Judgments

A‑424‑05

2006 FCA 281

Douglas G. Gunn (Appellant)

v.

Her Majesty the Queen (Respondent)

Indexed as: Gunn v. Canada (F.C.A.)

Federal Court of Appeal, Sexton, Sharlow and Malone JJ.A.—Toronto, April 4; Ottawa, August 21, 2006.

Income Tax — Income Calculation — Farming — Appeal from Tax Court of Canada judgment dismissing appeal from reassessments made under Income Tax Act (Act) for 1997, 1998, 1999, in which s. 31 applied to limit farm loss deduction to $8,750 — Appellant building up law practice, farming business for over 30 years — Law practice relatively profitable whereas farming business resulting in operating losses — Appellant testifying farming resulted in connections enhancing profitability of law practice, unique synergy existing between two sources of income — Test for application of s. 31 involving principal question (whether farming chief source of income), combination question (whether chief source of income is combination of farming, other source of income) — S. 31 applying if both questions negatively answered — 1978 Supreme Court of Canada decision in Moldowan v. The Queen establishing if farming merely hobby, taxpayer not entitled to claim any deduction in respect of expenses incurred therein — Distinction between farmers burdened, not burdened by s. 31 based on comparison between economic characteristics of farming business, other taxable activities — Moldowan’s treatment of combination question in s. 31 criticized, particularly Dickson J.’s comment s. 31 should apply to person for whom farming “sideline” business, “subordinate” source of income — S. 31 not imposing additional requirement farming must be predominant element in combination — Combination question requiring aggregation of capital, income, time — Because appellant’s farming operations clearly having profit potential, Tax Court judgment set aside — Tax Court incorrectly interpreting s. 31 since factual connection between farming, other source of income not precondition for positive answer to combination question.

Construction of Statutes — Income Tax Act, s. 31 — Appeal from Tax Court of Canada judgment dismissing appeal from reassessments made under Income Tax Act (Act) for 1997, 1998, 1999, in which s. 31 applied to limit farm loss deduction to $8,750 — Textual, contextual, purposive analysis of s. 31 — In Moldowan v. The Queen, 1978 S.C.C. case, Dickson J. attempting to give rational meaning to general words of s. 31 when interpreting combination question — Approach contravening recent case law warning against development of judge‑made rules in tax matters — Words in s. 31 regarding combination question general but ordinary meaning comprehensible — “Combination” implying addition or aggregation — In fiscal context, statutory interpretation must be informed by recognition taxpayers requiring consistent, predictable, fair rules — Where taxing statute not explicit, reasonable uncertainty or factual ambiguity resulting from lack of explicitness, should be resolved in favour of taxpayer — Principle used only as last resort when ordinary statutory interpretation principles leaving uncertainty as to application of statute to particular case — Because s. 31 not reasonably clear, principle should apply — Combination question not to be interpreted according to judge‑made test requiring farming to be predominant element in combination of farming, second source of income but requiring generous interpretation, aggregation of various relevant economic factors.

This was an appeal from a Tax Court of Canada judgment dismissing the appellant’s appeal from reassessments made under the Income Tax Act (Act) for the years 1997, 1998 and 1999, in which section 31 was applied to limit the appellant’s farm loss deduction to $8,750. Section 31 provides a formula to calculate the taxpayer’s deemed loss where the chief source of income is neither farming nor a combination of farming and some other source of income. For over 30 years, the appellant has built up a law practice and a farming business, in which he raises pure‑bred cattle and produces tobacco. Although the law practice required a modest investment of capital and has been relatively profitable, the farming business required a greater capital investment and resulted mostly in operating losses. Despite the losses, the farming operations undisputedly comprise a business, a commercial activity undertaken for profit and with a reasonable expectation of profit. Between 1990 and 1997, the appellant acquired six farm properties in addition to the home farm and invested considerable time and money to bring them up to his high standards. The bulk of the appellant’s net farming assets consist of land and buildings. He spends about 30% to 35% of his working time on the farming operations and the balance on his law practice. Without the financial support provided by his law practice, the appellant could not have financed the expenditures required to improve his farming operations. Moreover, the farming losses beginning in the 1990s were greater than they might otherwise have been because of several nonrecurring expenditures and unforseen events. The issue was whether section 31 applied to the appellant in the years in question.

Held, the appeal should be allowed.

The opening words of section 31 set out the test, comprising two questions, for its application. The “principal question” is whether farming is the taxpayer’s chief source of income and the “combination question” is whether the taxpayer’s chief source of income is a combination of farming and some other source of income. Section 31 only applies if both questions are negatively answered. A straightforward textual analysis leaves unanswered the important questions of what the phrase “chief source of income” means and whether a positive answer to the combination question requires farming to be predominant.

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. Sections 28 to 31 provide a number of special rules for the determination of the profit or loss of a farming business. Section 31 limits the entitlement of certain farmers to claim a deduction for certain farming losses and is an exception to the general rule that 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.

In Moldowan v. The Queen, a 1978 case on section 31, the Supreme Court of Canada established that 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. However, the intended target of section 31 was unclear in 1977 when Moldowan was decided and it remains unclear.

Generally, when a provision of the Act imposes a tax disadvantage on one group of taxpayers and not on 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 discloses about the meaning of “chief source of income” remains obscure. Finally, despite considerable judicial criticism of section 31, one of the most litigated provisions in the Act, none of the available authorities provided a satisfactory explanation for the existence thereof.

