L. Gordon Jahnke v. Minister of National Revenue, [1991] 1 CTC 2517, 91 DTC 731

Christie, A.C.J.T.C.:—The appellant appealed from reassessments of his liability to income tax in respect of 1981, 1982 and 1984. As initially cast, the notice of appeal raised a considerable number of issues, but at the commencement of the trial counsel informed the Court that what had been in dispute was reduced to the issue of the deductibility of losses incurred in a ranching undertaking carried on in Australia. The amounts involved are 1981—$97,157; 1982—$69,481 and 1984—$19,155. Regarding 1981 and 1982 the quantum of the losses is no longer challenged by the respondent, only their deductibility. Both quantum and deductibility continue in dispute regarding 1984.

The appellant is currently a grape farmer in California and has been for about three years. He was born on a farm near Herbert, Saskatchewan, and lived there until he was 22 years of age. It was mixed farming on 2,000 acres with emphasis on beef cattle. As would be expected he assisted in all aspects of the work on the farm and this background instilled in him a desire to engage in farming. He has six brothers, five of whom are farmers.

After graduating in law he secured a position at the University of British Columbia Law School. He was there from 1961 to 1982 with intervening periods of leave of absence. He taught an aspect of commercial law called "Secured Transactions" in relation to personal property. One of those absences was in 1974 when he was engaged as a part-time lecturer and in doing research at the University of New South Wales in Sydney, Australia. He met individuals there who were involved in farming on a large scale and, in particular, he came to know Philip Gibson who managed farms in the northern part of Queensland, Northern Territory and Western Australia. Through them and reading literature on farming in Australia he made the decision in 1977 to acquire a farm there. At this time the appellant was residing in Canada.

In 1978 he was in Australia and Gibson played a role in what followed. In addition to managing farms he was a real estate broker and the principal owner of a corporation carrying on business in Sydney called Philip Gibson Proprietary.

From his own inquiries and research the appellant had concluded that the prospects for raising beef in Australia were particularly good in the late 1970s because herds in the major beef-producing countries of Canada, Australia and the United States were very low by reason of poor prices in the early and mid-70s. He said this shortage could not be rectified overnight and it would take a period of three to four years. Also it was anticipated that restrictions on the importation of beef to Japan and the United States would be alleviated. Further, the potential for a large beef operation with a smaller capital commitment was much greater in Australia than in Canada.

In company with Gibson he looked at cattle ranches (or stations as they are called in Australia) in northern Queensland, in the Northern Territory and in Kimberley which is the northern part of Western Australia. They examined about ten stations, not all of which were for sale. There were three or four possible acquisitions and the appellant regarded the Drysdale River Station (” Drysdale") as the one with real potential. It consisted of 667,620 acres and is located in the Kimberley Division. It is regarded as an average size ranch in that area. It had a plentiful supply of water and was reasonably level. Large escarpments are to be avoided as they are an impediment to the movement of cattle. The property was regarded as suitable for the sowing of grass and the production of other feed.

Drysdale, like the other stations in the area, was on Crown land and what ranchers obtained was a lease of those lands. The leases were issued by the Department of Lands and the term was in the order of 50 years. To obtain an assignment of a lease from a tenant or a subtenant it was necessary for plans of the operation and development of the land to be submitted to the Department of Agriculture. This was done. The appellant obtained an assignment of the balance of the term on the lease of Drysdale from Lima Investments Pty. Ltd. The term of the head lease was 48 years six months from January 1, 1967. The appellant was the second assignee. He paid $360,000 Aus. (estimated conversion rate 1.2935 $465,660 Cdn.) $200,000 of which was in cash and payment of the balance was secured by a mortgage in favour of Lima Investments Pty. Ltd. The assignment is not an exhibit, but the evidence is that it was made in late July or early August 1979. The acquisition was made without a perusal of financial statements of the business and, apparently without even endeavours to obtain them. Only the muster (round-up) figures for the previous year were reviewed. Other muster figures were not produced. Drysdale was sold in May 1986 for $325,000.

When the appellant acquired Drysdale there were about 6,000 head of cattle on the property. There was a manager, Rex Dickson, a head stockman and eight or nine stockmen. Photographs were placed in evidence depicting such things as the manager's house; stockmen's quarters; a large shop constructed of metal sheeting which included in it a large freezer-cooler; two 5,000 gallon tanks of water mounted on towers of which there were five altogether on the property; a portable stockyard (in addition to these there were five permanent stockyards); a powerhouse which contained a diesel generator and a large stock truck and other vehicles used on the station.

