Date: 19990122
Docket: 96-4750-IT-G
BETWEEN:
GESTION JEAN-PIERRE RUEL INC.,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
Appeal heard on May 26 and 27, 1998, at Québec, Quebec, by the Honourable Judge Alain Tardif
Reasons for judgment
Tardif, J.T.C.C.
[1] These are appeals for the 1990, 1991 and 1992 taxation years.
[2] The issue is whether the deduction of the farm losses incurred by the appellant during each of those years is restricted by subsection 31(1) of the Income Tax Act (“the Act”), as determined by the Minister of National Revenue (“the Minister”). That provision states that the restriction applies “[w]here 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”.
[3] What must be decided is whether the appellant, Gestion Jean-Pierre Ruel Inc., was entitled to deduct all the losses it incurred during the above-mentioned
taxation years, namely $175,684, $130,600 and $102,121, or basically the maximum amount for each of those years under section 31 of the Act.
[4] The appellant was incorporated by Jean-Pierre Ruel on October 21, 1982; at that time, its firm name was Les Écuries de Tilly Inc. Mr. Ruel has always been the company’s majority shareholder and sole manager.
[5] Jean-Pierre Ruel, who is still the majority shareholder and sole manager of the appellant company, testified at length in support of the appeal. His testimony indicated that, over the years, he had acquired a solid reputation in the real estate field as a result of having carried out a number of significant projects.
[6] He was the guiding spirit in a family that was involved in impressive construction projects in the Québec area. He and his family did remarkably well in real estate. To achieve such success, Mr. Ruel had to be intensely involved on a sustained basis and totally committed over many years.
[7] As a real estate developer, he handled mainly the management, financing and legal organization and structuring of projects; he was especially involved in making the financial and legal arrangements for projects, and was also responsible for dealing with various government authorities.
[8] The other members of his family were more involved in the practical and concrete execution of projects.
[9] Mr. Ruel said that, after a brilliant career in real estate and after building up considerable financial security for himself, he decided to change careers in 1984.
[10] However, he did not give up real estate altogether and retained some of his investments and interests in specific projects; he testified that his involvement was limited to occasional selective attendance at various partners’ meetings and other meetings dealing with the organization and management of certain projects. He stated that he was very selective in choosing the projects to which he continued to make a partial contribution.
[11] To illustrate how he was involved for the most part, he indicated that he attended some meetings having to do with the proper functioning of investments; another example he gave was that he countersigned, at the request of the financial backers, who saw this as a form of enhanced control, cheques related to the execution of projects.
[12] Overall, Jean-Pierre Ruel clearly stated that his interest in real estate declined considerably following his career change. That loss of interest was characterized mainly by a major decrease in the time he had always devoted to real estate. He spent a good part of his testimony illustrating and expanding on the fact that the new business was by far his main occupation and that he devoted himself to it almost completely during the years at issue.
[13] Mr. Ruel asserted that, after that change of course in his career, his availability was much greater and he had a great deal of time to devote to the new direction he had taken. He vigorously maintained that his new career was full-time work.
[14] Given the nature of his work as a real estate contractor, it was difficult if not impossible to put a figure on his claims in terms of hours or percentage as is often done by appellants working in fields such as medicine or other fields where a day planner is used and makes it possible to determine exactly how much time they had available.
[15] To show his very great interest in horses, Mr. Ruel also reviewed the path he had taken.
[16] He began by saying that he bought a country house in the early 1980s for $125,000. At the time, it was a second home that was intended to enable the Ruel family to enjoy itself in an environment that was healthy, quiet and close to nature.
[17] The Ruel family thus owned a farm made up of land, a home and a cottage. The Ruels had riding horses but put an end to that after Mr. Ruel’s spouse had a riding accident. Following that accident and the calling into question of his career in real estate, Mr. Ruel decided to sell the second home and everything associated therewith to the appellant, which had been incorporated on October 21, 1982.
