Papineau v. Canada (Minister of National Revenue - M.N.R.)
Joseph Papineau, Appellant,
v. The Minister of National Revenue, Respondent
 T.C.J. No. 552
 A.C.I. No 552
Action No. 90-460(IT)
Tax Court of Canada
Heard: April 22-23, 1991
Judgment: June 28, 1991
Income tax -- Deductions -- Farming losses -- Restricted farm loss -- Appellant employed as electrician while starting up farm -- Losses during start up period.
This was an appeal from a reassessment for income tax. The appellant was employed as a car electrician. In 1984 he purchased a farm on which he began to grow tomatoes and cucumbers. He experienced considerable losses in 1985 and 1986 due to poor climatic conditions and the loss of a canning contract due to the collapse of the market. He continued working, intending to quit once he was established over the next five years. He deducted his full farm losses in 1985 and 1986 but the Minister restricted those losses to $5,000 for both years under section 31(1) of the Income Tax Act.
HELD: The appeal was allowed. The appellant discharged the onus on him to show he was entitled to deduct the full farm losses as he fell within class I of a full-time farmer. While a quantum measurement of farm to non-farm income was important in determining if he was a full-time farmer, a capacity over a reasonable period of time to build farm income up to the point where non-farm income could be decreased was to be allowed for. The appellant's projections over the next five years were not unreasonable.
STATUTES, REGULATIONS AND RULES CITED:
Income Tax Act, S.C. 1970-71-72, c. 63, s. 31(1).
P.G. Colautti, Esq. and G. Campbell, Esq., for the Appellant.
David O'Brien, Esq., for the Respondent.
ROWE T.C.J.:-- The appellant appealed from a reassessment of income tax for his 1985 and 1986 taxation years. In computing his income for the 1985 and 1986 taxation years, the appellant sought to deduct losses, in respect of his farming operation in the amounts of $40,111.21 and $32,780.36 respectively. The respondent restricted the losses to $5,000 for both taxation years pursuant to subsection 31(1) of the Income Tax Act.
The appellant testified he is an electrician employed by Ford Motor Company Ltd. He apprenticed in his trade, obtained the necessary qualifications, and began working for Ford in 1976. His father-in-law owned a 100 acre farm and the appellant worked on it in 1969 and 1970 part-time and also was employed at a pickle canning factory during the summer months for three years. The plant also canned tomatoes and he had friends and acquaintances who operated tomato farms. Except for a maternal grandfather, he was not from a farming background but was interested in growing crops and felt it was a better way of life than spending 25 years in a foundry. In 1984 a farm came up for sale and he drew up a plan, spoke to some friends who were farmers, and talked to some bankers. He felt land prices were on the increase and wanted to buy before prices went too high. At the time he was working for Ford on the shift from 11:30 p.m. to 8:00 a.m. and as a machine a tool electrician in the casting plant at Windsor he was functioning primarily in the role of a troubleshooter. As a result he was called to attend to breakdowns and, if things ran smoothly, could sleep or use the time to read during the shift. On occasion, he would not be called to perform any electrical work at all during a shift but had to be available in case of need. He worked seven days a week but with the nature of the work was able to use the slack time to study and decided to use the time by taking courses in business farm management and tomato processing which were sponsored by the Ministry of Agriculture. He successfully completed both courses and received certificates which were filed as Exhibits A-4 and AS. His intention was to use his employment at Ford to provide money for his family and to plow farm profits back into the business over a five year period so that he could then live off the farm and leave his job. Since his teenage years he had always held more than one job at a time and intended to supplement farm income by working part-time as an independent electrician. Prior to purchasing his farm he ensured the soil was suitable for growing tomatoes and cucumbers and obtained contracts from a tomato and cucumber processing plant to purchase his crop, without which the Marketing Board would not permit sale of the produce. He was aware of a program administered by the Ontario Ministry of Agriculture and Food which was designed to assist new farmers. The Beginning Farmer Assistance Program or BFAP, was designed to assist individuals to become self-sufficient on farm income over a five