Moldowan’s treatment of the combination question has attracted criticism, particularly Justice Dickson’s statement that section 31 should apply to a person for whom farming is a “sideline” business or a “subordinate” source of income. Section 31 does not use the words “sideline” or “subordinate” or any analogous term. Dickson J. was attempting to give a rational meaning to general words, thus avoiding the prospect of giving section 31 no meaning at all. With respect to the principal question, he concluded reasonably that the determination of a person’s chief source of income requires a weighing and balancing of a number of relevant factors. But when it came to the combination question, he devised guidelines based on an assumption as to the underlying objective of the statute, an assumption that is not rooted in anything expressed or implied in the statute itself. That approach to the interpretation of the combination question contravenes the more recent teaching of the Supreme Court of Canada that warn against the development of judge‑made rules in tax matters. These recent cases involved a statutory provision that had a discernible literal meaning in which the taxpayers argued that they should be entitled to rely on the words of the statute rather than an unlegislated gloss proposed by the Crown. The words of section 31 that set out the combination question are general but their ordinary grammatical meaning is comprehensible; section 31 speaks of a combination, which in ordinary language implies an addition or aggregation. There is nothing in section 31 or elsewhere in the Act that imposes an additional requirement that farming be the predominant element in the combination.

In the fiscal context, statutory interpretation must be informed by the recognition that, in a self‑assessing tax system that respects the right of taxpayers to plan their tax affairs intelligently, taxpayers require rules that are consistent, predictable and fair. These objectives of fiscal statutory interpretation are undermined by provisions that are so vague that their application cannot be predicted with reasonable certainty. They may be further undermined if they are applied on the basis of a judge‑made rule that has no statutory foundation. Where the taxing statute is not explicit, reasonable uncertainty or factual ambiguity resulting from lack of explicitness in the statute should be resolved in favour of the taxpayer. This principle is to be used only as a last resort, where the application of the ordinary principles of statutory interpretation leave a reasonable uncertainty as to whether the provision in question is intended to apply in a particular case. Because section 31 of the Act is not reasonably clear, that principle should still apply. The combination question should be interpreted to require only an examination of the cumulative effect of the aggregate of the capital invested in farming and a second source of income, the aggregate of the income derived from farming and a second source of income, and the aggregate of the time spent on farming and on the second source of income, considered in the light of the taxpayer’s ordinary mode of living, farming history, and future intentions and expectations. This would avoid the judge‑made test that requires farming to be the predominant element in the combination of farming with the second source of income.

Because the evidence in this case was that the appellant anticipated that his farm had a potential for profit, which the Crown admitted, the Tax Court judgment was set aside. Furthermore, because the Tax Court answered the principal question in the negative, it was obliged to consider the combination question. In doing so, it considered only the appellant’s argument that the financial success of his law practice is attributable in part to a synergy between it and his farming operation. It rejected the appellant’s argument that this factual link was a sufficient basis for concluding that his farming operation and his law practice, in combination, comprised his chief source of income with the result that section 31 of the Act could not apply to him. The Tax Court’s conclusion that the appellant’s farm was not a major contributor to the success of the law practice and the law practice did not owe its existence or its success to the farm was based on the premise that, in determining whether section 31 applies to a particular taxpayer, farming and a second source of income cannot be “combined” unless there is a factual connection between farming and that other source of income. This was not the correct interpretation of section 31 since a factual connection is not a precondition for a positive answer to the combination question. Although the notion of “connectedness” has never been part of section 31, it does not follow that the existence of a connection between farming and the other source of income is irrelevant to the combination question.

The appellant’s evidence of the unique “synergy” between his farm and his law practice should have been given some weight in the context of the combination question. The appellant’s farm and law practice together comprised virtually all of his income and represented most, if not all, of the appellant’s business‑related capital. A more generous interpretation of the combination question in section 31 that requires an aggregation of the various relevant economic factors leading to the conclusion that the appellant’s chief source of income is a combination of farming and the practice of law was needed. Finally, even on the Moldowan interpretation of the combination question, the answer to the combination question was “yes” and the appellant should have been entitled to a full deduction for his farm losses.

statutes and regulations judicially

considered

Income Tax Act, R.S.C. 1952, c. 148, s. 12(1)(b).

Income Tax Act, R.S.C., 1985 (5th Supp.), c. 1, ss. 18(1)(b), 28 (as am. by S.C. 1994, c. 7, Sch. II, s. 18; 1995, c. 21, s. 7; 1998, c. 19, s. 83; 2001, c. 17, s. 18), 29, 30, 31 (as am. by S.C. 1995, c. 21, s. 8), 248(1) “farming”.

Income Tax Act (The), S.C. 1948, c. 52, s. 13 (as am. by S.C. 1950‑51, c. 51, s. 4; 1952, c. 29, s. 4).

Income Tax Act, S.C. 1970‑71‑72, c. 63, s. 31.

Income War Tax Act, 1917 (The), S.C. 1917, c. 28, ss. 3 (as am. by S.C. 1919, c. 55, s. 2; 1920, c. 49, s. 2; 1923, c. 52, s. 1), 4.

Income War Tax Act, R.S.C. 1927, c. 97, s. 10.

cases judicially considered

not followed:

Moldowan v. The Queen, [1978] 1 S.C.R. 480; (1977), 77 D.L.R. (3d) 112; [1977] CTC 310; 77 DTC 5213; 15 N.R. 476.

applied:

Canada Trustco Mortgage Co. v. Canada, [2005] 2 S.C.R. 601; (2005), 259 D.L.R. (4th) 193; [2005] 5 C.T.C. 215; 2005 DTC 5523; 340 N.R. 1; 2005 SCC 54; Royal Bank of Canada v. Sparrow Electric Corp., [1997] 1 S.C.R. 411; (1997), 193 A.R. 321; 143 D.L.R. (4th) 385; [1997] 2 W.W.R. 457; 46 Alta. L.R. (3d) 87; 44 C.B.R. (3d) 1; 8 C.P.C. (4th) 5089; 97 DTC 5089; 12 P.P.S.A.C. (2d) 68; 208 N.R. 161; Shell Canada Ltd. v. Canada, [1999] 3 S.C.R. 622; (1999), 178 D.L.R. (4th) 26; [1999] 4 C.T.C. 313; 99 DTC 5669; 247 N.R. 19; Johns‑Manville Canada Inc. v. The Queen, [1985] 2 S.C.R. 46; (1985), 21 D.L.R. (4th) 210; [1985] 2 C.T.C. 111; 85 DTC 5373; 60 N.R. 244.

