Every now and then a taxpayer gets a break from the courts.
One recent case involved an individual who farms and practises law for a living.
For more than 40 years he built up his farm to the point where he now raises a sizeable herd of purebred Hereford cattle and grows rye, hay and tobacco as his main cash crops. During the same period he expanded his law practice so that he now employs four other lawyers.
His law practice required a relatively modest investment of capital and has been consistently profitable. The farming operation absorbed a significantly greater investment of capital, but it has resulted in operating losses in all but two of the past 15 years.
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The taxpayer claimed that his farming operation and law practice were so intertwined that he gained many of his clients through people he had met as a result of his farming activities. He argued that he should be allowed to deduct all of his farming losses from his professional income.
The Canada Revenue Agency disagreed, largely on the basis that he spent approximately 30 percent of his time farming and the balance in his law practice. Although CRA agreed that he was employed in a legitimate commercial farming operation, it maintained that farming was a sideline to his main source of income, which was the practice of law. The agency therefore restricted his farm losses that could be deducted against other sources of income to $8,750 per year under subsection 31(1) of the Income Tax Act.
The taxpayer appealed the CRA tax assessment to the Tax Court of Canada in 2005, but it largely agreed with CRA that the farming losses should be restricted. The court concluded that farming did not constitute the taxpayer’s chief source of income and that the law practice provided the bulk of his livelihood.
The taxpayer then took his case to the Federal Court of Appeal this year for another hearing. The appeal court was much more generous to the taxpayer. In a unanimous decision, it overturned the lower court’s decision and found that because of a factual connection between the taxpayer’s farm and law practice, his chief source of income was, in fact, a combination of farming and the practice of law. Although his farm investment and farm losses were subsidized by his law practice, the appeal court also found that the taxpayer’s farm and law practice together comprised all of his income and business-related capital.
Based on this conclusion, the appeal court allowed the taxpayer’s appeal with costs and instructed CRA to reassess the taxpayer, allowing full farm losses to be deducted from his law income.
Larry Roche is a tax analyst with farm taxation and planning specialists Farm Business Consultants Inc. He can be contacted at fbc@fbc.ca or call 800-860-7011.