year period by subsidizing interest costs. The appellant submitted the appropriate application forms to BFAP including a projected budget of costs, revenue, expected yields, and received approval for entry into the program. Filed as Exhibit A-6, the material submitted to BFAP was based on a five year projection and included comments on anticipated equipment purchases and the advantages and disadvantages of turning to mechanical harvesting as opposed to hand labour. The approval from BFAP for enrolment in the program came in the form of a letter dated March 15, 1984 (Exhibit A-7). The appellant proceeded to finalize his land purchase and by April 20, 1984 had 66.5 acres available to farm that season. The cost was $172,100. He owned two rental houses and put them up for collateral as well as his own residence. Prior to planting he had contracts in hand for the sale of produce and knew the price per tonne and the average yield anticipated based on statistics provided by the Agriculture Ministry. By using a mechanical harvester he anticipated a profit of $14,400 in 1984 and would earn about $50,000 from his job at Ford. In terms of projections for the 1985 farming season he used 25 acres of tomatoes as the basis for his calculations and also anticipated renting an additional 100 acres. He had received a loan from the Credit Union in the sum of $258,000 at 13 1/2 % interest in order to purchase the land and equipment but the effect of the BFAP approval would be to receive an interest rebate reducing the effective rate to 8.5%. Once BFAP approval had been obtained in March of 1984 he began to attend auction sales in his area and spent time telephoning various equipment dealers to check on availability and price of machinery. He would spend the day on farm activities, sleep from 7:00 p.m. to 11:00 p.m. and then go to work the midnight shift at the Ford plant. He was able to acquire a harvester for $18,000 which was a bargain but required some repair and maintenance which he performed himself. He purchased a sprayer for $850 and installed new accessories, gauges and booms to make it ready for use. He bought a tractor for $8,000 and did the necessary repairs. By the middle of 1985 he had purchased $55,000 worth of equipment, including another tractor, which was about $3,000 more than his anticipated costs. At this point together with the land, he had invested $255,000.
On April 22,1984 the appellant received his contract for tomatoes and began planting on May 6th. The land had to be worked and the beds prepared. He would begin work at 9:00 a.m. and continue until 7:30 p.m., sleep for three hours, get up and drive to work at Ford to perform his duties until 8:00 a.m. Then, he would return home, have breakfast, and begin work on the farm. He had in hand a contract for the purchase of 15 acres of tomatoes and another contract from a smaller canning factory. He seeded 11,000 tomato plants per acre and hired 10 employees to assist in the process. During the growing season he cultivated the land, sprayed the crop and also planted soya beans and corn. He applied the appropriate fertilizers, pesticides and herbicides. The harvest began in August and was about 75% completed when excessive rainfall flooded the field making it impossible to use the mechanical harvester. It was necessary to hire hand-pickers which resulted in increased costs and the quality of the produce was severely affected by the adverse weather conditions.
In 1985 he had a contract for the sale of 15 acres of tomatoes with a reasonable assurance another four acres of produce would be purchased. However, a drought early in the season required about 13 acres out of 19 to be replanted. Despite putting in long hours together with his wife and other family members, he had to hire extra labour in order to meet the planting deadline. In August it began to rain an excessive amount, significantly above the long-term average for the area, and the level of the lake adjoining his land rose and flooded the field. Again, mechanical harvesting was nearly impossible and pickers could not be found who were willing to work under the severe conditions. About 75% of the crop was left to be harvested and ultimately only nine acres out of 19 were taken off the field. The grade was affected and the cull rate jumped from 1-8% up to 11-26% which had a combined effect of decreasing revenue. The appellant discovered that part of his flooding problem was caused by a defective drain which was higher than the level of the lake. As a result he had to have the problem corrected in the spring of 1986 and the Municipality assessed him the majority of the cost which it put on his tax bill over a three year period.
