Deductibility of Farm Losses from a Horse Racing Venture
Generally, a taxpayer who incurs losses from the operation of a business is entitled to deduct these losses from other income. Subsection 31(1) of the Income Tax Act provides an exception to this rule in the case of farming losses.1 This subsection allows a taxpayer, whose chief source of income is neither farming, nor a combination of farming and some other source of income, to only deduct a maximum of $8,750.00 as farming losses for the year. It has been suggested that the purpose of this exception is to deal with the problem of "gentlemen farmers" who make their money in the city, and lose it in the country.2
There has been a plethora of case law regarding the deductibility of farm losses incurred by taxpayers in the course of a horse racing venture, and the purpose of this tax bulletin is to identify the factors that will be considered in determining whether full farming losses will be deductible or not.
2. Definition of farming
Maintaining horses for racing is included in the definition of "farming" under the Income Tax Act.3 The courts have stated that the word "maintaining" implies the provision of the means of subsistence and necessaries of life, and the preservation, continuation or improvement of a certain state of being.4 However, the act of maintaining horses for racing does not need to be physically performed by the taxpayer who undertakes the activity, rather, it can be accomplished by engaging someone else to furnish the requisite services, and by paying for those services.5 Thus, a taxpayer can be found to be "maintaining horses for racing" if they do not own any land or buildings used to accommodate the horses they own, nor any tack or equipment used for racing or training horses, but instead, they hire a third party to board the horses and take care of them. The passive investment of capital, plus contributions towards expenses and fees for the care and maintenance of horses for racing by a syndicate may also be considered farming.6
If a taxpayer maintains horses for racing, then they are considered to be farming, and losses will be deductible subject to subsection 31(1) of the Income Tax Act.
3. Reasonable expectation of profit
In order for a taxpayer to deduct any farming losses from its horse racing venture, the first question to be answered is whether there is a reasonable expectation of profit, which will distinguish commercial activities from personal activities. Under the Income Tax Act, losses from a personal activity are not deductible.7 Where there is no personal or hobby element to a venture undertaken with a view to a profit, the activity is commercial, and the pursuit of profit is established.8 However, where there is a suspicion that the taxpayer's activity is a hobby or a personal endeavour, rather than a business, the taxpayer's so-called reasonable expectation of profit is a factor, among others, which can be examined to ascertain whether the taxpayer has a commercial intent.9
The factors that will be considered in determining whether a taxpayer has a reasonable expectation of profit include (1) the profit and loss experience in past years, (2) the taxpayer's training, (3) the taxpayer's intended course of action, and (4) the capability of the venture to show a profit.10 The overall assessment to be made is whether or not the taxpayer is carrying on the activity in a commercial manner, and should not be used to second-guess the business judgment of the taxpayer.
In reviewing the case law, the following factors may be helpful in determining the question of whether a horse racing venture has been set up in a commercial manner:
- the taxpayer has implemented a plan for managing and/or minimizing identified risks;
- the taxpayer has formed or implemented a plan to change a string of losses from the horse racing venture;
- the taxpayer had consulted with knowledgeable persons in the industry on how to conduct their business;
- the taxpayer has implemented a plan of action for their horse racing venture;
- the taxpayer has a partnership agreement that outlines the financing, division of profits, assignment of losses, and the keeping of accounts for the horse racing venture;
- the taxpayer has invested their own capital;
- the taxpayer is involved in the day to day running of the horse racing venture; and
- the taxpayer has a valid, objective strategy for making the venture profitable.
4. Chief source of income
Once it is determined that a horse racing venture has a reasonable expectation of profit, the taxpayer must next overcome the restriction set out in subsection 31(1) of the Income Tax Act regarding their chief source of income in order to deduct full farming losses. The seminal Supreme Court of Canada case that discusses the issue of chief source of income from farming, or a combination of farming and some other source of income, is Moldowan v. R.11 With regards to the "chief source of income", the court found that it was both a relative and an objective test, and that the distinguishing features were the taxpayer's reasonable expectation of profit from their various revenue sources, and their ordinary mode and habit of work, which could be tested by considering (1) the time spent, (2) the capital committed, and (3) actual and potential profitability.12
The factors set out in Moldowan will apply to every taxpayer, even if the taxpayer is a corporation.13 The time spent by a corporation can be measured by considering the time spent by employees in the horse racing business and the other revenue source.14 If the farming business employs more people then the corporation's other revenue source, this would suggest that a combination of farming and some other source of income is the corporation's chief source of income. Profitability will be determined by the average annual income of the horse racing business, and the other source of income.15
5. Combination of farming and some other source of income
In a recent 2006 decision, the court clarified the meaning of "a combination of farming and some other source of income" under the "chief source of income" test as discussed in Moldowan, supra.16 The issue was whether the other source of income had to be subordinate or connected to farming. The court concluded that the words of subsection 31(1) of the Income Tax Act did not impose an additional requirement that farming be the predominant element in the combination.17 In the court's opinion, the combination question should be interpreted to require only an examination of the cumulative effect of the aggregate of the capital invested in farming and a second source of income, the aggregate of the income derived from farming and a second source of income, and the aggregate of the time spent on farming and on the second source of income, considered in the context of the taxpayer's ordinary mode of living, farming history, and future intentions and expectations.18 It would result in a positive answer if, for example, the taxpayer has invested significant capital in the farming enterprise, the taxpayer spends all of his or her working time on a combination of farming and the other principal income earning activity, and the taxpayer's day to day activities are a combination of farming and the other income earning activity, in which the time spent in each is significant.19
A taxpayer will be able to deduct farming losses from their horse racing venture up to a maximum of $8,750.00, if the venture is undertaken in a sufficiently commercial manner. However, to deduct full farming losses, the taxpayer must be able to show that their chief source of income is farming, or a combination of farming and some other source of income. A taxpayer's chief source of income will be a combination of farming and some other source of income if (1) they have invested significant capital in the horse racing venture, and (2) their day to day activities are a combination of the horse racing venture and the other income earning activity, in which the time spent in each is significant. If the taxpayer is a corporation, it must show that (1) the Corporation has invested significant capital in the horse racing venture, and (2) the Corporation's employees or independent contractors' day to day activities are a combination of the horse racing venture and the other revenue source, in which the time spent in each is significant.