[18] From 1984 on, time and capital were invested in the appellant to make it quite a different organization. The immovable was also transferred to it for $125,000, the amount paid a few years earlier. Following that acquisition, some buildings were put up, others were altered or enlarged and a real track was set up to train racehorses.
[19] Mr. Ruel is very interested in racehorses and devotes himself to them by investing time, energy and resources. He is involved in everything having to do with racehorses. He buys, sells and trains horses and very regularly takes part in races on various tracks in Quebec. He is involved with a number of organizations whose purpose is to promote the development of the racehorse industry.
[20] The farming business’s activities also included breeding and looking after racehorses; it rented box stalls to other horse owners, thus generating income called “boarding income”.
[21] Along with farming, the company took care of Mr. Ruel’s investments. Starting in 1984, and during the years at issue, the appellant’s income came from various sources, namely participation in horse races, payments for boarding and looking after horses, rental income, interest from investments and dividends.
[22] The substantial income from interest on investments and the dividends subsidized the losses generated by the business’s farming activities, namely $175,684, $130,600 and $102,121, respectively, during the years at issue.
[23] The appellant argued that it was entitled to deduct all its losses for the years at issue. It stressed the following points, inter alia:
· the significant amount of time spent on farming activities
· the large amount of capital committed
· the major, radical change in Jean-Claude Ruel’s work habits and lifestyle
· potential profitability
[24] In support of its arguments, the appellant referred to the many cases that follow:
Moldowan v. The Queen, 77 DTC 5213
Van Straubenzee v. M.N.R., 81 DTC 552
Kasper v. The Queen, 82 DTC 6148
Mairleitner v. M.N.R., 84 DTC 1426
Astroff v. M.N.R., 84 DTC 1689
Hadley v. The Queen, 85 DTC 5058
Juravinski v. M.N.R., 86 DTC 1274
Gray v. M.N.R., 88 DTC 1520
The Queen v. Morrissey, 89 DTC 5080
Mohl v. The Queen, 89 DTC 5236
Twigg v. M.N.R., 91 DTC 1059
The Queen v. Roney, 91 DTC 5148
Moauro v. M.N.R., 92 DTC 1071
Connell v. The Queen, 92 DTC 6134
The Queen v. Wylie, 92 DTC 6294
The Queen v. Poirier, 92 DTC 6335
Hover v. M.N.R., 93 DTC 98
The Queen v. ICHI Canada Limited, 95 DTC 5384
Felicella et al. v. The Queen, 95 DTC 402
[25] The appellant also referred to Interpretation Bulletin No. IT-322R dated October 25, 1978, which concerns farm losses.
[26] As regards the time spent on farming, the evidence did show that Mr. Ruel made a real change in his use of his time but the respondent argued that a distinction had to be drawn between how Mr. Ruel spent his time personally and the role of the appellant company, which did not change its ways at all and a very large part of whose role involved looking after Mr. Ruel’s investments. Farming was thus a kind of add-on.
[27] As regards the capital committed, despite the respondent’s comments and submissions, it is my view that it was significant, especially since the significance of the capital committed must be a function of the farming activities involved; I do not think that excessive investments necessarily contribute to the quality of such an endeavour. However, where the capital committed by the appellant loses some of its significance and relevance is when it is compared with the other part of the combination, since the income-generating investments were substantial.
[28] From the outset, the respondent admitted that the appellant had a reasonable expectation of profit and was therefore operating a business.
[29] Although the Court greatly appreciated the quality of the research and work done by counsel for the appellant, it must point out the aptness of the Honourable Judge Pierre Dussault’s statement in Henderson v. The Queen, 98 DTC 1904, at page 1909 (English version: TCC Nos. 95-1134(IT)G and 96-2494(IT)G, May 7, 1998, at page 11):
[36] At the outset, I would say that applying well-defined rules is likely to produce a more satisfactory conclusion than simply comparing the appellant’s situation with that of other taxpayers, since it is always possible to find inconsistencies which make comparisons awkward.
[30] However, the evidence was much less clear on the issue of actual or potential profitability. In other words, did the evidence show that the income produced by farming might ultimately constitute profits that could measure up to the income from other sources?
