The federal government maintains that the intent of its restricted farm loss (RFL) rules was to limit the ability to deduct farm losses from total income if farming is not the major source of income.
This is a major issue to most farmers because more than 75 percent of them depend on non-farm income.
Subsection 31(1) and the restricted farm loss rules were introduced in 1951. The RFL rules limit the deduction of farm losses to a maximum of $8,750 annually: $2,500 plus half of the next $12,500.
Farm losses in excess of that limit can be carried forward for 20 years to be claimed against farming income. It should be noted that the $8,750 limitation has not been updated, indexed or changed since 1988.
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The Supreme Court of Canada, specifically in the 1978 Moldowan v. the Queen case, seemed to agree with the government in early rulings and interpreted the chief source of income test in the RFL rules.
The court held that farming that results in a loss could satisfy the chief source of income test without restriction if farming is the taxpayer’s chief source of income in combination with a non-farming source of income. However, the other source of income must be subordinate or a side-line employment or business. Otherwise, farm losses would be restricted.
The Moldowan ruling introduced two classes of taxpayers in which farming was either the chief source of income or subordinate. However, it could not be a combination.
The government argued that the Moldowan decision was consistent with the purpose of the chief source of income test, which is to ensure that taxpayers for whom farming is not the principal occupation are limited in their ability to deduct farm losses from their nonfarm income.
The counter argument by the taxpayer was that a farming business, based on the subsection 31(1) wording, could be a combination of farming and another source of income regardless of which one was subordinate.
In 2012, in The Queen v. Craig, 2012 SCC 43, the Supreme Court overruled Moldowan by holding that the particular taxpayer could meet the chief source of income test by reviewing his effort and activity in addition to reviewing his source of income from practicing law and farming. In effect, the court established a test that permits the full deduction of farming losses when a taxpayer places significant emphasis on both farming and non-farming sources of income, even if it believes that farming is subordinate to the other source of income.
Nowhere does the legislation suggest that subsection 31(1) applies if farming is subordinate to any other source of income.
The Craig decision restored the original wording in subsection 31(1).
However, in the finest example of “if we don’t like court decisions, we’ll change the rules,” the federal government decided to change the Income Tax Act in the 2013 budget and codify that the other sources of income must now be subordinate to farming income.
The budget also proposes to increase the RFL limit to $17,500 of deductible farm losses annually: $2,500 plus half of the next $30,000.