distinguished:

Morrissey v. Canada, [1989] 2 F.C. 418; [1989] 1 C.T.C. 235; (1988), 89 DTC 5080; 95 N.R. 140 (C.A.); Poirier (B.) Estate v. Canada, [1992] 2 C.T.C. 9; (1992), 92 DTC 6335; 142 N.R. 9 (F.C.A.).

considered:

R. v. Graham, [1985] 2 F.C. 107; [1985] 1 C.T.C. 380; (1985), 85 DTC 5256; 59 N.R. 221 (C.A.); Watt v. Canada, [2001] 2 C.T.C. 228; 2001 DTC 5237; 273 N.R. 201; 2001 FCA 72; Canada v. Donnelly, [1998] 1 F.C. 513; (1997), 154 D.L.R. (4th) 261; [1998] 1 C.T.C. 23; 97 DTC 5499; 220 N.R. 329 (C.A.); Kroeker v. Canada, [1983] 1 C.T.C. 183; 2002 DTC 7436; 295 N.R. 137; 2002 FCA 392; Québec (Communauté urbaine) v. Corp. Notre‑Dame de Bon‑Secours, [1994] 3 S.C.R. 3; [1995] 1 C.T.C. 241; (1994), 95 DTC 5017; 3 G.T.C. 8071; 171 N.R. 161; 63 Q.A.C. 161; Gestion S.A.P. Inc. v. Canada (Minister of National Revenue), [1994] 1 C.T.C. 2450; (1993), 94 DTC 1349 (T.C.C.).

referred to:

Gunn v. Canada, [2005] 4 C.T.C. 2032; 2005 DTC 1074; 2005 TCC 437; Canderel Ltd. v. Canada, [1998] 1 S.C.R. 147; (1998), 155 D.L.R. (4th) 257; [1998] 2 C.T.C. 35; 98 DTC 6100; 222 N.R. 81; Pioneer Laundry and Dry Cleaners Ltd. v. Minister of National Revenue, [1940] A.C. 127 (P.C.); D.R. Fraser and Co. Ltd. v. Minister of National Revenue, [1949] A.C. 24 (P.C.); Minister of National Revenue v. Barbara A. Robertson, [1954] Ex. C.R. 321; (1954), 54 D.T.C. 1062; [1954] C.T.C. 110; Poirier (Trustee of) v. M.N.R., [1986] 1 C.T.C. 308;  (1986), 86 DTC 6124; 2 F.T.R. 11 (F.C.T.D.); Hover v. M.N.R., [1993] 1 C.T.C. 2585; (1992), 93 DTC 98 (T.C.C.); Hadley v. R., [1985] 1 C.T.C. 62; (1985), 85 DTC 5058 (F.C.T.D.); 65302 British Columbia Ltd. v. Canada, [1999] 3 S.C.R. 804; (1999), 179 D.L.R. (4th) 577; [2000] 1 W.W.R. 195; 69 B.C.L.R. (3d) 201; [2000] 1 C.T.C. 57; 99 DTC 5799; 248 N.R. 216.

authors cited

Benson, Edgar J. Proposals for Tax Reform. Ottawa: Department of Finance, 1969.

Canada. Report of the Royal Commission on Taxation. Ottawa: Queen’s Printer, 1966‑67 (Chair: K. M. Carter).

Hogg, Peter W. and J. E. Magee. Principles of Canadian Income Tax Law, 2nd ed. Scarborough, Ont.: Carswell, 1997.

House of Commons Debates, Vol. III, 6th Sess., 21st Parl., May 27, 1952, at pp. 2626 ff.

House of Commons Debates, Vol. V, 4th Sess., 21st Parl., June 13, 1951, at p. 4054.

Stikeman, Heward et al. “Transactions to Avoid or Minimize Tax” in Special Lectures of the Law Society of Upper Canada on Taxation. Toronto: Richard De Boo Ltd., 1944.

Thomas, Richard B. “Current Cases—A Farm Loss with a Difference—The Farmer is Successful” (1993), 41 Can. Tax J. 513”.

APPEAL from a Tax Court of Canada judgment ([2005] 4 C.T.C. 2032; 2005 DTC 1074; 2005 TCC 437) dismissing the appellant’s appeal from reassessments made under the Income Tax Act for the years 1997, 1998 and 1999 because the Tax Court found that section 31 had been correctly applied in each of those years, thereby limiting the appellant’s farm loss deduction to $8,750. Appeal allowed.

appearances:

Sandra L. Monger for appellant.

Charles Camirand for respondent.

solicitors of record:

Gunn & Associates, St. Thomas, Ontario, for appellant.

Deputy Attorney General of Canada for respondent.

The following are the reasons for judgment rendered in English by

[1]Sharlow J.A.: 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 (5th Supp.), c. 1 for the years 1997, 1998 and 1999. The only issue is whether the Judge was correct in concluding that section 31 [as am. by S.C. 1995, c. 21, s. 8] 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 30 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. Gunn 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:

[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 non-recurring 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

(a) the lesser of

(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

(ii) $2,500 plus the lesser of

(A) 1/2 of the amount by which the amount determined under subparagraph (i) exceeds $2,500, and

(B) $6,250, and

(b) the amount, if any, by which

(i) the amount that would be determined under subparagraph (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).

