In an age when almost two-thirds of total income for Canadian farmers comes from off-farm sources, section 31 of the Income Tax Act has always presented a problem.
Section 31 limits deductible losses “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.”
The problem with Section 31 arose in a 1978 Supreme Court Case (Moldowan vs. The Queen), which found that there were three classes of taxpayers involved in farming.
The first class included those who derive the bulk of their income from farming and whose losses are not limited.
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In the second class are taxpayers who essentially carry on farming as a subordinate source of income to other work or in essence farming is a sideline activity. In this case, farm losses are limited.
Falling into the third class are hobby farmers whose losses are not deductible at all.
This interpretation seemed to override the actual words of the Income Tax Act in most court cases.
The Canada Revenue Agency generally took the 1978 precedent as a basis to apply the source of major income as the prime test for establishing limits to deductible farm losses.
In 2006, the Federal Court of Appeal found a more generous interpretation of what could constitute “a combination of farming and some other source of income.”
The problem with this more flexible interpretation according to the Supreme Court is that it’s not up to lower courts to overturn a Supreme Court finding — only the Supreme Court can do that.
However, the Supreme Court in a recent decision found that its 1978 decision was wrong and should be changed.
The current court found that there are several relevant factors that would define a combination of farming and some other source of income. These are:
- the capital invested in farming and the other source of income
- the amount of money that comes from each source of income
- the time spent on each source of income
- the taxpayer’s ordinary mode of living
- farming history
- future intentions and expectations
The court found that if the taxpayer places significant emphasis on both farming and non-farming sources of income, then there is no reason that such a combination should not constitute a chief source of income.
This would then avoid the loss deduction limitation of Section 31 of the Income Tax Act. Both farm and non-farm income must be significant endeavours of the taxpayer, but they don’t need to be connected, and farming doesn’t have to be the predominant source of income.
Although the decision is a positive one for those involved in farming activities, it can take years for Sup-reme Court decisions to be fully applied by lower courts and the CRA.