[31] If the appellant could not expect such large profits, was it possible, realistic and reasonable to expect that the income generated could suffice to simply ensure the survival of the farming operation? In other words, did the evidence show that the farming activities might ultimately simply break even? I do not think so. The appellant attached great importance to the capital committed; although that is admittedly a significant factor, it is not conclusive in itself.
[32] Accepting such an interpretation would mean that a very affluent or rich person would definitely be favoured by this criterion, which is why I consider it necessary to look at the matter of capital committed as one component and one that might serve to complete or even enhance the whole of the available facts.
[33] Moreover, the many decisions on this issue have often pointed out that the famous tests set out in Moldowan must be assessed as a whole. They are cumulative and interdependent. Appellate courts have repeatedly stated that all the factors must be assessed cumulatively and not disjunctively.
[34] The test of the time and energy devoted to farming is just as difficult to assess, since it is easy to imagine situations in which the owner of a large farming operation would spend time only on management; this might occur for many reasons, ranging from physical disability to a lack of knowledge about some kinds of work that are nevertheless essential.
[35] The time spent and the capital committed are also components of the “major preoccupation” concept defined by the courts. This concept encompasses both the question of the time spent and that of the capital committed while at the same time allowing all the relevant facts to be relativized based on the distinctive characteristics of the taxpayer concerned.
[36] Can it be concluded from the evidence as a whole that the prescribed requirements for the deductibility of the full amount of farm losses were met during the years at issue?
[37] First of all, it is essential to refer to the case law, which has clarified a number of points over the years.
[38] Robertson J.A. of the Federal Court of Appeal made the importance of this question very clear when he stated the following in Her Majesty the Queen v. Andrew Donnelly (A-604-93, October 15, 1997):
Though it has been 20 years since Moldowan v. The Queen, [1978] 1 S.C.R. 480 was decided, we continue to hear appeals involving taxpayers who earn their income in the city and lose it in the country. In this appeal, the respondent taxpayer, a medical practitioner, sought to deduct from his professional income the full amount of farming losses incurred in the 1986, 1987 and 1988 taxation years. According to Moldowan, the taxpayer must satisfy two tests in order to succeed. First, he must establish that the farming operation gave rise to a “reasonable expectation of profit” and, second, that his “chief source of income” is farming (the so-called “full-time” farmer). If the taxpayer is unable to satisfy the first test no losses are deductible (the so-called “hobby” farmer). If he satisfies the first test but not the second then a restricted farm loss of $5,000 (now $8,500) is imposed under section 31 of the Income Tax Act (the so-called “part-time” farmer).
[39] Since the financial performance of the farming activities is of great importance, I consider it relevant to reproduce, as an appendix to this judgment, the descriptive tables appended to the Reply to the Notice of Appeal. While one may not necessarily draw any conclusions based on the information in those tables showing substantial and repeated losses, that information certainly gives rise to an obligation to provide a reasonable and plausible explanation to support the likelihood of eventual profitability.
[40] Any sensible businessman who is concerned about profitability and wants to make a business, including a farming business, profitable will ask himself questions; he will call into question the future of his business, especially if it is continually incurring substantial losses.
[41] That standing back, that questioning and that repositioning generally involve input by experts, the hiring of consultants, the streamlining of operations and the addition or reduction of certain activities.
[42] In other words, a business that systematically incurs substantial financial losses must ask itself some questions about its objectives and how to attain them. A business in which a combination of activities basically gives rise to significant, cumulative losses over several years must certainly ask itself questions, for otherwise there arises a kind of presumption that viability is not the ultimate objective. This is all the more relevant if the role of the business concerned corresponds to an activity that for many individuals is a leisure activity, a pastime or an amusement, and not their bread and butter.
[43] On this issue of a business’s nature or role, Linden J.A. of the Federal Court of Appeal provides invaluable assistance in Tonn et al. v. Her Majesty the Queen, 96 DTC 6001 et seq.
