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For the first time in 35 years the Supreme Court (SCC) has unanimously ruled on a farm loss deductibility case and in so doing overruled its own 1977 decision in Moldowan. In The Queen v. John H. Craig the Supreme Court unanimously ruled that Mr. Craig, a lawyer, could fully deduct losses he incurred from his horse-racing business without restriction against all sources of income. Following hard on the 2006 Federal Court of Appeal (FCA) decision in Gunn (interestingly, also a lawyer), the Supreme Court has established a new set of factors and analysis to determine whether the full amount of losses incurred in a farming operation are deductible.
The relevant wording of subsection 31(1) of the Act has changed little over the past 35 years:
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 ...to a maximum $8,750 deduction.
The key interpretive issue has been under what circumstances the combination of farming and some other source of income constitutes a "chief source of income" allowing the taxpayer to avoid this farm loss restriction. Under the 1977 Moldowan SCC decision, the Court found that if farming income is subordinate to the other source of income the restricted farm loss rules apply to limit the amount of loss that can be claimed. The combination test was effectively read out of the legislation. This left taxpayers in a situation where they had to demonstrate that farming was the predominant source of income in order to avoid the application of the restricted farm loss rules. Relying on Moldowan, CRA has routinely denied and successfully litigated farm loss deductions over the past 35 years. Unless a taxpayer could prove farming was his or her chief source of income, the taxpayer was to be denied full deduction of their farming losses.
The first significant crack in this interpretation came in the 2007 FCA decision in Gunn which 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 his law firm income. In Gunn, the FCA ruled 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 second source of income, the income from each of the sources, the time spent on the two sources and the taxpayer’s ordinary mode of living, 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).
On August 1, 2012 the SCC overrode Moldowan in the Craig decision, ruling that s 31(1) will not apply to a taxpayer where:
While a definition of “significant emphasis” is not provided, the decision sets out a list of factors to be considered:
The SCC confirmed that as long as the taxpayer devotes considerable time and resources to the farming business, the fact that another source of income (which does not have to be a connected business) produces greater income than the farm does not mean that such a combination is not a chief source of income for the taxpayer. If this requirement is satisfied, then the taxpayer can deduct the full amount of any losses from the farming operation against the other source of income, without limitation.
This decision should be welcomed by farmers particularly those that support their farming activities by working off farm. If you believe that this case is relevant to your tax position, you should consult your MNP tax advisor.
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