In 1986, the appellant still had corn and beans standing in the field left over from the poor 1985 harvest. They were harvested in the spring of 1986 but were of poor quality and yielded revenue of less than $1,350. On April 16, 1986 he received a letter from the canning factory advising him that it no longer needed his services to provide tomatoes. He went to see the management of the factory seeking an explanation and was informed that other farmers in the area were shareholders and as such held an option, which they exercised, to force the canning factory to buy their tomatoes as opposed to purchasing from other producers such as the appellant who were regarded as junior producers. The appellant tried without success to obtain contracts from other canning factories but the tomato industry was being affected by the import of processed tomatoes from Italy at a price less than could be produced in Canada. Several canning factories closed down and growers, brokers and others in the industry suffered losses. The appellant also discovered pickle canning factories had shut down and he could not obtain contracts for his cucumbers. By the time he had been informed no tomato contract was available he had already prepared the beds and put all the machinery in condition ready for planting. Once he realized he could not rely on tomatoes or cucumbers he planted soya beans and attempted to line up custom work for his mechanical harvester. However, he was only able to earn less than $2,900 from that source as other growers were also not planting tomatoes and the established growers had their own equipment. In 1987 the appellant had to pay increased taxes to the municipality as a result of the repair to the drainage system the previous year and again planted corn and soya beans. At this point he realized it was not possible to obtain enough revenue from this crop and in 1988 and thereafter no longer claimed his full losses against his income but filed on the basis of claiming restricted losses.
In cross-examination, the appellant admitted he borrowed the entire purchase price of the land but was counting on the interest rebate from BFAP and the fact he paid the mortgage weekly from his electrician's income to reduce interest costs. He stated he used less than average yields in his area for the purpose of his projections and had reason to believe the canning factory would continue to give him contracts for his tomatoes as his cousin was an established shareholder in the enterprise. He agreed that from 1984 to 1989 his farming operation had lost a total of $156,794.76.
Gerald Fraser testified he operates a tax consulting and accounting service in Essex, Ontario. He holds a degree in Business Administration from the University of Windsor and articled for three years towards obtaining his Chartered Accountant's designation but did not complete the course. In 1974 he opened up his tax preparation office and over the years about 50% of his clients were farmers. On their behalf he prepares financial statements, profit and loss and revenue statements and tax returns. He is familiar with the tomato growing industry and relies on information provided by the Ministry of Agriculture and Food and the various programs instituted by that Ministry including compilation of annual averages of revenue and expenses for tomato farmers. Fraser met the appellant in 1984 and reviewed with him the budget that had been prepared for the application to Beginning Farmers Assistance Program - BFAP - and found the information contained therein to have been based on data issued by the Agriculture Ministry. The projected revenue of $595 per acre was reasonable and the other figures used in the budget (Exhibit A-1) were drawn from published statistics. In Fraser's opinion the machinery and equipment acquired by the appellant in 1984 and 1985 was suitable for the operation and was obtained at agreeable prices. There was excessive rainfall in the area in 1984 in the middle of harvest and the same situation resulted in 1985, after a spring drought, which was compounded by the appellant's drainage problem due to the high level of the lake. Fraser prepared a comparative statement of farm income and expense for the appellant's 1985 taxation year based on projected revenue and expenses calculated on average yields without the intervention of problems caused by the weather together with the actual figures of revenue and expenses as filed. The document (Exhibit A-3) indicated the actual revenue to have been $45,244 from soya beans, corn, tomatoes, farm subsidies and the interest rebate from BFAP. However, the early drought which led to replanting increased labour costs by more than $8,000 and an additional $5,300 was expended in purchasing replacement plants. Then, during harvesting season wet weather affected the yield and the quality and prevented the use of the mechanical harvester which in turn led to extra costs to hire hand-pickers; The yield from the tomato crop was only 48% of the projections which were based only on average yields for the area from published data. Instead of a profit of $9,130 before CCA, a loss of $26,772 resulted. The effect of CCA even if projections had been met would have resulted in a loss of $4,208. In 1986 the appellant's municipal tax bill increased dramatically to cover the costs of repairing the drainage problem and the contracts to sell tomatoes did not materialize. The switch to corn and soya beans together with reduced revenue from custom work reduced gross farming income to $28,454.01 while expenses were $61,234.37. The 1987 taxation year produced a loss of $18,261.65 and the loss was claimed on the basis the appellant was a full-time farmer. In 1988, the loss was $18,496.96 and Fraser advised the appellant to deduct the loss on a restricted basis, limited to $5,000. The restricted loss was again claimed when filing the 1989 return, a year in which the actual loss was $31,631.57.