[44] He wrote the following at page 6008:
. . . The Moldowan test is stricter than the business purpose tests set out in subsection 9(1) and paragraph 18(1)(a). As mentioned above, these tests stipulate that a taxpayer be subjectively motivated by profit when incurring an expenditure. The Moldowan test, however, also requires the presence of a profit motive, but, in addition, it must be objectively reasonable. In reality, in most situations, the objective Moldowan test and the subjective statutory tests will not yield many different results. A subjective intention is often determined by what may be reasonably inferred from the circumstances. Someone who claims a subjective intention that is foolish may not be believed. A taxpayer’s intention to produce profit normally has to be reasonable before a Court will accept it.
[45] Linden J.A. continued as follows at pages 6009-10:
A closer look at this jurisprudence will illustrate that this is the approach now taken in most of the cases. The cases in which the “reasonable expectation of profit” test is employed can be placed into two groups. One group is comprised of the cases where the impugned activity has a strong personal element. These are the personal benefit and hobby type cases where a taxpayer has invested money into an activity from which that taxpayer derives personal satisfaction or psychological benefit. Such activities have included horse farms, Hawaii and Florida condominium rentals, ski chalet rentals, yacht operations, dog kennel operations, and so forth. Though these activities may in some ways be operated as businesses, the cases have generally found the main goal to be personal. Any desire for profit in such contexts is no more than a “pious wish” or “fanciful dream”. It is only a secondary motive for having set out on the venture. What is really going on here is that the taxpayer is seeking a tax subsidy by deducting the cost of what, in reality, is a personal expenditure.
[46] The judge wrote the following at page 6011:
The other group of cases consists of situations where the taxpayer’s motive for the activity lacks any element of personal benefit, and where the activity cannot be classified as a hobby. The activity, in these cases, seems to be operated in a commercial fashion and not as a veiled form of personal recreation. Usually these deductions are not challenged by the Department, and, therefore, they do not get appealed and are not reported very often in the law reports. The Courts still have a role, however, in deciding whether there exist less apparent factors which might suggest a different conclusion in cases such as these. The Courts are less likely to disallow these expenses, but they do so in appropriate circumstances.
[47] The following can be found at page 6012:
When the cases are categorized into two groups as above, one cannot help observing that the hobby and personal benefit cases are rarely decided in the taxpayer’s favour. In contrast, where the activity is purely commercial, they rarely are challenged. If they are the Courts have been reluctant to second-guess the taxpayers, with the benefit of the doubt being given to them. I also note that in terms of sheer numbers, the hobby/personal-benefit cases vastly outnumber those of the commercial activity variety, which are quite rare, indicating that taxpayers are challenged less often in such situations.
The primary use of Moldowan as an objective test, therefore, is the prevention of inappropriate reductions in tax; it is not intended as a vehicle for the wholesale judicial second-guessing of business judgments. A note of caution must be sounded for instances where the test is applied to commercial operations. Errors in business judgment, unless the Act stipulates otherwise, do not prohibit one from claiming deductions for losses arising from those errors. This point was stated strongly by Sheldon Silver . . . .
[48] Linden J.A. added at page 6013:
Though I do not support the use in the Nichol case of the word “patently,” I otherwise agree that the Moldowan test should be applied sparingly where a taxpayer’s “business judgment” is involved, where no personal element is in evidence, and where the extent of the deductions claimed are not on their face questionable. However, where circumstances suggest that a personal or other-than-business motivation existed, or where the expectation of profit was so unreasonable as to raise a suspicion, the taxpayer will be called upon to justify objectively that the operation was in fact a business. Suspicious circumstances, therefore, will more often lead to closer scrutiny than those that are in no way suspect. (Emphasis added.)
[49] At page 6014, Linden J.A. indicated that losses may be incurred for a number of years until the project becomes profitable. In the case at bar, has the appellant shown that its project was likely to become profitable? The evidence demonstrated that the appellant wished, hoped or dreamed the venture would be profitable. But has it been proved that its decisions were made as part of a rational process entirely divorced from personal interests and characterized solely by absolute administrative rigour?
