JUSTICE TO THE FARMER WITH OFF-FARM INCOME
Originally published on October 26, 2000
I phoned two of our clients recently and asked them to review the front page of the September 28, 2000 Western Producer. I was hoping that the headline "Judge rules for farmers; scolds tax department" would give them some comfort.
For those who missed it, judge Dave Beaubier from the Tax Court of Canada ruled in favor of Brian Finch, a Kelvington, Sask., farmer who was appealing tax reassessments issued by the Canada Customs and Revenue Agency.
In his reassessments for the 1992, 1993 and 1994 taxation years, Finch was told that only a portion his farming losses could be applied against the income he earned as a lead and zinc miner. His wife, Brenda Finch, was quoted as saying that they were facing tax bills exceeding $200,000 and if they had lost they would have had to sell their farm.
In our clients' situation, both the husband and wife were denied their ability to write off their farm losses against their off-farm income.
Reassessments were issued for their 1997 and 1998 taxation years, with their 1999 taxation year remaining in limbo. Our office filed the required Notice of Objections and we are now in appeal. If we lose, our clients are facing bills of about $40,000 and a probable sale of their farm.
With 82 percent of Saskatchewan farmers having off-farm income, there are thousands of similar situations. I believe it is important to know what enables a farmer to deduct losses against other income.
The First Test - Establish a reasonable expectation of profit
Hobby farmers are not entitled to deduct any farm losses since they do not have a reasonable expectation of profit. Court jurisprudence describes this expectation as being much less onerous than the expectation in the second test. The explanation was laid out in the written decision in the case Queen versus Donnelly.
To paraphrase the decision: There is a difference between the amount of evidence the taxpayer must produce concerning profitability under the second test, as opposed to that relevant in the first test. In the case of the first test, the taxpayer need only show that there was an expectation of profit, be it $1 or $1 million.
In passing this test and proving an expectation of profit, you have established that you are not a hobby farmer. Two more tests are left to determine your farming status: restricted, part-time, sideline or full-time.
The Second Test - Reasonable expectation of substantial profits
To be able to deduct losses with no restrictions, you must pass this second test as set out in the Donnelly case.
To paraphrase: With respect to this second test, the amount of farm profitability is relevant because it provides a basis on which to compare 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.
This is where anyone still reading is going to think of throwing rocks at my glass tower. Who in agriculture right now can prove an expectation of substantial profits?
Well, in the Donnelly case, the Tax Court judge also stated that there was "no evidence presented to show what profit the taxpayer might have earned had certain events not occurred." If this isn't hypothetical, I don't know what is.
Assuming that you can prove a hypothetical year of substantial profits, then you are ready to move to test three.
Third Test - Chief source of income
This third test set out in the Donnelly case evaluates whether farming is a taxpayer's chief source of income.
"It requires a favorable comparison of (farming) with the taxpayer's other income source in terms of capital committed, time spent and profitability, actual or potential. The test is both relative and objective. It is not a pure quantum measurement. All three factors must be weighed with no one factor being decisive."
In my experience, this test is the one that farmers most frequently misinterpret. Farmers can have a dual focus and declare a combination of farming and another source as their chief source of income.
I believe judge Donald Bowman said it best in the Hoover v. Minister of National Revenue, when he stated, "a restricted farmer is someone who is 'testing the water' so to speak. For this person, farming is the sideline."
For today's farmers, testing the water isn't the norm. To succeed in agriculture, substantial time, energy and capital are mandatory. To again quote Bowman: "the taxpayer plunged fully and without reservation into the water." The conclusion from Bowman in the Hover case was that Hover's chief source of income was indeed a combination of farming and his work as a dentist.
If you pass the second and third tests, then you are categorized as a full-time farmer and you are able to deduct all of your losses, without restriction, against other income.
I was fortunate to hear Beaubier speak in May this year at the Prairie Provinces Tax Conference. I remember one story in particular. Beaubier spoke of a court proceeding in which a young counsel kept addressing him as "Mr. Justice."
He corrected the young lawyer on numerous occasions and finally, at the end of the proceeding, stated that "judges of the Tax Court are not called Mr. Justice. We are called Judge. There is a reason for that. When you have been in the tax field as long as I have, you will find that there is no justice in income tax."
For the Finch family in Kelvington and hopefully for our clients and others in appeals, Beaubier's ruling has delivered more justice to those individuals working off the farm.
Allyn Tastad, chartered professional accountant, is a partner in the accounting firm of Hounjet Tastad Harpham in Saskatoon at 306-653-5100, e-mail at firstname.lastname@example.org or website www.hth-accountants.ca. All data and information provided is for informational purposes only. Readers are cautioned that laws and regulations are subject to change. Consult your accountant for current professional advice tailored to your situation.