Good News For Farmers: Supreme Court Of Canada Clarifies Proper Interpretation Of Restricted Farm Loss Rules
On August 1, 2012 the Supreme Court of Canada released its decision in Canada v. Craig, 2012 SCC 43 (“Craig”).
It’s good news for farmers, especially those farmers that need to work off the farm to make ends meet.
Mr. Craig’s horse racing business incurred losses of $222,642 in 2000 and $205,655 in 2001. Mr. Craig is also a lawyer. He reported the farm losses and used them to reduce his taxable income from his legal practice.
The Canada Revenue Agency reassessed Mr. Craig denying his claim of farm losses by applying the restricted farm loss rule contained in subsection 31(1) or the Income Tax Act which, when applicable, operates to restrict farm losses to a maximum of $8,750.
The restricted farm loss rules apply unless the taxpayer can show that:
- farming is the taxpayer’s chief source of income; or
- a combination of farming and some other source of income is the taxpayer’s chief source of income (the “combination test”).
The CRA relied on a 1978 Supreme Court of Canada decision Moldowan v. The Queen,  1 S.C.R. 480 (“Moldowan”) in applying the restricted farm loss rules to Mr. Craig’s horse racing business.
The Moldowan decision interpreted the combination test and found that the restricted farm loss rules applied because the taxpayer’s farming business was subordinate to the taxpayer’s other source of income. In other words, Moldowan found that if farming income is subordinate to the other source of income the restricted farm loss rules apply to limit the amount of loss that can be claimed. This left taxpayers in a situation where they had to demonstrate that farming was the predominant source of income in order to avoid the application of the restricted farm loss rules.
The Moldowan decision was widely criticized as reading language into the legislation that was not actually there.
Because of the Moldowan decision, the combination test was effectively read out of the legislation. If a taxpayer could show that farming was the predominant source of income, then that taxpayer would have to rely on the first exception to the restricted farm loss rules: the taxpayer would have to prove that farming was the taxpayer’s chief source of income.
The Supreme Court of Canada decision in Moldowan effectively ignored the combination test in subsection 31(1) and drew much criticism but stood as a precedent for over 30 years.
In 2006 the Federal Court of Appeal addressed similar facts in Gunn v. Canada, 2006 FCA 281 (“Gunn”) and decided not to follow and purported to overrule Moldowan because it considered Moldowan to be wrongly decided. However, the Federal Court of Appeal is not permitted to overrule binding precedent from the Supreme Court of Canada.
This created some uncertainty for taxpayers, tax professionals, the CRA and the Tax Court of Canada.
This uncertainty is now resolved by today’s decision of the Supreme Court of Canada in Craig. The Supreme Court of Canada decided that, although the Federal Court of Appeal should not have purported to overrule a Supreme Court of Canada decision, the Federal Court of Appeal’s reasoning in Gunn was correct.
In Craig the Supreme Court of Canada overruled Moldowan.
Accordingly, it is no longer necessary for a taxpayer to show that farming is the predominant source of income in order to avoid the application of the restricted farm loss rules.
The taxpayer must only show that the combination of farming and some other source of income are in aggregate the taxpayer’s chief source of income. The following excerpt from Craig at paragraph 41 provides some useful guidance:
“The provision still contemplates that the taxpayer will devote significant time and resources to the farming business, even if he or she will also devote significant time and possibly resources to another business or employment. It seems to me that, as long as the taxpayer devotes considerable time and resources to the farming business, the fact that another source of income produces greater income than the farm does not mean that such a combination is not a chief source of income for the taxpayer.”