Ronald Hendrick testified he is a Farm Management Specialist with Ontario Ministry of Agriculture and Food, stationed in Essex County. He has been so employed for 22 years, the last eight in Essex County, where the appellant has his farm. Hendrick is a graduate from the University of Guelph with a B.Sc. in Agriculture, majoring in crop science. The Ministry began BFAP in 1983 and it was designed to bring a new group of farmers into the agriculture industry by providing an interest rebate to lower the effective rate to about 8.5% and to provide an educational component in assisting new farmers to manage their business. A beginning farmer would first go to a lending institution with a proposal and if approved the lender was required to provide a five year fixed rate of interest. The lender was always at risk but the new farmer, if accepted by BFAP, and if ongoing qualifications were met, would receive an interest rebate cheque which could then be used to pay the lender. The appellant satisfactorily met the BFAP criteria of "bona fide farmer" which was a category designed for those individuals who either immediately, or within five years, could live off of farm income. The appellant's budget and projected revenue and expenses were reasonable which led to approval into BFAP on March 15, 1984. Inherent in the approval was that the appellant had met the criteria of a "viable farm" and the appellant maintained regular contact with the Ministry's office in Essex County and otherwise satisfied all of the continuing requirements throughout a five year period. In order for the interest rebate to be obtained a Certificate of Eligibility was required to be submitted in which the farmer certified the assets were on hand and also submitted a statement of income and expenses for the past year and cash flow projections for the next farming season. Sample documents were filed as Exhibit A-11 pertaining to the obtaining of the rebate. The Ministry had compiled data regarding various costs including the variation between hand-picking the crop and mechanical harvesting. It was reasonable for the appellant to have chosen the option of mechanical harvesting in order to save on labour costs. The rainfall figures for August of 1985 indicated a 66% increase in precipitation which made mechanical harvesting extremely difficult. In 1985 the average tomato farm in Essex County was 28.8 acres and by 1986 the appellant had projected devoting 30 acres to tomatoes. For BFAP purposes, CCA is treated as a non-cash expenditure and the interest rebate is not paid until the following year but is included into income for a current year for BFAP budgeting approval.
The jurisprudence in the area of farm losses is a well cultivated field, with the ground having been prepared by the Supreme Court of Canada in Moldowan v. The Queen,  C.T.C. 310. Then, the Federal Court of Appeal in Her Majesty the Queen v. Morrissey,  1 C.T.C. 235, reworked the soil. As a consequence, Strayer J. of the Federal Court Trial Division, in Mohl v. Her Majesty the Queen,  1 C.T.C. 425, was able to apply the resulting methodology and the extensive analysis done by him at trial in Morrissey to inspect the issue and arrive at the conclusion the taxpayer had produced nothing more than a sideline business.
In Moldowan, at p. 315 of the judgment of Dickson J. (as he then was) His Lordship stated:
"In my opinion, the Income Tax Act as a whole envisages three classes of farmers:
(1) A taxpayer for whom farming may reasonably be expected to provide the bulk of income or the centre of work routine. Such a taxpayer, who looks to farming for his livelihood, is free of the limitation of subsection 13(1) in those years in which he sustains a farming loss.
(2) The taxpayer who does not look to farming, or to farming and some subordinate source of income, for his livelihood but carried on farming as a sideline business. Such a taxpayer is entitled to the deductions spelled out in subsection 13(1) in respect of farming losses.
(3) The taxpayer who does not look to farming, or to farming and some subordinate source of income, for his livelihood and who carried on some farming activities as a hobby. The losses sustained by such a taxpayer on his non-business farming are not deductible in any amount.
