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Reasonable expectation of profit

The Canada Revenue Agency (CRA) refers to permitted business deductions in a number of sections of the Income Tax Act (ITA).


October 19, 2016
By FBC Tax Consultants

Topics

October 19, 2016 – The Canada Revenue Agency (CRA) refers to permitted business deductions in a number of sections of the Income Tax Act (ITA). However, these deductions can only be used if the taxpayer can show their business has a reasonable expectation of profit. The problem is that reasonable expectation of profit is not defined in the ITA so how is “reasonable expectation of profit” applied for tax purposes?  

Farm losses and restricted farm losses are a prime example of the interpretive confusion that might exist under Section 31 of the Tax Act. These rules limit the amount of losses from a farming operation that can be deducted from other income by taxpayers whose chief source of income is neither farming nor a combination of farming and some other source.

There is extensive case-law dealing with the issue of what a taxpayer’s “chief source” of income is for this purpose. The last bench-mark case found in favour of a producer and ignored whether the source of income was a combination of farming or some other source. The court ruling did not factor the government’s contention that farm income had to be the main source of income.

The court decision didn’t last long because the federal budget of 2013 introduced a change to the Act that reinforced the government’s earlier interpretation of the legislation. The amendment states that if your chief source of income is not farming, then the restricted farm loss rules apply. Farm losses in this case may reduce income from other sources for the year only to the extent of the lesser of the farm loss for the year or $2,500 plus half of the farm loss exceeding $2,500 to a maximum of $15,000.

The deduction for the farm loss for a year is therefore limited to a maximum of $17,500 representing an actual loss of $32,500. Any farming loss which is not deductible currently by virtue of Section 31 becomes a “restricted farm loss”.

There are subtle differences in the way CRA categorizes two sets of farmers.

  1. The taxpayer who does not look to farming or to farming and some subordinate source of income for his livelihood but carries on farming as a sideline business
  2. The taxpayer who does not look to farming or to farming and some subordinate source of income for his livelihood and who carries on farming activities with no reasonable expectation of profit.

Whether a taxpayer has a reasonable expectation of profit from his farming operations is a subjective or objective determination to be made from all of the facts.  Some of the criteria to be considered are:

  • Extent of activity in relation to businesses of comparable nature and size
  • Amount of gross revenue from farming in relation to the relevant expenses
  • Time spent in the operation as compared to other income earning activities
  • Profit and loss experience in the past years
  • Taxpayer’s training
  • Taxpayer’s intended course of action
  • Capability of the venture as capitalized to show a profit after charging capital cost allowance

As you might expect, the importance of documenting and supporting the above noted criteria will assist you in ensuring you can claim your farm losses.