Many horse businesses are subject to special rules set out in section 31 of the Income Tax Act, R.S.C. 1985, c.1. (5th Suppl.), as amended (the “Act”), that severely restrict the deductibility of losses against other sources of income.
Section 31 of the Act creates a restriction on the general ability of a farming business to deduct business losses where the losses are generated by a farming business which does not constitute a taxpayer’s chief source of income. It allows only the first $2,500 of the farm loss, plus one-half of the loss in excess of $2,500 to a maximum of an additional $6,250, to be deducted against other income ($8,750 in total). The amount of deduction permitted under section 31 in 50 years has grown from $5,000 to $8,750 at a time when the rate of inflation alone would make it over $50,000.
Good News for Businesses:
Recently, the Courts have stepped in to help the racing and farming industries. The Courts have removed the requirement instituted by the Supreme Court of Canada in the Moldowan case that farming income be the chief source of income for the business operator in order to avoid the application of section 31 farm loss restrictions.
In Craig v. The Queen, 2011 FCA 22, the Court permitted a taxpayer, whose chief source of income was not farming, to claim full deduction of business losses from his horse racing business even though in most years, his racing business ran at a significant loss. Mr. Craig’s primary income was from his law practice.
In excluding the taxpayer’s horse business from the application of section 31, the Court considered the following:
- time spent, capital committed, potential profitability, and the taxpayer’s ordinary mode and habit of work
- these will be looked at cumulatively to determine whether farming is more than a sideline business
- in this combination test, farming does not need to provide the bulk of a taxpayer’s income or even ever be the predominant business or work activity of the taxpayer
With Craig, it is now easier for a taxpayer to claim full deduction of business losses from a horse racing business.
The Crown appealed this decision to the Supreme Court of Canada and lost in August of 2012. The Supreme Court used the opportunity to overrule its own decision of Moldowan. Horseracing or farming income does not need to be a taxpayer’s primary source of income to avoid the application of section 31.
Bad news for Businesses:
The Harper Government has redrafted section 31 as of December 2013 to enshrine the pre-Craig interpretation of section 31. In short, it reads:
“If 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 that is a subordinate source of income for the taxpayer, then ………[section 31 will apply and the taxpayer will be subject to the restricted farming loss]”. [Underlined words are new as added by the Harper Government.]
This is a bad law:
- It makes no sense and is redundant. If a taxpayer’s chief source of income is farming, then all other sources of income are lesser.
- Redrafting is a complete rebuke to the Supreme Court of Canada and the wisdom implicit in their decision in Craig. The Supreme Court of Canada tried to make sense of a nonsensical provision of the Act and did a good job of it. The Harper Government has gone back to nonsense.
Where do we go from here?
- The Harper Government amendment applies to the 2013 taxation year and on. Years prior to that would still be governed by the old section and by Craig. As such, for 2012 you can still file for full deduction based on Craig and other cases.
Get rid of Section 31. You have the power to make a difference in the next election.
Catherine Willson is counsel at Goldman Sloan Nash & Haber LLP in Toronto (www.gsnh.com).