxation, known as the Carter Commission, published an extensive and detailed report on income and sales tax reform. The question of farm losses was a minor aspect of the report (three pages out of a seven volume report). The Carter Commission accepted that in principle, the deduction of a farm loss should not be permitted in the case of a farm maintained primarily as a hobby or for personal rather than business purposes, but the Commission recommended that the vague test in section 13 be replaced with a bright line test, such as a maximum lifetime limit on farm losses, or the disallowance of all losses from a farm that showed a loss in three years out of five. Those recommendations were not accepted.
[40] The federal government’s response to the Carter Commission Report was a White Paper entitled “Proposal for Tax Reform”, published in 1969 by then Minister of Finance E. Benson. The 1969 White Paper had little to say about section 13. The following appears at page 69 of the 1969 White Paper:
5.52. Section 13 of the Income Tax Act limits the deductibility for income tax purposes of losses suffered on the operation of what are commonly referred to as “hobby farms”. A taxpayer who is not primarily a farmer can deduct only $5,000 of farming losses annually from his other income – all of the first $2,500 and half of the next $5,000.
5.53. Because this provision is intended to prohibit the deduction of personal expenses from taxable income, it would remain in the Act under the new system. A taxpayer would, however, be allowed to reduce these non-deductible losses by capitalizing property taxes on the farm and interest paid on loans related to the purchase of the farm. This procedure would reduce the capital gain taxed on the sale of the farm, but it would not be allowed to increase the capital loss that may be deducted.
[41] Item 5.53 of the 1969 White Paper suggests that the purpose of the restriction on farm losses in section 13 was to prohibit the deduction of hobby farm losses, which is equated to the notion of the prohibition on the deduction of personal expenses. That suggests to me that the term “hobby farm” was used to denote a farming operation carried on for personal or social purposes, rather than as a business. In my view, this reflects a misapprehension of the purpose of section 13; that misapprehension was corrected by Justice Dickson in Moldowan v. R., [1978] 1 S.C.R. 480 (this is discussed in more detail below).
[42] In 1972, a new income tax law was enacted as the result of the 1969 White Paper: Income Tax Act, S.C. 1970-71-72, c. 63. That statute enacted major tax reforms including the introduction of the capital gains tax. What had been section 13 of the 1948 Income Tax Act became section 31 of the 1972 Income Tax Act, with no changes. The suggestion in Item 5.53 of the 1969 White Paper for a capital gain adjustment for property taxes and interest incurred to acquire farm land was accepted, and it remains part of the current Income Tax Act. Since 1972, there have no substantial changes to the statutory tests for the application of section 31.
[43] The legislative history outlined above demonstrates little more than this: originally, the determination of whether a farmer was subject to a loss limitation was a matter of unfettered Ministerial discretion, but it is now a statutory test with no explicit statutory guidelines.
[44] Nothing in the legislative history helps to explain the meaning of the phrase “chief source of income”, or the manner in which the combination question should be addressed. References in the Parliamentary debates to “gentlemen farmers”, or to those “make their money in the city and lose it in the country”, are not helpful in elucidating the statutory test. Neither is the reference to “hobby farmers” in the 1969 White Paper.
(c) Purpose of section 31
[45] To the extent that the purpose of a tax provision is determined by its effect, it could be said that the purpose of section 31 is to preclude certain farmers from claiming tax relief for farming losses in excess of a statutory threshold (currently $8,750). But why are some farmers chosen for this particular tax burden, and not others?
[46] In 1944, Heward Stikeman, then the Assistant Deputy Minister of the Department of National Revenue, made some comments on the general loss restriction in section 10 of the Income War Tax Act (Special Lectures of the Law Society of Upper Canada on Taxation, published by Richard De Boo Limited, 1944, at pages 121-124). The title of his lecture was “Transactions to Avoid or Minimize Tax”. Mr. Stikeman offered the following explanation for the existence of section 10:
An example of this would be the case of an individual who maintained an active manufacturing business and at the same time operated a dairy farm. It might be that both activities were carried on equally for profit, yet the one can clearly be said to be the principal occupation and the other a secondary occupation. In such a case the taxpayer could not be permitted to charge his farm losses against the profits from his manufacturing business since they did not bear any direct relationship to the latter, nor were they properly incurred to earn them.
