RED DEER – Defining the difference between a hobby farm and a serious
business is a conundrum for Revenue Canada and the courts.
“Revenue Canada looks at small acreage farming, hobby farming, as a
lifestyle choice, not as a business,” said Greg Gartner, a chartered
accountant from Edmonton who handles agricultural clients and small
business taxation.
He explained the complexities of farm taxation at a horse breeder’s
conference in Red Deer last month.
Horse operations concern Revenue Canada because the activities are
Read Also
VIDEO: British company Antler Bio brings epigenetics to dairy farms
British company Antler Bio is bringing epigenetics to dairy farms using blood tests help tie how management is meeting the genetic potential of the animals.
difficult to define. As well, expenses are often large and returns are
low.
Under the Income Tax Act, farm losses can’t be deducted if the
taxpayer’s chief source of income isn’t farming, or if it is a
combination of farming and off-farm income.
The tax department is also challenging commercial farm operations that
may have a profitable sideline business, such as a trucking service.
For farmers with a reasonable expectation of profit but whose chief
source of income is not farming, losses are restricted to $2,500 plus
half of the next $12,500 to a maximum of $8,750. The loss may be
carried forward and used against any farm income for 10 years.
It may also be carried back to reduce farm income reported in any of
the three previous years.
Regardless of the type of farming activity, farmers are only allowed to
write off losses if the business has a reasonable expectation of profit.
The Income Tax Act sorts farmers into three categories, the main
difference being the extent to which they can deduct losses relating to
their farm activities.
- Farmers who may reasonably expect their farms to provide the bulk of
their income and be the centre of their work routine.
They are allowed to treat their farming business like any other
business and can claim losses against other income for tax purposes if
they suffer losses in a given year.
- Farmers who do not have a reasonable expectation of profit from their
farm.
They are considered hobby farmers and can deduct no losses from their
farms. Gartner said Revenue Canada would prefer to put most horse
operations in this class.
- Farmers who have a reasonable expectation of profit, but whose chief
source of income is neither farming nor a combination of farming and
some other source of income.
The amount of loss they can deduct is restricted. When a tax case is
defended in court, some consideration is given to capital commitment,
profit compared to other sources of income, and the amount of time
devoted to the farm.
At one time, tax cases had to prove they broke even, but now courts
demand sustainable profit and proof that profits would have been
achieved without reasonable setbacks.
If a taxpayer ends up in court, certain pieces of evidence are
required, such as farming history and knowledge the taxpayer has
developed in farming as a skill, including experience and education.
The taxpayer must illustrate that time committed to the farm is equal
to other businesses.
“Profitability is the greatest obstacle which must be overcome when a
taxpayer is seeking to persuade the courts that farming is their chief
source of income,” Gartner said.
To claim losses a taxpayer must prove:
- There was no change in occupational direction when the loss
occurred.
- Farming could potentially generate substantial income and that the
farm was not a hobby.
If someone had to get an off-farm job to pay bills, the case may be
ruled in his favour.
“The courts have some sympathy for farmers who have to bring in an
outside source of income,” Gartner said.
Audit notices must be taken seriously and questionnaires must be
completed. Auditors may ask what setbacks occurred and what profits
were expected if these had not occurred.
An income projection should be provided to show the taxpayer is able to
demonstrate a reasonable expectation of profit in the future.
The chance of a profit cannot be absurd. Strange claims catch the
attention of tax collectors.
Courts will not accept losses that carry on for extended periods of
time. Farms that report losses for six to 10 years are treated as
having no business.
