Several sections of the Income Tax Act refer to permitted business deductions but only if the taxpayer can show the business has a “reasonable expectation of profit.”
However, the act does not define reasonable expectation of profit, so how is it applied for tax purposes?
Farm losses and restricted farm losses are a prime example of the interpretive confusion that might exist under Section 31 of the act. These rules limit the amount of losses from a farming operation that can be deducted from other income by taxpayers whose chief source of income is neither farming nor a combination of farming and some other source.
There is extensive case law dealing with the issue of what a taxpayer’s “chief source” of income is for this purpose.
The last bench mark case found in favour of a producer regardless of whether the source of income was a combination of farming or some other source and rejected the government’s contention that farm income had to be the main source of income.
The court decision didn’t last long because the federal budget of 2013 introduced a change to the tax act that reinforced the government’s earlier interpretation of the legislation.
The amendment states that the restricted farm loss rules apply if your chief source of income is not farming. Farm losses in this case may reduce income from other sources for the year only to the extent of the lesser of the farm loss for the year or $2,500 plus half of the farm loss exceeding $2,500 to a maximum of $15,000.
The deduction for the farm loss for a year is therefore limited to a maximum of $17,500 representing an actual loss of $32,500.
Any farming loss that is not deductible currently by virtue of Section 31 becomes a “restricted farm loss.”
There are subtle differences in the way the Canada Revenue Agency categorizes two sets of farmers:
- the taxpayer who does not look to farming or to farming and some subordinate source of income for his livelihood but carries on farming as a sideline business
- the taxpayer who does not look to farming or to farming and some subordinate source of income for his livelihood and who carries on farming activities with no reasonable expectation of profit
Whether a taxpayer has a reasonable expectation of profit from his farming operations is a subjective or objective determination to be made from all the facts.
Criteria to be considered include:
- extent of activity in relation to businesses of comparable nature and size
- amount of gross revenue from farming in relation to the relevant expenses
- time spent in the operation as compared to other income-earning activities
- profit and loss experience in the past years
- taxpayer’s training
- taxpayer’s intended course of action
- capability of the venture as capitalized to show a profit after charging capital cost allowance
As you might expect, the importance of documenting and supporting the above noted criteria will help ensure you can claim your farm losses.
Grant Diamond is a tax analyst in Saskatoon, SK., with FBC, a company that specializes in farm tax. Contact: firstname.lastname@example.org or 800-265-1002.