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. 601, 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 [subsection 248(1)]:

248. (1) . . .

“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;

[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 [as am. by S.C. 1994, c. 7, sch. II, s. 18; 1995, c. 21, s. 7; 1998, c. 19, s. 83; 2001, c. 17, s. 18] 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 businesses 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 [S.C. 1970‑71-72, c. 63] 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, 1917, 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, 1917 set out specific rules for the computation of profit. In 1919, paragraph 3(f) was added by S.C. 1919, c. 55, s. 2, 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 [S.C. 1920, c. 49, s. 2], 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, 1917 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, s. 1, 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 (P.C.); D.R. Fraser and Co. Ltd. v. Minister of National Revenue, [1949] A.C. 24 (P.C.)). 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 ([The 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 (Minister of National Revenue v. Barbara A. 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 subsections 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, [1989] 2 F.C. 418 (C.A.), 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 2626 ff; quoted in Morrissey, cited above, at pages 424‑425)). 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  “gentlemen farmers” who never make money from their farms, but claim their losses for tax purposes. The meaning of the term “gentlemen 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 businesses.

[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 [Report of the Royal Commission on Taxation]. 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. J. 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 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. By “capitalizing” we mean adding the amount involved to the cost to the taxpayer 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. The Queen, [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 been 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 who “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 “gentlemen 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 pursuing 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 [as he then was], 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 [at page 482] “an awkwardly worded and intractable section and the source of much debate”. See also the comments of Justice Marceau in his dissenting reasons in R. v. Graham, [1985] 2 F.C. 107 (C.A.) (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 (Trustee of) v. M.N.R. [1986] 1 C.T.C. 308 (F.C.T.D.). Most recently Justice Sexton, speaking for this Court in an oral judgment in Watt v. Canada, [2001] 2 C.T.C. 228 (F.C.A.), 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:

[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 1960s, 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 no farm loss deduction.

[59]Justice Dickson also proposed a number of principles to assist in determining how to categorize a farmer in any given case. I summarize those principles as follows:

(1) The phrase “chief source of income” in section 31 must be interpreted to include a farming business, even in a year in which the farming business has resulted in a loss. Otherwise, no taxpayer with a farm loss could ever claim losses in excess of the maximum permitted by section 31 (page 485).

(2) A “source of income” must be an activity carried on for  profit  or with a reasonable expectation of profit. For  a  taxpayer  who  operates  a  farm  as  a hobby, with  no  reasonable  expectation of profit, the farm is not a “source of income” and no farm losses are deductible (page 485).

(3) In determining whether there is a reasonable expectation of profit from a farming operation, it is necessary to consider the taxpayer’s profit and loss experience in past years, the taxpayer’s training, the taxpayer’s intended course of action, the capability of the venture as capitalized to show a profit after charging capital cost allowance, and the nature and extent of the undertaking. For example, a farmer who purchases a productive going operation cannot be expected to suffer the same start-up losses as one who begins a tree farm on raw land (pages 485‑486).

(4) The test for determining a taxpayer’s chief source of income is both a relative and an objective test, and not a pure quantum measurement. The factors to be considered, for each source of income, include (a) the taxpayer’s reasonable expectation of income from his various revenue sources; (b) his ordinary mode and habit of work; (c) the time spent; (d) the capital committed; (e) the profitability of the operation, both actual and potential (page 486).

(5) In considering whether a taxpayer’s chief source of income is a “combination” of farming and some other source of income, it is not necessary that the two sources be connected, but at the same time it is not correct simply to add any two sources of income (page 487). The combination question is intended to benefit a taxpayer whose major preoccupation is farming, but who has other pecuniary interests as well, such as income from investments, or income from a sideline employment or business (page 488).

(6) Section 31 does not apply to a taxpayer for whom farming may reasonably be expected to provide the bulk of income or the centre of work routine and who looks to farming for a livelihood (page 487).

(7) Section 31 applies to a taxpayer who does not look to farming, or to farming and some subordinate source of income, for his livelihood but carries on farming as a sideline business (pages 488‑489).

[60]Based on this understanding of former section 13, Justice Dickson concluded that it applied to Mr. Moldowan for the following reasons (see pages 488‑489):

He devoted considerable effort towards launching new ventures. Horse‑racing consumed only several hours of his day and that for part of the year only. His commitment of capital was cautious. The nature of the enterprise is risky. It is difficult reasonably to plan to devote energies to it principally in the expectation of a steady living. He suffered constant and increasing losses with the exception of two years in which minor profits were made. Although none of the above is alone determinative, together they suggest only one business venture of several, with nothing distinguishing in the way of a “chief source of income”.

[61]Moldowan has been cited in hundreds of cases. It has been particularly influential in cases involving a relatively straightforward application of the principal question—whether the taxpayer’s chief source of income is farming. In that regard, it has become accepted practice to address the principal question by considering the relevant factors listed in item (4) above, recognizing that no single factor is necessarily determinative, and that each factor must be examined against the broad context of the taxpayer’s history, his work routine, and his future prospects and intentions.

[62]However, the Moldowan treatment of the combination question has proved to be more difficult to deal with. Among the many section 31 cases that have reached this Court are five cases that illustrate the difficulty in predicting the outcome of a case involving the combination question.

[63]The first case is R. v. Graham, [1985] 2 F.C. 107 (C.A.). That case involved a stationary engineer, a full‑time employee of Ontario Hydro, who transferred to a rural work location so that he could become a farmer. In 1975, he began a hog farm. His employment income was approximately $30,000 per year, and he lost between $5,000 and $12,000 per year on his hog farm, but he spent approximately twice as many hours on the farm as on his employment. He was successful in his tax appeal, and the Crown’s appeal to this Court did not succeed. The decision contains a short analysis in which Justice Urie, for the majority, agreed with the Trial Judge that this taxpayer’s sideline activity was employment rather than farming so that, based on Moldowan, his chief source of income was a combination of farming and employment.