The reference in subsection 13(1) to a taxpayer whose source of income is a combination of farming and some other source of income is a reference to class (1), it contemplates a man whose major preoccupation is farming, but it recognizes that such a man may have other pecuniary interests as well, such as income from investments, or income from a sideline employment or business. The section provides that these subsidiary interests will not place the taxpayer in class (2) and thereby limit the deductibility of any loss which may be suffered to $5,000. While a quantum measurement of farming income is relevant, it is not alone decisive. The test is again both relative and objective, and one may employ the criteria indicative of 'chief source' to distinguish whether or not the interest is auxiliary. A man who has farmed all of his life does not become disentitled to class (1) classification simply because he comes into an inheritance. On the other hand, a man who changes occupational direction and commits his energies and capital to farming as a main expectation of income is not disentitled to deduct the full impact of start-up costs."
In Morrissey, the taxpayer like the appellant in this appeal, had been granted the concession by the respondent that he was farming with a reasonable expectation of profit. As to the suitability of the taxpayer falling into the category of a Class 1 farmer, Mahoney J. at p. 242 stated:
"On a proper application of the test propounded in Moldowan, when as here, it is found that profitability is improbable notwithstanding all the time and capital the taxpayer is able and willing to devote to farming, the conclusion based on the civil burden of proof must be that farming is not a chief source of that taxpayer's income. To be income in the context of the Income Tax Act that which is received must be money or money's worth. Absent actual or potential profitability, farming cannot be a chief source of his income even though the admission that he was farming with a reasonable expectation of profit is tantamount to an admission which itself may not be borne out by the evidence, namely that it is at least a source of income."
In Mohl, at p. 428, Strayer J. stated:
"It now appears clear from the Supreme Court decision in Moldowan as recently interpreted by the Federal Court of Appeal in Her Majesty the Queen v. Morrissey, (1989) 1 C.T.C. 235; 89 D.T.C. 5080 that, for a person to claim that farming is a chief source of income, he must show not only a substantial commitment to it in terms of the time he spends and the capital invested, but also must demonstrate that there is a reasonable expectation of it being significantly profitable. I use the term 'significantly profitable' because it appears from the Morrissey decision that the quantum of expected profit cannot be ignored and I take this to mean that one must have regard to the relative amounts expected to be earned from farming and from other sources. Unless the amount reasonably expected to be earned from farming is substantial in relation to other sources of income then farming will at best be regarded as a sideline business to which the restriction on losses will apply in accordance with subsection 31(1)."
In 1985, 1986 and 1987 the appellant's employment income was $60,167.05, $61,366.45 and $64,452.78, respectively. The appellant's plan from the outset was to continue to work as an electrician for a five year period, during which the farm operation could be brought along, and then to quit his job at Ford and rely on farm income, in combination with other income earned as a part-time electrician, to provide for his family. The nature of his work and the seniority he had achieved, together with his capacity to operate for long periods of time with a few hours of sleep, permitted him to expend vast amounts of energy on the farm. There is no doubt on the evidence that the farm consumed the bulk of his time and energy and he was fortunate in having an occupation that permitted him to attend seven days a week and to earn a relatively high income without causing exhaustion or burnout. The issue as to whether or not the farm could reasonably have been significantly profitable requires an examination as to what the appellant did and what went wrong. The fact the Ministry of Agriculture and Food granted approval to the appellant to participate in the assistance program, BFAP, does not bind the Court to accept that opinion as qualifying, without more, the appellant to become a Class 1 farmer. However, it is significant evidence that professional moneylenders and the personnel in the Ministry in charge of administering BFAP, reviewed the appellant's net worth, experience, dedication, achievements, budgets and cash flow projections over a five year period and found the plan to be reasonable. For the most part the projected revenue and expenses were based on actual data compiled by the Ministry and the appellant, in terms of expected yield, used figures which were two tonnes below the average for his County. The farming operation was burdened by debt in that 100% of the land, equipment and start-up costs were financed. The effect of BFAP was to provide in the next year an interest rebate which, together with anticipated cash profits, could be applied on the mortgage. From employment income, the appellant was paying the loan off on a weekly basis to reduce the effect of the annual interest. The machinery and equipment purchases were prudent and good value for the dollar was obtained. His special skills as a tradesman came into play and he was able to repair, maintain, adapt and re-rig most of the necessary equipment at reduced cost. The farm was of average size for the County and the plan was to increase acreage by renting or additional purchase which did occur in 1986. Unlike most appellants in these cases, Papineau's work arrangement was such that he could expend energy and time on his farm without damaging his capacity to earn employment income.