[47] This explanation suggests that, for the purposes of section 10 of the Income War Tax Act, two activities would not be “combined” to comprise a taxpayer’s “chief position, occupation, trade, business or calling” unless they were directly related, or the expenses of one were incurred to earn the income of the other. That explanation is not particularly satisfactory. First, if either of those conditions were met, it is arguable that there would be one enterprise, not two. Second, this explanation ignores the 1923 amendment to the statutory predecessor to section 10, which removed the test of “connectedness” in the determination of a whether a taxpayer’s chief source of income was a “combination” of two or more sources.
[48] Mr. Stikeman goes on to suggest that section 10 could also apply to solve the problem of “gentleman farmers.” On that point, he says:
In the United States, somewhat the same problems arise in connection with gentleman farmers. It should be noted, however, that there is no provision similar to section 10 in the United States Tax Laws. There the decided cases indicated that the bona fide intention to run a farm at a profit cannot be denied by the fact that the farm is actually run at a loss. This of course presupposes sufficient surrounding facts and circumstances to establish the bona fides of the intention.
[…]
Finally, the American jurisprudence is effectively summed up by Smith, J., in the case of Marshall Field v. Commissioner of Internal Revenue, 26 U.S.B.T.A. at page 123.
“From a consideration of all of them (the cases) we reached the conclusion that the intention of the taxpayer with respect to the operation of the farm is material. . . . If the taxpayer operates a farm with the intention of making a profit and not merely as a place of pleasure, exhibition and social diversion, the fact that losses may be sustained from the operation of the farm does not change the character of the enterprise from one operated for profit to one not operated for profit.”
[49] It is not clear what Mr. Stikeman meant by the phrase “gentlemen farmers.” It would appear that when Mr. Stikeman made these remarks in 1944, there was some concern that, but for section 10 of the Income War Tax Act or an equivalent provision, the expenses incurred in pursing a hobby or other activity undertaken for “pleasure, exhibition and social diversion” might be deductible for income tax purposes, despite the lack of profit motive from such an activity. The same concern underlies the comments in the 1969 White Paper, quoted above.
[50] In 1977, that concern was found to have no foundation. In that year, it was established by Moldowan (cited above), that even without a provision like section 10 of the Income War Tax Act (or section 31 of the current Income Tax Act), a farm loss is not deductible unless the farming activity constitutes a business. The following appears in the judgment of Justice Dickson, writing for the Supreme Court of Canada in Moldowan at page 485 (emphasis added):
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: Dorfman v. M.N.R. [[1972] C.T.C. 151.] See also s. 139(1)(ae) of the Income Tax Act which includes as "personal and living expenses" and therefore not deductible for tax purposes, the expenses of properties maintained by the taxpayer for his own use and benefit, and not maintained in connection with a business carried on for profit or with a reasonable expectation of profit. If the taxpayer in operating his farm is merely indulging in a hobby, with no reasonable expectation of profit, he is disentitled to claim any deduction at all in respect of expenses incurred.
[51] If Moldowan established in 1977 that section 31 was not needed to stop non-commercial farmers from claiming farm losses, why has section 31 remained in effect? Parliament apparently believes that section 31 serves some purpose. However, it seems to me that the intended target of section 31 was unclear in 1977 when Moldowan was decided, and it remains unclear.
[52] Generally, when a provision of the Income Tax Act imposes a tax disadvantage on one group of taxpayers and not others, the tax policy underlying the provision may be inferred from the statutory conditions for its application. The distinction between farmers who are burdened by section 31, and those who are not, is based on a comparison between the economic characteristics of the farming business and the farmer’s other taxable activities. What that may disclose about the tax policy underlying section 31, the meaning of the phrase “chief source of income”, or the problem of how to answer the combination question, however, remains obscure.