[50] Linden J.A. stated the following at page 6015:
. . . The evidence clearly showed that the taxpayers engaged themselves in a business enterprise and their expectations of profit were not unreasonable in the circumstances. A small rental business was launched without the aid of sophisticated market analysis at a time when the rental market looked promising. Soon after, as a result of unforeseen circumstances, it became precarious. No personal benefit accrued to the taxpayers by the rental arrangements. The property was not a vacation site. The house was not used to give free or subsidized housing to relatives or friends. They made an honest error in judgment and lost money instead of earning it. It is not for the Department (or the Court) to penalize them for this, using the reasonable expectation of profit test, without giving the enterprise a reasonable length of time to prove itself capable of yielding profits.
[51] In light of the case law, the appellant had to show on the balance of evidence that there was an explanation for the losses, that corrective action was taken and, finally, that the activities were judiciously monitored thereafter.
[52] The farming activities were not structured but were engaged in without a specific goal or objective, aside from the intuitive hope that one day things would or should improve; this shows a certain lack of seriousness and is inconsistent with the parameters set out in the case law.
[53] In this regard, the Honourable Judge Pierre Dussault of this Court stated the following in Henderson,supra, at page 1910 (English version, at page 14):
[42] In any case, it is really on the crucial question of potential profitability that, here again, as in many other cases, the evidence is below the critical threshold. Bearing in mind the amount of money invested by the appellant, which I repeat exceeded $900,000, one cannot help being surprised to find that in 1993 the appellant himself was hoping to get a gross annual income of $50,000 from his operation when it reached maturity. At the hearing, he said several times that his objective was an annual net income of $30,000. This is where farming cannot be favourably compared with the appellant’s other sources of income, in particular engineering, as his chief source of income. Anticipating or hoping for a net income of $30,000 after investing over $900,000 amounts to anticipating a return of less than three percent on the capital invested, and this could never be regarded as what was referred to as “substantial” or even “reasonable” profits from farming, contrary to what counsel for the appellant argued. Moreover, this $30,000 net income was not even anticipated in 1993. Although Mr. Boutet’s testimony was favourable to the appellant, it must be noted that he did not suggest a figure on the question of profitability. It should also be noted that he was not consulted until 1996, for the specific purpose of helping the appellant make raising livestock his chief source of income and attempting to make the operation profitable. In any case, this is not exactly what could be called relevant evidence in establishing the situation in 1989 to 1993.
[54] In Her Majesty the Queen v. Andrew Donnelly (A-604-93), Robertson J.A., rendering judgment for the Federal Court of Appeal, provided a concise summary of the analytical principles set out in previous decisions to which the respondent has referred.
[55] Robertson J.A. stated the following:
[8] 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. Were the law otherwise there would be no basis on which the Tax Court could make a comparison between the relative amounts expected to be earned from farming and the other income source, as required by section 31 of the Act. The extent to which the evidential burden regarding the profitability factor or test differs from the one governing the reasonable expectation of profit requirement is a matter which I will address more fully below.
(Emphasis added.)
A little further on, he added:
[12] 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.
[56] It is certainly important that a taxpayer involved in a farming operation devote time, energy, capital and knowledge to that operation in order to achieve positive results for his or her business, with a reasonable and probable hope of ultimate profitability.
[57] A business often incurs losses for reasons over which it has no influence or control; this is especially true in farming, where there are many imponderables. I am referring, inter alia, to production shortfalls and surpluses, which have a direct effect on the prices that make the difference between profits and losses.
[58] Production is also dependent on weather conditions, which can vary from region to region.
[59] These are factors that put farm producers in such a vulnerable position that they are obliged to organize themselves and impose contributions on themselves for the purpose of setting up various insurance programs, quota programs, co-operative programs for the purchase and sale of their inputs and outputs and all sorts of arrangements aimed at obtaining prices that take into account their production costs.
[60] These are examples or initiatives whose purpose is basically to achieve viability, stability and profitability so that farm producers can provide for themselves and their families through farming.
