Please read the disclaimer before perusing the following article.
written 1998, published in Beef in B.C. July 98
Since 1996 Revenue Canada has re-assessed approximately 120 landowners who had sold timber over the previous several years. Revenue Canada said that the landowners should have declared the timber sale proceeds as income, and not as a capital gain eligible for the capital gain exemption for sale of qualified farm property.
Revenue Canada’s position was tested, and lost, in a case heard in the Tax Court of Canada on June 10, 1998. Judge D.W. Beaubier handed down his decision on July 9, 1998. The case is Jens Larsen v. Her Majesty the Queen.
Kamloops tax lawyer Ken Hauser acted for Mr. Larsen. This is a test case, and there is little doubt that this case will be appealed to the Federal Court of Appeal, and possibly to the Supreme Court of Canada.
Mr. Larsen and his brother ran the summer grazing portion of a cow-calf operation on 480 acres near Slocan. A creek ran through the property, with adjacent valley bottom, and treed slopes on either side. Their cattle grazed the property from May through September.
The land had been in the family since 1951. Mr. Larsen and his brother took over from their father in 1976. At no time had the land been commercially logged between 1951 and 1994.
The farm was not of a size to allow Mr. Larsen and his brother to support their families by working full time on the farm, so both brothers worked for a local forest company and farmed as well.
Mr. Larsen was one of four children. When Mr. Larsen’s father died, the property was left to all four children. In time, one of the non-farming children asked the two farming brothers to buy out the non-farming children’s interests.
The family valued the land without timber, and settled on a land-only value for the interest of each sibling. They decided to divide the timber value by having the property logged. Mr. Larsen intended to use his share of the logging proceeds to buy out the non-farming child. Mr. Larsen and his brother wanted only to log enough to pay out the other children, but the family eventually agreed to take off timber down to a 10-inch butt size, rather than the 12-inch butt size that Mr. Larsen and his brother preferred.
Mr. Larsen got quotes for the sale of the timber. The quotes were on a per cubic metre basis. The Larsen family did not want to sell the timber on a lump sum basis including all the timber on the property. They believed that a per cubic metre basis was fair to them and fair to the timber purchaser.
Mr. Larsen was not involved in the logging, except to check the size of the trees being removed. The logging contract included stipulations to protect the ranch land and business.
After the land was logged, Mr. Larsen planted 300 trees to prevent erosion and allow natural tree regeneration and shade for grazing cattle.
The judge considered the following factors to be important in making his decision:
The judge decided that what was sold was, indeed, a capital asset rather than income from a business or property. He also decided that the timber sale proceeds are included in an exception in paragraph 12(1)(g) of the Income Tax Act, which says:
The judge then looked at the definition of “qualified farm property” in section 110.6(1) as “…a property owned at that time by the individual…or a partnership, an interest in which is an interest in a family farm partnership…that is…(a) real property that has been used by (v) a partnership, an interest in which is an interest in a family farm partnership of …(the individual) and (vi)…(B) the property was used by (the) …partnership…principally in the course of carrying on the business of farming in Canada throughout a period of at least 24 months during which time an individual…was actively engaged on a regular and continuous basis in the farming business in which the property was used…”.
The judge decided that the proceeds from the timber sale were qualified farm property, and the $500,000 capital gain exemption applied.
The case was referred back to Revenue Canada to correct its assessment according to the judge’s decision.
Ken Hauser, the lawyer who argued and won the case for Mr. Larsen in the Tax Court, said that in argument, Revenue Canada suggested that only part of the property was used by the cattle and therefore for farm purposes, and only that part of the land (not the whole parcel) should be qualified farm property. For example, if trees were sold from an area which was too steep to permit cattle grazing, then that area would not be qualified farm property and the timber sale proceeds from that area would not get the special capital gains exemption.
The judge, however, was not interested in an “inch by inch” analysis of the use of the property. If a part, presumably a substantial part, was used for cattle grazing and the rest of the property was not useable for grazing (and was not used for any other business purpose), the qualified farm property definition includes the whole parcel.
The Larsen case follows previous authority, Queen v. Mel-Bar Ranches, a 1989 case upon which many accountants and tax lawyers throughout British Columbia have based opinions for clients.
On October 29, 1999, the Federal Court of Appeal upheld the original decision of the Tax Court of Canada in Her Majesty The Queen v. Jens Larsen.
The Federal Court of Appeal decision means that, for people in similar circumstances to the Larsen case, proceeds from the sale of standing timber can be taxed as capital gains rather than income. As well, if the land from which the logs are taken is qualified farm property, the special $500,000 capital gain exemption for sale of qualified farm property can apply to the sale of timber.
The logging in the Larsen case was a one-time removal of standing timber, where someone other than Mr. Larsen performed the logging over a set period of time. The timber sale proceeds were based on the amount of timber removed. The Federal Court of Appeal said that calculating the price based on volume of timber is acceptable, as long as the total payment represents the sale value of all of the type of timber which is logged from the area agreed to be logged.
Revenue Canada had reassessed a large number of taxpayers, arguing that proceeds from logging are income rather than capital. Of those reassessed, some 270 taxpayers appealed the reassessment. Their fate hung in the balance of the Larsen case.
Kamloops tax lawyer Ken Hauser, who acted for Kootenay rancher Jens Larsen, said that an appeal to the Supreme Court of Canada is theoretically possible, but unlikely.