[64]The second case is Poirier (B.) Estate v. Canada, [1992] 2 C.T.C. 9 (F.C.A.). The Crown relies particu-larly on this case. However, I am not persuaded that it involves the combination question at all. Rather, it seems to me that the case was decided adversely to the taxpayer on the basis of the principal question. At trial [(1986), 86 DTC 6124 (F.C.T.D.)], Associate Chief Justice Jerome, as he then was, concluded that section 31 did not apply to a person who had embarked upon a cattle business that [at page 6128] “would reasonably be expected to be a source of income combined with his other sources of income to form his chief source of income” in the years under appeal. In an oral decision, this Court allowed the Crown’s appeal on the basis that the trial decision incorrectly used the combination of two sources of income to conclude that [at page 6336] “the respondent’s farming income was a chief source of income”, which I take to mean that Associate Chief Justice Jerome found that farming income alone was the taxpayer’s chief source of income. This Court considered the matter anew, and concluded that, as the taxpayer spent about the same amount of time on farming and his other source of income, but had invested less capital in the farm and earned less income, his chief source of income was not farming.

[65]The third case is Canada v. Donnelly, [1998] 1 F.C. 513 (C.A.). It involved a successful urologist who, after practicing his profession for over ten years, started a horse-breeding operation in which he invested significant capital, and lost approximately $2 million over a 20-year period. This Court found, among other things, that there was no basis for concluding that the farming activities had a prospect for profit. It seems to have been significant to the Court that, in the years in which a profit might have been earned, the taxpayer invariably bought another horse, turning his potential profit into a loss. It is not clear how that situation arose, given the mandatory inventory adjustment referred to above in paragraph 28(1)(c) of the Income Tax Act, but in any event the conclusion was that the taxpayer’s chief source of income for the years in question came from his medical practice, and his horse‑farming activity was held to be a sideline business.

[66]Donnelly is particularly interesting for the following comments made by Justice Robertson to address the differences between Donnelly and Graham [at paragraphs 19-21]:

It seems to me that Graham comes closer to a case in which an otherwise full‑time farmer is forced to seek additional income in the city to offset losses incurred in the country. The second generation farmer who is unable to adequately support a family may well turn to other employment to offset persistent annual losses. These are the types of cases which never make it to the courts. . . . I have yet to see a case where the Minister denies such a taxpayer the right to deduct full farming losses because of a competing income source. Perhaps this is because it is unlikely a hog farmer such as Mr. Graham would pursue the activity as a hobby.

As is well known, section 31 of the Act is aimed at preventing “gentlemen” farmers who enjoy substantial income from claiming full farming losses: see Morrissey v. Canada, supra, at pages 420‑423. More often than not it is invoked in circumstances where farmers are prepared to carry on with a blatant indifference toward the losses being incurred. The practical and legal reality is that these farmers are hobby farmers but the Minister allows them the limited deduction under section 31 of the Act. Such cases almost always involve horse farmers who are engaged in purchasing or breeding horses for racing. In truth, there is rarely even a reasonable expectation of profit in such endeavours much less the makings of a chief source of income.

It may well be that in tax law a distinction is to be drawn between the country person who goes to the city and the city person who goes to the country. In future, those insisting on obtaining tax relief in circumstances approaching those under consideration should do so through legislative channels and not through the Tax Court of Canada. The judicial system can no longer afford to encourage taxpayers or their counsel to pursue such litigation in the expectation that hope will triumph over experience.

[67]If these comments are meant to suggest that section 31 ought to be applied more assiduously to a horse breeder than a hog farmer, or to an individual with a relatively high professional income earned in a city than an individual with more modest employment income earned in a small rural town, then I do not subscribe to them. Even so, they leave open the question of how to apply section 31 to Mr. Gunn, an individual who is not a horse breeder or a hog farmer, and whose non‑farm income is not earned in the city, but in a small town in Ontario not far from his farm.

[68]The fourth case is Watt, cited above. It involved a Saskatchewan dentist with a substantial income from his practice. He worked with his wife on the family farm growing wheat, peas, canola, barley and alfalfa. Dr. Watt spent approximately 2000 hours per year on the farm operation, and 1500 hours per year in his dental practice. His farm lost money every year. His case failed in the Tax Court primarily on the basis that there was no evidence that the farm could ever produce a profit. His appeal to this Court failed for the same reason.

[69]The fifth case is Kroeker v. Canada, [2003] 1 C.T.C. 183 (F.C.A.). Ms. Kroeker was a partner, with her spouse, in a farming business that suffered losses. She had significant income from employment, but her employment activities were arranged in such a way as to accommodate her farm work. Practically all of her employment income was invested in the farm, and the farm actually achieved profits in the years after the years under appeal. The evidence was that the farm was the focus of the taxpayer’s life. Her appeal to the Tax Court failed because the Judge interpreted Donnelly, cited above, as requiring evidence that the taxpayer’s farming activities had a prospect of “substantial” profits, a test that Ms. Kroeker could not meet. This Court reversed that decision on the basis that Donnelly could not be read as adding a new substantive test of “substantial profitability” to the Moldowan principles. In the result, this Court found little to distinguish this case from Graham so that, based on Moldowan, her chief source of income was a combination of farming and another source of income.

[70]None of the cases cited above alters or purports to alter any of the Moldowan principles; nor do they question any of those principles, including the principles relating to the combination question. However, the Moldowan treatment of the combination question has attracted criticism. That criticism is focussed on Justice Dickson’s statement that section 31 should apply to a person for whom farming is a “sideline” business or a “subordinate” source of income. The problem is that section 31 does not use the words “sideline” or “subordinate”, or any analogous term.