[53] There has been considerable judicial criticism of section 31, beginning with Justice Dickson in Moldowan (cited above), who referred to it as “an awkwardly worded and intractable section and the source of much debate”. See also the comments of Justice Marceau in his dissenting reasons in The Queen v. Graham, [1985] 2 F.C. 107 (at page 113 and following), as well as the comments of Justice Mahoney in Morrissey (cited above) at page 430, and Associate Chief Justice Jerome in Poirier (Estate of) v. Canada, [1986] 1 C.T.C. 308, 86 D.T.C. 6124 (F.C.T.D.). Most recently Justice Sexton, speaking for this Court in an oral judgment in Watt v. Canada, 2001 FCA 72, said this (at paragraph 15):
While we feel bound by the authorities in this Court to dismiss this appeal, we cannot help but note the many section 31 cases being brought before the Tax Court and this Court producing sometimes conflicting results. Despite the appearance of unfairness in some of those cases, where a taxpayer with a well-paying job is also seriously involved in unprofitable farming but not a “hobby farm”, Parliament has not re-examined this provision which Justice Dickson in 1977 described as an “awkwardly worded and intractable section”. Nor has the Supreme Court of Canada revisited this problem since 1977. Perhaps it is time to amend or at least clarify this provision to make it more suited to our time.
[54] After reviewing the authorities available to me, I have been able to find nothing that provides a satisfactory explanation for the existence of section 31 of the Income Tax Act. It would appear that in the past, some tax policy makers and tax policy advisers believed, incorrectly, that the statutory predecessors to section 31 were needed to control a particular form of tax abuse – treating the cost of a hobby farm (that is, a non-commercial farming activity undertaken solely for personal or social purposes) as a business loss. If the same flawed justification for section 31 survives to this day, there would be a cogent argument for a Parliamentary review of section 31. However, that is not an issue that can be resolved in this case, or by this Court.
(d) Jurisprudence
[55] Section 31 is one of the most litigated provisions in the Income Tax Act, but there are only a handful of cases that may be described as jurisprudential, as opposed to factual. The leading case on section 31 is Moldowan (cited above). Mr. Moldowan was appealing his income tax assessments for 1968 and 1969 on the basis that section 13 of the Income Tax Act (the statutory predecessor to section 31) did not apply to him. During the years 1960 to 1972, Mr. Moldowan had the following income and losses:
Year
Employment
($)
Investment
($)
Business
($)
Farming
($)
Rental
($)
1960
11,500
-0-
-0-
(1,213)
2,700
1961
15,600
-0-
-0-
(2,235)
(872)
1962
15,600
300
-0-
(1,718)
(750)
1963
15,900
39
-0-
1,593
(1,131)
1964
16,200
38
-0-
1,369
-0-
1965
15,900
1,364
-0-
(1,684)
-0-
1966
15,900
1,194
-0-
(885)
-0-
1967
13,500
1,625
-0-
(8,505)
-0-
1968
1,750
8,822
12,500
(21,907)
-0-
1969
17,833
17,049
-0-
(20,811)
-0-
1970
17,309
19,920
(914)
(7,536)
-0-
1971
6,607
7,657
17,416
(7,539)
-0-
1972
22,306
13,385
-0-
(4,038)
(312)
[56] During the years 1960 to 1967, Mr. Moldowan owned and was employed by Active Trading Ltd., a scrap company. His employment income during that period came from that company. In 1967 he sold that company and started Cascade News Ltd., which carried on the business of distributing racing forms. He received dividends from that company (investment income). In 1968 he started a manufacturing company, Cascade Fasteners Ltd., from which he earned a salary.
[57] Beginning in the early 1960’s, Mr. Moldowan was actively engaged in training, boarding and racing horses on his own behalf and for others. He leased land near a racetrack on which was located a house occupied by his trainer, three paddocks and horse stalls. Between 1962 and 1969, he bought 53 horses at a total cost of over $180,000, and sold horses to the value of approximately $121,000. He raced horses in Canada and the United States, winning purses totalling over $180,000. After 1964 he sustained losses from his horse racing activities, which peaked in 1968 and 1969. Thereafter he reduced his farming activities and disposed of almost all of his horses.
[58] Justice Dickson, writing for the Supreme Court of Canada, analyzed former section 13 in some detail. His decision is most often cited for his categorization of all farmers into three classes: Class 1 farmers – those whose farming activities comprise a business and who are entitled to claim all of their farming losses because section 31 does not apply to them; Class 2 farmers – those whose farming activities comprise a business but who are not entitled to claim all of their farming losses because section 31 applies to them; and Class 3 farmers – those whose farming activities do not comprise a business at all, and who therefore are entitled to