Supreme Court Releases Decision in Craig
On August 1, 2012, the Supreme Court released a unanimous decision written by Justice Rothstein in Canada v. Craig, 2012 SCC 43. In Craig, the Supreme Court was faced with two issues. First, the Supreme Court was required to settle conflicting case law regarding the application of the restricted farm loss rules in section 31 of the Income Tax Act (the “Act”). Once that issue was settled, the Supreme Court then needed to determine whether the Federal Court of Appeal correctly applied the test, to the facts, in coming to its decision.
The taxpayer in this case was a Toronto lawyer whose primary source of income was professional income from his law practice, but was also in the business of buying, selling, training, and maintaining horses for racing.
The taxpayer’s horse farming activities had been profitable for some years until 2000 and 2001, when the taxpayer incurred losses in excess of $200,000 in each year, respectively. In his 2000 and 2001 tax returns, the taxpayer deducted the full amount of these losses. The taxpayer was reassessed by CRA limiting the amount of the loss to $8,750, pursuant to subsection 31(1) of the Act
The taxpayer successfully appealed to the Tax Court of Canada, where the Tax Court followed the reasoning of the Federal Court of Appeal in Gunn v. Canada, 2006 FCA 281 as opposed to the Supreme Court of Canada’s decision inMoldowan v. The Queen,  1 SCR 480. The Minister appealed the decision to the Federal Court of Appeal, where it was upheld.
Restricted Farm Losses
According to subsection 31(1) of the Act, farming losses are not restricted 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…”.
According to the decision in Moldowan, this section contemplated three types of taxpayers with farming losses: taxpayers who farm to provide the bulk of their income; taxpayers who farm as a secondary source of income; and taxpayers who farm as a hobby. According to Moldowan, the taxpayer who farm as a secondary source of income would be subject to the restrictions in subsection 31(1) of the Act.
However, in Gunn, the Federal Court of Appeal did not follow Moldowan. Instead, it performed its own statutory interpretation of subsection 31(1) and ultimately found that in order to make the determination of whether a taxpayer had a combination of farming and some other source of income was based on a number of factors.
The Supreme Court first dealt with the issue of whether the lower courts should have followed Moldowan or Gunn. Rothstein J.gives lower court judges some direction. Despite the numerous criticisms that have followed Moldowandecision, “what the court in this case ought to have done was to have written reasons as to why Moldowan was problematic, in the way that the reasons in Gunn did, rather than purporting to overrule it” (Craig, at para 21). This statement highlights the struggle between judicial fairness and certainty. Rothstein J. demands lower courts follow stare decisis, which is the legal principle that courts are to respect the precedents set in previous decisions. He also says that if a precedent case is problematic and cannot be differentiated, a court may depart from its reasons as long as deference is shown and reasons are given. Nevertheless, this error was not fatal to the taxpayer.
Interpretation of Subsection 31(1)
The Supreme Court performed its own statutory interpretation of subsection 31(1). Based on this analysis, the Supreme Court overruled Moldowan and adopted Sharlow J.A.’s combination test from Gunn that relevant factors include “the capital invested in farming and the second source of income, the income from each of the two sources of income, the time spent on the two sources of income, and the taxpayer’s ordinary mode of living, farming history, and future intentions and expectations, are all factors involved in running a farming business together with another source of income”. Based on this analysis, the taxpayer’s farm losses were not restricted by subsection 31(1).
While the decision in Craig to overrule the more restrictive interpretation found in Moldowan in favour of the more generous interpretation fromGunnmay settle the question of how to interpret subsection 31(1), there is no question that this section will continue to be litigated frequently at the Tax Court of Canada. Therefore, the first few post-Craig restricted farm loss cases that emerge from the Tax Court should be monitored for two reasons. Firstly, although it is expected to do so, it will be interesting to see how the Tax Court will respond to Justice Rothstein’s comments regarding stare decisisand whether it will follow the Supreme Court’s decision in Craig versus their previous decision in Maldowan. Secondly, when the Tax Court does follow the test in Craig, it will certainly be interesting to see how the Tax Court will balance the various factors listed in Gunn when making its decision.