If you are a part-time farmer, or if you engage in activities that would qualify as farming activities (horse-racing, for example), you may be interested in the recent decision of the Supreme Court of Canada in The Queen v. John H. Craig (2012 SCC 43), which addressed the issue of the deductibility of farm losses.
Under Canadian tax laws, there are three categories of farm losses:
- If the farming is done as a hobby rather than as a business, there is no deduction for the loss.
- Where the farming is a business but the taxpayer's chief source of income is neither farming nor a combination of farming and some other source of income, the deduction for the loss is "restricted" and is limited to $8,750 for the tax year. Any unused "restricted" farm loss for a tax year may be carried back three years or carried forward twenty years to be applied against farming income only.
- Farm losses are fully deductible against other sources of income for the year in which the farming is a business and the chief source of income is either farming or a combination of farming and some other source of income. Any unused loss for a tax year may be carried back three years or carried forward twenty years to be applied against other sources of income.
Prior to Craig, the 1977 decision of Moldowan v. The Queen ([1978] 1 S.C.R. 480) provided the basis for determining if a farm loss was "restricted." In Moldowan, the Supreme Court ruled that, if the farming could reasonably be expected to provide the bulk of income or the centre of work routine, the farm loss would not be "restricted." Thus, a taxpayer who carried on farming activities as a sideline business, even in combination with another source of income, but did not rely on farming for his or her livelihood, was subject to the "restricted" farm loss rules. Farm losses would be "restricted" unless the farming itself was a chief rather than a sideline source of income.
In the 2006 decision of Gunn v. The Queen (2006 FCA 281), the Federal Court of Appeal considered the case of a taxpayer who carried on a law practice and also had a farming business. The Court concluded, in contrast to the outcome in Moldowan, that the combination question should be interpreted to require only an examination of the cumulative effect of the aggregate capital invested in farming and the second source of income, the aggregate of the income derived from the farming and the second source of income, and the aggregate of the time spent on farming and the second source of income. This analysis should be considered in light of the taxpayer's ordinary mode of living, farming history, and future intentions and expectations.
The court allowed the deduction of the entire farming loss even though the farming was not the chief source of income. Surprisingly, the Minister of Revenue did not appeal the Gunn decision.
The Craig case appears finally to have settled these conflicting authorities, with the Supreme Court in effect overturning Moldowan and preferring the reasoning from Gunn; it is no longer necessary for farming to be the chief source of income.
The relevant facts in the Craig case are as follows:
- Mr. Craig was a lawyer practicing in Toronto.
- He had owned and raced horses for over 25 years, including buying and selling horses.
- He derived his principal income from his law practice.
- He spent more time in his law practice than he spent in the horse racing operation.
- He devoted both a material amount of capital and a very significant part of his daily work routine to horse racing.
- Mr. Craig's mornings, evenings and weekends were consumed by a dedication to enhancing the potential profitability of the operation, which was more than a distraction from his normal mode of living or an entertainment or sport.
- He was an active member of, and contributor to, the community of standard-bred racing, working to improve the integrity of standard-bred racing so as to improve the potential profitability of his operation.
- His knowledge of the horse-racing competitions (which was important for profitability) was sufficient to earn him the role of chairperson of the industry's appeal board.
- Mr. Craig's losses from the horse racing operation exceeded $200,000 in each of 2000 and 2001. He realized losses in 19 of the past 25 years, to 2008.
The Court confirmed that the relevant factors to be considered are:
- the capital invested in the farming and the second source of income;
- the level of income from each of the two sources;
- the time spent on the two sources of income; and
- the taxpayer's ordinary mode of living, farming history, and future intentions and expectations.
The Court further stated that the approach must be flexible, recognizing that each individual factor need not be significant. The question is whether, looking at the factors together, the taxpayer places significant emphasis on each of the farming business and the other earning activity. If so, the combination will constitute a chief source of income and will avoid the loss deduction limitation.
The Supreme Court concluded that farming, in combination with Mr. Craig's law practice, was a chief source of income, and that the "restricted" farm loss rules did not apply. Therefore, his losses from the horse racing operation were not limited to $8,750 per year but were fully deductible from his other sources of income, mainly his law practice.
If you are carrying on a farming business in combination with another source of income and you have incurred losses in the farming business, contact your Collins Barrow advisor to discuss whether those losses may be fully deductible in accordance with the Craig decision.
Mark Brewster, BA, CMA, is a Tax Manager in the London office of Collins Barrow.
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