[71]According to Justice Dickson, the combination question in section 31 must be answered in the negative (and therefore section 31 would necessarily apply) in the case of a taxpayer for whom farming is a sideline business, or whose non‑farming source of income is “subordinate” to farming. Richard Thomas says, in a case comment entitled “A Farm Loss with a Difference —The Farmer is Successful!” in “Current Cases” (1993), 41 Can. Tax J. 502, at page 513, that this view of the combination question strips it of meaning and effect. Consider the case of a person for whom farming is not the chief source of income, but who wishes to argue that his chief source of income is farming and something else. Based on Justice Dickson’s view of the combination question, that person cannot avoid the application of section 31 unless he can establish that his other source of income is subordinate to farming. But if he could establish that, he probably would be able to establish that farming is his chief source of income.

[72]The same criticism is made by Chief Justice Bowman in the case that is the subject of Mr. Thomas’ article: Hover v. M.N.R., [1993] 1 C.T.C. 2585 (T.C.C.)  and by Justice Joyal in Hadley v. R., [1985] 1 C.T.C. 62 (F.C.T.D.). Neither decision was appealed.

[73]In my view, there is merit in this criticism. Justice Dickson was attempting to give a rational meaning to general words, thus avoiding the prospect of giving section 31 no meaning at all. With respect to the principal question, he concluded reasonably that the determination of a person’s chief source of income requires a weighing and balancing of a number of relevant factors. But when it came to the combination question, he devised guidelines based on an assumption as to the underlying objective of the statute, an assumption that is not rooted in anything expressed or implied in the statute itself. One of those guidelines is that one cannot determine whether a person’s chief source of income is a combination of farming and some other source of income simply by addition. The other is that a person’s chief source of income cannot be a combination of farming and something else unless farming predominates (or is not a sideline business).

[74]That approach to the interpretation of the combination question contravenes the teaching of the Supreme Court of Canada in several recent cases that warn against the development of judge‑made rules in tax matters. See, for example, the comments of Justice Iacobucci, writing for the majority in Royal Bank of Canada v. Sparrow Electric Corp., [1997] 1 S.C.R. 411, at paragraph 112:

Finally, I wish to emphasize that it is open to Parliament to step in and assign absolute priority to the deemed trust. A clear illustration of how this might be done is afforded by s. 224(1.2) ITA, which vests certain moneys in the Crown “notwithstanding any security interest in those moneys” and provides that they “shall be paid to the Receiver General in priority to any such security interest”. All that is needed to effect the desired result is clear language of that kind. In the absence of such clear language, judicial innovation is undesirable, both because the issue is policy charged and because a legislative mandate is apt to be clearer than a rule whose precise bounds will become fixed only as a result of expensive and lengthy litigation.

[75]Similarly, Justice McLachlin (as she then was) said this in Shell Canada Ltd. v. Canada, [1999] 3 S.C.R. 622, at paragraph 43:

This Court has consistently held that courts must therefore be cautious before finding within the clear provisions of the Act an unexpressed legislative intention: Canderel Ltd. v. Canada, [1998] 1 S.C.R. 147, at para. 41, per Iacobucci J.; Royal Bank of Canada v. Sparrow Electric Corp., [1997] 1 S.C.R. 411, at para. 112, per Iacobucci J.; [Canada v. Antosko, [1994] 2 S.C.R. 312] at p. 328, per Iacobucci J. Finding unexpressed legislative intentions under the guise of purposive interpretation runs the risk of upsetting the balance Parliament has attempted to strike in the Act.

[76]The same principle is captured in these words from P. W. Hogg and J. E. Magee, Principles of Canadian Income Tax Law (2nd ed. 1997), at pages 475‑476:

It would introduce intolerable uncertainty into the Income Tax Act if clear language in a detailed provision of the Act were to be qualified by unexpressed exceptions derived from a court’s view of the object and purpose of the provision.

This passage was quoted with approval by Justice Iacobucci, writing for the majority in 65302 British Columbia Ltd. v. Canada, [1999] 3 S.C.R. 804, at paragraph 51, and by Chief Justice McLachlin and Justice Major, writing for the Court in Canada Trustco Mortgage Co. v. Canada, cited above, at paragraph 12.

[77]Each of the statements quoted above was made in the context of a statutory provision that had a discernible literal meaning, where the taxpayers argued that they should be entitled to rely on the words of the statute rather than an unlegislated gloss proposed by the Crown. The words of section 31 that set out the combination question are general but their ordinary grammatical meaning is comprehensible; section 31 speaks of a combination, which in ordinary language implies an addition or aggregation. There is nothing in section 31, or elsewhere in the Income Tax Act, that imposes an additional requirement that farming be the predominant element in the combination.

[78]In the fiscal context, statutory interpretation must be informed by the recognition that, in a self‑assessing tax system that respects the right of taxpayers to plan their tax affairs intelligently, taxpayers require rules that are consistent, predictable and fair (Canada Trustco Mortgage Co. v. Canada, cited above). These objectives are undermined by provisions that are so vague that their application cannot be predicted with reasonable certainty. They may be further undermined if they are applied on the basis of a judge‑made rule that has no statutory foundation. It seems to me that the courts would do well to approach the combination question in section 31with an eye on the case of Johns‑Manville Canada Inc. v. The Queen, [1985] 2 S.C.R. 46, decided some years after Moldowan.