[61] To shield themselves from certain misfortunes and make their investments secure, some diversify their production to obtain extra income so that they can continue farming and protect themselves from the many uncertainties inherent therein. Obviously, the losses incurred by such businesses are rarely challenged.
[62] In the case at bar, the survival of the business was never that much of a concern, since the income generated by investments totally shielded it from any initiatives that might undermine its overall financial strength. That other source produced so much income that there was no need to worry about the farming operation. Was the fact that the business as a whole had positive results sufficient to justify a rather passive attitude toward the losses incurred by the farming activities? I do not think so, especially since the losses were repeated and very substantial.
[63] The evidence never demonstrated that the business could realistically expect to eventually earn profits. Admittedly, it was shown that significant prize money was paid to the winners of races, but is that a rational, probative and reasonable indication of potential profitability? Although it is obviously much more difficult to prepare plans or strategies in such a special field, I nevertheless think that a business for which profitability is the ultimate objective would set up a structure that could protect earnings and rationalize expenditures so as to reduce losses.
[64] It is quite clear that a business never likes incurring losses; on the contrary, its goal is to make profits. I readily agree that losses are never an end in themselves and that the long-term objective is undeniably always to make a profit. However, there are situations in which passion, pleasure, ambition or excitement distort the profit objective, especially where a lack of profits does not lead to a calling into question of the survival or continuation of the business.
[65] With respect to racehorses, the available information may not make it possible to develop strategies over which perfect control can be exercised, the reason being the omnipresent factor of good luck or bad luck.
[66] However, it is possible to put forward strategies that demonstrate a real intention to plan activities that can help the business improve its financial performance.
[67] Did the evidence show that there was such a concern? Did it show that the appellant was deeply concerned about the substantial and continual losses?
[68] The evidence basically indicated that Mr. Ruel was very passionate about the racehorse business. He invested large sums of money in it and devoted a major portion of his time to it; it was shown that he hoped to become the owner of a horse that would wipe out all or at least some of the losses. However, I do not think that the attainment of the ultimate profit objective can depend essentially on good luck or the absence of bad luck.
[69] The evidence—the burden of proof being on the appellant—did not show that the appellant had set up a structure that would enable it to meet its fixed costs so as to mitigate the losses incurred through its participation in races. Rather, the evidence showed that Mr. Ruel ran the business on the basis of intuition and the hope of finding “a great champion”. It was never demonstrated that the losses were a genuine concern or that concrete, well-defined corrective action had been proposed to eliminate or even reduce them.
[70] In this regard, the only explanation came from counsel for the appellant, who stated and repeated insistently and firmly that no one was indifferent to substantial losses. Given the structure of the appellant company, which effortlessly generated significant income, and given Mr. Ruel’s interest in and indeed passion for horses, it became essential for the appellant to show on the balance of evidence that farming was at once a major preoccupation and a business with real potential built on rational foundations.
[71] Not only did the evidence not show this, but it instead established that the business was much more concerned with looking for a champion than with its bread and butter. Despite colossal and repeated losses, the business never did any soul-searching. The losses were never a major concern, or at least that is what the evidence indicates.
[72] I understand and accept that the racehorse business is a very special one in which there are very special constraints. Is that a sufficient reason to base the entire matter of profitability on the chance of discovering and raising the famous horse that will win huge purses and bring in big money when it is ultimately sold? I do not think that the future of a business can be built essentially on the chance that “its day will come”, even if real effort is put into the business. Despite the time devoted and the capital committed to the farming part of the business, it is clear that the appellant was not very concerned about its financial performance, probably because of the substantial income from another source.
[73] I conclude that the appellant’s chief source of income during the years at issue was its investments; raising horses and participating in races were basically a secondary business.
[74] For these reasons, the appeal is dismissed with costs to the respondent.
Signed at Ottawa, Canada, this 22nd day of January 1999.
“Alain Tardif”
J.T.C.C.
[OFFICIAL ENGLISH TRANSLATION]
Translation certified true on this 30th day of September 1999.
Erich Klein, Revisor
APPENDIX A
[Omitted]