The question then is: what went wrong. In 1984, the yield was poor due to excessive rainfall which damaged tomatoes and the other crops. Costs were increased, yields were less than reasonably anticipated according to the data, and a significant percentage was left in the field. In 1985, an early drought caused increased costs which may have been recouped except for a disastrous harvest due to excessive precipitation and flooding caused by a defective drainage system which was not readily observable until it occurred. By the spring of 1986 the drainage problem had been rectified by the Municipality, increasing the appellant's annual tax levy, but he was still in a position to recover and to produce significant revenue from the farm. Unfortunately, his contract to sell tomatoes and cucumbers did not materialize due to a downturn in the entire industry caused by the influx of cheap imports of tomatoes from Italy. Faced with this problem in April of 1986, after having readied the seed-beds for tomatoes, he had to switch to planting other crops whose yield could not generate enough revenue to cover expenses. The effect of the bad weather in 1984 and 1985 and the loss of any ability to market tomatoes in 1986 prevented any realization of the plan which had been formulated prior to beginning the farming business. The appellant had the ability to earn revenue from custom work for other farmers but the weather conditions in 1984 and 1985 were such that the machine bogged down in his field and, even accounting for the extra flooding by the drainage problem, neighbouring farmers were in the same boat. In 1986, the junior growers - probably most of whom were without mechanical harvesters - also lost their contracts to sell tomatoes and cucumbers as pickle canning factories also closed their doors.
There is no requirement in law in these cases for an individual to plod on until he drops, either as a wage-slave or in the pursuit of any given profession, trade or business. There is no requirement that the same levels of income be maintained throughout one's life. While quantum measurement of farm income to off-farm income is important, there must be a capacity over a reasonable period of time for the farm income to build to the point where the off-farm income can be eliminated or reduced. Depending on the occupation of a taxpayer, and taking into account the seasonal nature of most farming operations, off-farm income is nearly always going to be produced. At the same time, total income from all sources may be greatly reduced and a simpler, less expensive lifestyle pursued. The appellant, had everything gone according to plan over a five year period, would probably never have achieved the high level of income earned at Ford. But the evidence disclosed that prior to 1984 the appellant earned less than $30,000 and the higher incomes from 1984 through 1989 were based on increased plant production by Ford and the appellant's ability to work seven days a week. A reduction in plant production or a layoff would drastically affect the quantum of the off-farm income. The projections by the appellant, although not achieved, were not unreasonable. The turn of events from 1984 through 1986 was such that the plan became mortally wounded. That is a different matter than having been fatally flawed at the outset. The appellant throughout the years under appeal also owned rental properties which, perhaps, should have been sold and the funds applied on the farm debt. But, there would have been no point in following this course of action in 1986 as the whole operation to be viable depended on selling tomatoes and/or cucumbers. The yield from substitute crops was incapable of generating sufficient revenue to meet expenses, even by substantially reducing the interest component.
The application of hindsight is necessary but should be restricted to an objective examination of the facts known or ought to have been known and appreciated by the taxpayer. The average yields compiled by the Ministry obviously had factored in to them the effect of rainfall over a number of years. It is not appropriate, therefore, to conclude the appellant should have had the reserves in hand to ride out two consecutive disastrous years due to excessive rainfall, early drought, more heavy rainfall and flooding, and finally a near total collapse of the tomato growing industry. Ironically, the evidence showed that in 1990 rainfall at Leamington in September was more than double the long-term average and crops were left to rot due to the inability of mechanical harvesters to work the fields. It may be that new statistics are in order as from 1984 to 1990 excessive moisture affected three crops.
The appellant has satisfactorily discharged the onus placed upon him. The appeal is allowed. The respondent is directed to reassess the appellant for his 1985 and 1986 taxation years by allowing him to deduct the full farm losses as claimed. The appellant is entitled to costs on a party-party basis.