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Restricted Farm Losses


When all else fails, don’t be surprised if the government changes the rules.

Even if you disagree with the tax rules, challenge those rules in court and win, the government can always change the rules on you anyway. That’s exactly what  happened in a recent case regarding the restricted farm loss rules found in Section 31 of the Income Tax Act (ITA). This section was added in 1951 to restrict the deduction of full losses to actual farmers, as a means to stop hobby farmers from deducting their losses against other income. It reads:“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...” which is followed by a formula to adjust the loss down.  Here, the Department of Finance has contemplated a situation where a farmer’s chief source of income is both farming and some other source.

It’s important to recognize the Department of Finance actually drafts the ITA text while the Canada Revenue Agency (CRA) interprets and enforces that law. Over the years, the CRA has interpreted Section 31 to mean that farming must be the chief source of income. That interpretation was reinforced in a 1977 Supreme Court of Canada case of Moldowan v. Minister of National Revenue. While the decision in the Moldowan case favoured the CRA’s view, certain tax practitioners disagreed with the case because it eliminated the dual-income situation that appeared to be contemplated by the Department of Finance.

This position has been stable until a recent Supreme Court Case that overturned the Moldowan interpretation. The case of the Queen v. Craig 2012 changed the interpretation of Section 31 so that a person who is both farming and has some other occupation could still deduct full farm losses. The Supreme Court looked at a broad spectrum of factors such as “capital, time, effort, commitment and general emphasis on the part of the taxpayer with respect to the sources of income.” This decision seems to keep in context of the Section’s original intent, as Mr. Craig is a full-time practicing lawyer who devoted his spare time and most of his assets to raising race horses. 

In the tax community, we hoped the Supreme Court decision would clarify the situation as this interpretation was more reasonable than in prior years. That situation was short-lived as the government changed the restricted farm loss rules in the 2013 Federal Budget. The law now states the chief source of income must be farming - whether on its own or with another source. As a consolation prize, the government increased the deductible limit of losses to $17,500. This would require $32,500 in actual farm losses to receive the maximum deduction as allowed farm losses are the full first $2,500 and 50% of the next $30,000.

The cases of Moldowan and Craig could have been avoided had the Department of Finance more clearly articulated what they wanted in the first place.

In short, you simply have to remember – even if you fight the CRA and win, the government can still retaliate against court decisions that don’t fall in their favour. Your best strategy is to explore all possible tax advantages to minimize your exposure even if the rules should change.