[79]The issue in Johns‑Manville was whether a mining company was entitled to deduct, as an operating expense of its open-pit mine, the cost of acquiring land around the pit in order to continue the necessary wall slope and angle of repose of the overburden. These acquisitions occurred year in and year out as an integral part of the operation of the mine. The Crown had argued that because land is a permanent asset, the cost of the land was a capital outlay, the deduction of which was prohibited by the statutory predecessor [R.S.C. 1952, c. 148, s. 12(1)(b)] to paragraph 18(1)(b) of the Income Tax Act. The point of statutory interpretation was the meaning to be attributed to that provision, and in particular the principles to be applied in distinguishing capital outlays from ordinary operating expenses.

[80]That issue has a lengthy history in the jurisprudence in Canada, as well as the U.K., Australia and the United States, but it was not the subject of any statutory guidelines. After a fulsome analysis of the business purpose of the expenditures in question, and noting that if the expenditures were not deductible, the taxpayer would receive no tax relief for them at all, Justice Estey concluded that the cost of the land was fully deductible as an expense. He said this at page 72 (my emphasis):

The characterization in taxation law of an expenditure is, in the final analysis (unless the statute is explicit which this one is not), one of policy. . . . Such a determination is, further-more, consistent with another basic concept in tax law that where the taxing statute is not explicit, reasonable uncertainty or factual ambiguity resulting from lack of explicitness in the statute should be resolved in favour of the taxpayer. This residual principle must be the more readily applicable in this appeal where otherwise annually recurring expenditures, completely connected to the daily business operation of the taxpayer, afford the taxpayer no credit against tax either by way of capital cost or depletion allowance with reference to a capital expenditure, or an expense deduction against revenue.

[81]Justice Gonthier, writing for the Supreme Court of Canada in Québec (Communauté urbaine) v. Corp. Notre‑Dame de Bon‑Secours, [1994] 3 S.C.R. 3, cautioned that the Johns‑Manville principle is to be used only as a last resort, where the application of the ordinary principles of statutory interpretation leave a reasonable uncertainty as to whether the provision in question is intended to apply in a particular case. He said this at pages 19‑20 of his reasons:

Two comments should be made to give Estey J.’s observations their full meaning: first, recourse to the presumption in the taxpayer’s favour is indicated when a court is compelled to choose between two valid interpretations, and second, this presumption is clearly residual and should play an exceptional part in the interpretation of tax legislation. In his text The Interpretation of Legislation in Canada (2nd ed. 1991), at p. 412, Professor Pierre‑André Côté summarizes the point very well:

If the taxpayer receives the benefit of the doubt, such a “doubt” must nevertheless be “reasonable”. A taxation statute should be “reasonably clear”. This criterion is not satisfied if the usual rules of interpretation have not already been applied in an attempt to clarify the problem. The meaning of the enactment must first be ascertained, and only where this proves impossible can that which is more favourable to the taxpayer be chosen. [Emphasis in original document.]

[82]This caution should not preclude the application of the Johns‑Manville principle in relation to the combination question in section 31 of the Income Tax Act, because that aspect of section 31 is not “reasonably clear”. It is capable of bearing the meaning that Justice Dickson gave it in Moldowan, in which the combination question must be answered in the negative unless farming predominates as a source of income. However, the combination question is also capable of bearing a more straightforward meaning, in which it is not necessary for the farmer to propose a combination of sources of income in which farming predominates.

[83]In my view, the combination question should be interpreted to require only an examination of the cumulative effect of the aggregate of the capital invested in farming and a second source of income, the aggregate of the income derived from farming and a second source of income, and the aggregate of the time spent on farming and on the second source of income, considered in the light of the taxpayer’s ordinary mode of living, farming history, and future intentions and expectations. This would avoid the judge‑made test that requires farming to be the predominant element in the combination of farming with the second source of income, which in my view is a test that cannot stand with subsequent jurisprudence. It would result in a positive answer to the combination question if, for example, the taxpayer has invested significant capital in a farming enterprise, the taxpayer spends virtually all of his or her working time on a combination of farming and the other principal income-earning activity, and the taxpayer’s day to day activities are a combination of farming and the other income-earning activity, in which the time spent in each is significant.

The application of section 31 to Mr. Gunn

[84]In the case of Mr. Gunn, the Judge found that section 31 applied because Mr. Gunn’s chief source of income is not farming, or a combination of farming and the practice of law. The basis for that conclusion is summarized in at paragraphs 17 and 18 of the Judge’s reasons:

As I have said, the evidence does not establish that the Appellant had shifted the focus of his working life from law to farming in the years under appeal, or indeed that he had done so by 2005. Of the factors that I must consider, only the capital invested might militate in favour of the Appellant. It is not disputed that the bulk of his working time is spent in his law office, where he has a number of fulltime employees working for him, in addition to his own practice to attend to. I appreciate that the comparison of the taxpayer’s income from farming and from law is not simply a mathematical exercise. However, up to and including the years in issue the record shows a decade of very large losses, of which the largest two are the last year before the years under appeal, and the last of the three years under appeal. Over the same decade, the Appellant’s income from law had a strong upward trend, with the first and second years under appeal being two of the three most productive years of his practice in the period. Nor does the evidence establish that there is any reason to expect that to change greatly in the future. Although there have been profits from the farming in 2002 and 2004, the evidence does not persuade me that this is a trend that will necessarily continue. Nor can the losses simply be discounted as startup losses. It is true that in 1999 the Appellant went into tobacco farming on the basis of an ownership operation, rather than through sharecropping as he had previously operated. No doubt this exacerbated his losses in that year—it had by far the largest loss in the evidence before me. It was only a matter of degree, however; his losses for the 12 prior years cannot be explained that way. It is likely too, on the Appellant’s evidence, that some, if not all, of the modest profit in 2002 was attributable in part to expenses incurred during the startup years of 1999 to 2001. There was evidence that the income from tobacco is not realized until the calendar year after the majority of the expenses have been incurred.

