If a taxpayer incurs a loss from carrying on a farming business, section 31 of the Act may limit the amount of the loss that can be deducted in a particular taxation year. This limitation applies when the taxpayer’s “chief source of income for a taxation year is neither farming nor a combination of farming and some other source of income.” If this limitation applies, the maximum farming loss that can be deducted in the year is $8,750.
Traditionally, the test to determine whether a taxpayer’s chief source of income is farming or a combination of farming and something else was answered by applying the framework determined by the SCC in Moldowan.
In that case, the SCC held that section 31 contemplates three classes of farmers:
- A taxpayer for whom farming may reasonably be expected to provide the bulk of income or the centre of work routine. Such a taxpayer is not subject to the section 31 restrictions;
- A taxpayer who does not look to farming for his or her livelihood but carries on farming as a sideline business. Such a taxpayer is subject to the section 31 limitations;
- A taxpayer whose farming activities are a hobby. In these circumstances, the farming activities are not considered to be a source of income and therefore any losses are not deductible.
There has been some criticism over the 30-plus years following Moldowan with respect to Justice Brian Dickson’s description of the second category. Many saw it as “judge-made law” that was adopted because Justice Dickson relied on an “unexpressed legislative intent” in the otherwise clear wording of section 31.
For example, in Gunn v The Queen (2006 FCA 281), the Federal Court of Appeal (FCA) expressly criticized this aspect of the SCC’s decision in Moldowan and allowed the taxpayer to offset farming losses against professional income even though, on the facts, farming was a subordinate source of income relative to the taxpayer’s professional income.
Since Justice Dickson’s interpretation of s. 31(1) in Moldowan was a binding precedent, the Gunn case caused confusion and is likely one of the reasons the SCC granted leave to appeal in Craig. Plus, there has been a significant amount of litigation over the years concerning the proper application of section 31.
Facts in Craig
The taxpayer practised as a lawyer in Toronto. He was also involved for over 25 years in horse ownership and racing. He derived his principal income from his law practice, the total hours from which exceeded those devoted to the horseracing operation. However, he spent both a significant amount of capital and a significant part of his daily work routine on horseracing.
Further, his mornings, evenings and weekends were consumed with enhancing the potential profitability of the horseracing business, and he was an active member of and contributor to the standard-bred racing community. He even served as chair of the industry’s appeal board.
The taxpayer’s losses from the horse operation were more than $200,000 in each of 2000 and 2001, the years at issue (and, according to evidence at trial, the taxpayer realized losses from the horse operation in 19 of 25 years up to 2008). He deducted these losses from his other income, which was principally from his law practice.
The Minister reassessed on the basis that the losses were subject to the restricted farm loss provisions set out in section 31, and the taxpayer appealed.
Tax Court and Federal Court of Appeal decisions
The Tax Court of Canada (TCC) found in favour of the taxpayer, relying on Gunn as the primary basis for its conclusion that the taxpayer’s chief source of income was a combination of the farm and law practice income, regardless of whether the income from his farming operations was subordinate to that from his law practice.
The Minister appealed the decision to the Federal Court of Appeal (FCA) on the basis that the TCC had disregarded the SCC’s decision in Moldowan. The Minister alleged that permitting the taxpayer to avoid the effect of section 31 by relying on Gunn breached the principle of stare decisis, or binding judicial precedent.
The FCA dismissed the Minister’s appeal. It concluded that the Tax Court judge did not make any error of a law in applying the more generous test in Gunn. Although the FCA acknowledged that it may not have made the same decision as the TCC judge, the decision was not based on a palpable and overriding error warranting the FCA’s intervention.
Supreme Court decision
The SCC granted the Minister leave to appeal the FCA decision. The case was heard on 23 March 2012 and the Crown’s appeal was dismissed on 1 August 2012. The reasons were delivered by Justice Marshall Rothstein.
The stare decisis principle
The SCC first addressed the issue of stare decisis. The Court noted that the FCA should not have purported to overrule Moldowan, but also held that the purported overruling did not affect the merits of the appeal or the core question of whether Moldowan should, in fact, be overruled. On that core question, the SCC concluded that the case could and should be overruled.
In reaching this conclusion, the SCC emphasized that overruling a previous decision should not be done lightly and must involve a balancing exercise between the sometimes competing values of correctness and certainty.
In this case, it decided it was appropriate to overrule Moldowan for several reasons:
- The SCC in Moldowan was incorrect in finding that taxpayers were subject to the loss deduction limitation where farming income was subordinate to another source of income.
- There has been significant judicial, academic and other criticism of Moldowan since its issuance in 1977.
- Since Moldowan, the SCC has held on a number of occasions that an unexpressed legislative intention under the guise of interpreting legislation according to its purpose is to be avoided.
The interpretation of s. 31(1)
Justice Rothstein emphasized that it is necessary to interpret s. 31(1) with regard to its text, context and purpose (Canada Trustco Mortgage Co v. Canada, 2005 SCC 54, at para. 55). However, a purposive interpretation cannot justify finding unexpressed legislative intentions.
Rothstein could see nothing in the words or context in s. 31(1) to support the proposition that farming must be the predominant source of income when viewed in combination with another source in order to avoid the loss deduction limitation.
He reviewed the various authorities on the interpretation of s. 31(1) and agreed with the conclusion of Justice Sharlow in Gunn that s. 31(1) does not contemplate a simple aggregation of two sources of income, but requires a wider inquiry into the capital invested in farming and the other source of income, the income from each source, the time spent on each source and the taxpayer’s daily routine, farming history, and future intentions and expectations.
If these factors show that the taxpayer places significant emphasis on both farming and non-farming, such a combination can constitute a chief source of income and avoid the application of the loss deduction limitation of s. 31(1).
Applying these principles to the facts, Justice Rothstein found that there was no basis for the SCC to disturb the TCC judge’s factual conclusions and his finding that the loss deduction limitation was not applicable.
Persuasive factors included the fact that the taxpayer spent both a significant amount of capital and a significant part of his daily work routine on his horseracing business. His mornings, evenings and weekends were consumed with enhancing the potential profitability of the horseracing business, he was an active member of and contributor to the community of standard-bred racing and acted as chair of the industry’s appeal board.
Taxpayers and tax practitioners should welcome this decision, given that it overrules the SCC’s earlier problematic decision in Moldowan and provides guidance as to the proper application of s. 31(1). Of course, the application of the principles outlined in Craig will continue to be based on the facts of the particular case.