You reap what you sow, CRA insists: Lawyer fights to write off losses from farming 'sideline'

National Post

2005-10-22



Can the practice of farming and the practice of law be so intrinsically
connected such that they constitute part and parcel of the same business? And if
so, can farming losses be written off against one's professional income from a
legal practice? These questions came before a judge in a recent Tax Court of
Canada decision.

Douglas Gunn is a lawyer as well as a farmer who was reassessed by the Canada
Revenue Agency for the 1997, 1998 and 1999 tax years, during which time he
realized significant losses from his farming operations while earning
substantial income in his law practice.

While the taxman did not deny Mr. Gunn was, indeed, a "genuine farmer," and
that farming was a source of income for him, the CRA felt that farming was not,
either alone or in combination with the practice of law, Mr. Gunn's "chief
source of income." Mr. Gunn disagreed and considered farming and the practice of
law "in combination" to constitute his chief source of income.

This distinction is critically important, as it governs the tax treatment of
farming losses. Under the Income Tax Act, farmers can be divided into
essentially three categories. The first would be someone for whom farming may
reasonably be expected to provide him or her with the bulk of his or her income
for the year. This type of farmer is entitled to write off any farming losses
against all other sources of income, without any restrictions.

The second category of farmer is someone who does not look solely to farming
for her livelihood but rather carries on farming as a "sideline business." This
type of farmer is restricted in the amount of farming losses that can be
deducted against other sources of income. The unrestricted portion of such
losses is limited to $2,500 plus one-half of the next $12,500 of losses or, in
Mr. Gunn's case, $8,750 per year. The remainder of any losses is considered to
be a "restricted farm loss," which can be carried back three years or forward 10
years to offset farming income in those future years.

The third type of farmer is a taxpayer who does not look to farming for his
livelihood and who carries on some farming activities as a hobby. The losses
sustained by this type of farmer are never deductible.

Mr. Gunn testified that he does most of the work involved in his farming
operation himself, with the assistance of his wife. He estimates that, on
average, he spends about 50 hours per week working at his law practice, and
about 20 hours on farm work.

He also argued here were "substantial synergies between his law practice and
his farming operations," since many of the clients of the law practice are
people he met through his farming connections.

The judge, in attempting to decide in which of the three categories of farmer
Mr. Gunn properly fit, took into account the relative amounts of capital he
committed to his farming operation and law practice, as well as the amount of
time he spent on each activity and their relative potential profitability.

Unfortunately for Mr. Gunn, however, the judge found the amount of capital
and time he spent on the practice of law was far more significant than the
amount he spent on his farm. He also was somewhat skeptical of the "synergy"
between the farming operation and legal practice, observing that "lawyers
attract clients for all sorts of reasons and through numerous avenues. [While] I
have no doubt that Mr. Gunn obtained many clients over the years as a result of
contacts made in the course of his farming business ... the evidence falls far
short of establishing the kind of synergy" required to connect the two.

The judge concluded Mr. Gunn's farming operation was "a sideline business"
and was not "either alone or in combination with his law practice, his chief
source of income." Mr. Gunn was thus permitted to claim only $8,750 per year of
farm losses.

Mr. Gunn has appealed this decision to the Federal Court of Appeal, which
will likely hear his case next year.