It is true that the Appellant has farming assets of approximately $3.354 million. However $2.5 million of that is made up of land and buildings, some of which were put to agricultural use during the relevant time period, and some of which were not. I think it is a reasonable inference that the capital the Appellant invested in land and buildings was not at risk in the way that capital invested in machinery or inventory might be. I do not consider this to be a factor strong enough to outweigh the relative application of the Appellant’s time and effort, or the relative potential for profit of the law practice and the farm.

[85]The Judge’s answer to the principal question is based on the Moldowan principles for determining a taxpayer’s chief source of income, combined with the comment from Morrissey v. Canada, cited above, to the effect that if it is unlikely that the taxpayer’s farming operations will ever be profitable, notwithstanding all the time and capital the taxpayer is willing and able to devote to farming, the conclusion must be that farming is not a chief source of the taxpayer’s income.

[86]In my view, Morrissey is not an apt precedent for the case of Mr. Gunn. The statement in Morrissey referred to above was made in the context of a case in which the taxpayer’s own evidence indicated that he doubted the future profitability of his farm. Mr. Gunn’s evidence was that he anticipated that his farm had a potential for profit. The Crown adduced no evidence to the contrary, and in fact admitted the potential for future profit. I can find in the record no evidentiary support for the Judge’s conclusion that Mr. Gunn’s farming operations showed no potential for profit. That is a sufficient basis for setting aside the Tax Court judgment. However, there is also a second reason.

[87]Once the Judge answered the principal question in the negative, he was obliged to consider the combination question. In doing so, he considered only Mr. Gunn’s argument that the financial success of his law practice is attributable in part to a synergy between it and his farming operation. Mr. Gunn argued that this factual link was a sufficient basis for concluding that his farming operation and his law practice, in combination, comprise his chief source of income, with the result that section 31 of the Act could not apply to him. Mr. Gunn relied on Gestion S.A.P. Inc. v. Canada (Minister of National Revenue), [1994] 1 C.T.C. 2450 (T.C.C.). In that case, the combination question was answered in the taxpayer’s favour on the basis that it operated a successful grocery store that sold high-quality meat produced on its own farm. The taxpayer’s farming and retail operations were integrally connected in that the farm owed its existence to the retail operation, was nurtured by the retail operation, and existed for the retail operation.

[88]The Judge rejected Mr. Gunn’s argument on this point because his farm was not a major contributor to the success of the law practice, and the law practice did not owe its existence or its success to the farm. That conclusion appears to be based on the premise that, in determining whether section 31 applies to a particular taxpayer, farming and a second source of income cannot be “combined” unless there is a connection that is analogous to the connection in Gestion S.A.P.

[89]In my view, that is not the correct interpretation of the combination question in section 31. While it is true that the facts of Gestion S.A.P. are distinguishable from the facts of this case, it does not follow that the combination question must be answered in the negative unless the connection between the farm and the other source of income is as close as the farm and the grocery store in that case. As that error in principle is the foundation of the Judge’s conclusion on the combination question, it is necessary for this Court to consider that question anew.

[90]A factual connection between farming and another source of income is not a precondition for a positive answer to the combination question in section 31. The notion of “connectedness” has never been part of section 31; indeed it does not appear in its statutory predecessor, section 10 of the Income War Tax Act, after 1923.

[91]However, it does not follow that the existence of a connection between farming and the other source of income is irrelevant to the combination question. In this case, Mr. Gunn testified that his farming activities resulted in connections that enhanced the profitability of his law practice. He did not suggest that his law practice owed its existence to his farm, or that any of the expenses of his farming operation were so integrally tied to his law practice that they should, for example, be deductible in computing income from his law practice. His point, as I understand it, was that his time and resources were not neatly divided between farming and the practice of law. Rather, his day-to-day life involved both, and the contacts he made in farming became valuable to his law practice. This seems to me to be a “combination” in the most ordinary meaning of that word. In my view, Mr. Gunn’s evidence of the unique “synergy” between his farm and his law practice should have been given some weight in the context of the combination question.

[92]In addition to that factual connection, it is clear from the record that Mr. Gunn’s farm and his law practice together comprise virtually all of his income and represent most, if not all, of Mr. Gunn’s business-related capital. His farm investment and his farm losses are subsidized by his law practice, leaving overall a substantial income. For the reasons explained in the discussion above, I would have adopted a more generous interpretation of the combination question in section 31 that requires an aggregation of the various relevant economic factors (capital, income and time), leading to the conclusion that Mr. Gunn’s chief source of income is a combination of farming and the practice of law.

[93]In my view, the result would be the same in this case even if the authority of Moldowan precludes me from adopting the more generous interpretation of the combination question. I am unable to distinguish this case from Kroeker, particularly once it is recognized that it makes no difference that Ms. Kroeker’s non‑farm income was from employment, while Mr. Gunn’s is from a more lucrative law practice. I also find it difficult to characterize Mr. Gunn’s farming activities as a mere sideline, given his substantial investment of capital, time and expertise, and his undisputed evidence as the profit potential of his farm. When all of that evidence is considered in light of Mr. Gunn’s evidence as to the ways in which his law practice is enhanced by the factual connection between the farm and the law practice, I would conclude that even on the Moldowan interpretation of the combination question, the answer to the combination question is “ yes”. It follows that he should be entitled to a full deduction for his farm losses.

Conclusion

[94]I would allow this appeal with costs in this Court and in the Tax Court, and I would set aside the Tax Court judgment and refer this matter back to the Minister for reassessment on the basis that section 31 of the Income Tax Act did not apply to Mr. Gunn in the years under appeal.

Sexton J.A.: I agree.

Malone J.A.: I agree.