At issue
Like any other endeavour, farming can sometimes be a profitable undertaking, and at other times a losing proposition. Should losses arise in a year, the ability to deduct them depends on whether there had been an intention to undertake a commercial activity, and what other income sources the taxpayer may have had:

Where a farming business is the chief source of income, losses can be applied against other income sources, including 3 year carryback and 20 year carryforward.

At the other extreme where there is no expectation of profit – so-called ‘hobby farming’ – losses are not deductible, despite that any net income is fully taxable.

In between, where the “chief source of income … is neither farming nor a combination of farming and some source of income” [Income Tax Act s.31(1)], the ‘restricted farm loss’ rules apply.

It is this in-between category that is often a bone of contention between taxpayers and the Canada Revenue Agency (CRA). A formula is used to cap the amount of losses that may be claimed in a given year to $8,750. As with the chief income source, these losses may be carried back 3 years and forward 20 years, but can only be used against farming income.

A taxpayer win over the CRA at the Supreme Court of Canada (SCC) in 2012 drew the government’s attention, with a double-edged response making its way into the 2013 Federal Budget.

Moldowan v. The Queen, [1978] 1 S.C.R. 480

This SCC decision sets forth the three classes of farming taxpayers summarized above. On the facts, the Court found that Mr. Moldowan’s farming business was subordinate to his other sources of income, and therefore the farm loss deduction limitations applied.

This case has been considered and followed in dozens of subsequent cases.

Gunn v. Canada, 2006 FCA 281

In the approximate three decades that elapsed since Moldowan, there had been much criticism of the judgment. It required farming to be the chief source of income in both the first and second classifications, despite that nothing in the relevant ITA sections appears to require that.

In the Gunn decision, the Federal Court of Appeal sought to give effect to the word “combination” in the second classification, and declined to follow Moldowan.

Canada v. Craig, 2012 SCC 43

In Craig, both the trial and appeal courts followed the FCA in Gunn, effectively purporting to overrule Moldowan. The SCC in the present case remarked that the lower courts should have merely given reasons why they found Moldowan problematic, but otherwise followed it. Still, the matter now stood before the SCC.

The judges then proceeded to review the troubled history of Moldowan, and the concurrent development in legislative interpretation at the SCC. There is a delicate balance between the values of correctness and certainty when the top court considers overruling one of its own decisions, but in the end that is what it did.

The revised view of “combination” is to look at a variety of factors including capital invested, time spent, farming history and future intentions. If a taxpayer places significant emphasis on both farming and non-farming income, the combination suffices to be the chief source of income whether or not the farming income is greater.

Mr. Craig was entitled to his approximate $425,000+ losses for the two years in question.

Federal Budget – March 21, 2013

The Budget document briefly recaps the preceding history culminating in Craig, then proposes to restore the interpretation in Moldowan. Assuming passage of the Budget, for taxation years ending after March 21, 2013, “a taxpayer’s other sources of income must be subordinate to farming in order for farming losses to be fully deductible against income from those other sources.”

Concurrently, and in recognition that the deduction limits have not changed for 25 years, the formula will be amended to effectively double the annual deduction limit to $17,500.

Practice points:
1

• Certainty is an important part of legal and tax planning. Unfortunately for part-time farmers, it is now the certainty of being caught by the restricted farm loss rules where farming is not the chief source of income.2- For those taxpayers with more modest farming losses than the six figure amounts in these high-profile cases, the doubling of the deduction limit is the good news in this development.