Just prior to the assignment being made the appellant and Dickson prepared a final budget for 1979-80 which was reviewed by Gibson. Dickson had been on the station for six or seven years. In summary this budget projected income of $114,000, expenses of $57,000 and outlays for a land cruiser, saddle and horses totalling $18,000. I assume these are Australian dollars.

The organization to manage the ranch had Dickson in charge of day-to-day operations and Ted Boreham of Darwin, which is some 400 miles from Drysdale, was appointed as the appellant's agent for the acquisition of materials of all kinds needed at the station. Banking arrangements were established in this regard. Also Dickson had a bank account which was limited to $1,000.

At this time the appellant had not taken up permanent residence in Australia, but he said that was his intention. He had applied for landed immigrant status in Australia and it was approved on June 1, 1979. He returned to Canada. The appellant's returns of income for 1979 to 1985, with the exception of 1983, are in evidence. In 1979 he reported employment income from the University of British Columbia of $19,140. This sum reflects his part-time attendance in that year. He also had income from other sources. In each of the other years in respect of which his returns of income are in evidence, income from professional employment and from other sources is reported. The 1979 return includes a statement of farm losses that shows income from the sale of cattle of $38,485 (Aus.). Expenses were $116,490 (Aus.), with a net loss of $78,005 (Aus.) which translated into $100,899 (Cdn.). In addition there were expenses paid by the appellant of $19,258 (Cdn.). In total there was a loss of $120,157 Cdn. In 1980 the appellant again included a statement of farm losses in his return. The income from the sale of cattle is $46,335 (Aus.) and expenses are $134,380 (Aus.) with a net loss of $88,045 (Aus.) which translated into a loss of $117,355 Cdn. Additionally he paid expenses of $18,759 (Cdn.) with the result that the total farm loss was $136,114 Cdn. When these results are compared with the 1979-80 budget prepared by the appellant and Dickson which was reviewed by Gibson we see these differences in Canadian currency between projected income and expenses: projected income—$147,459; actual income—$111,540; projected expenses—$73,729; actual expenses—$367,812.

The appellant said that in September 1979 Dickson's wife was diagnosed as having abdominal cancer. She died in July 1980. This completely distracted Dickson from his work and he was described by the appellant as incapable of being an effective manager. His major preoccupation was seeking treatment for his wife and he took numerous charter flights to Brisbane and other places. Included in expenses were considerable amounts for charter flights and his expenditures were totally out of line with what had been projected. Material was being purchased that was not strictly necessary. Dickson circumvented the arrangement with Boreham by establishing a line of credit with Elders, a large beef marketing and farm supply company located in Perth. Elders had previously had an account with Drysdale and the appellant indicated he may have discussed the possibility of continuing the account with them if needed. In any event the line of credit was established.

In 1980 he returned to Australia and Dickson was replaced by another manager, Steve Maclnnes. When hired, Maclnnes was working as assistant manager at a large station.

Because of the performance of Drysdale in 1979 and 1980 the plan to move to Australia was put in abeyance because the appellant needed his Canadian employment income which together with assets he had in Canada would allow him to raise funds.

In respect of 1981 (the figures that follow are all in Canadian currency) the appellant reported farming losses of $97,157. The income in that year from the sale of cattle was $36,595 and expenses were $133,753. Compared with 1980 this shows a reduction in income from $61,760 to $36,595 or $25,165 and reduced expenses, i.e., from $197,874 to $133,753 or $64,121. The appellant attributed the final results in 1981 to two things. First a slump in the price of beef in that year and second the manner in which Maclnnes performed. He was not sufficiently " experienced or motivated" to carry out a proper round-up so that adequate numbers of cattle would be sent to market. He concentrated too much on developing the herd and not enough on marketing it. Funds were raised by the appellant in respect of this loss by selling some of his Canadian assets.

In 1981 Macinnes resigned as manager and was replaced by Peter Reynolds. The appellant and Reynolds drew up new plans for 1982 that included substituting farm hands for helicopters in rounding up cattle. It had been intended to begin the round-up at the usual time in May, but in January or February 1982 a Mr. D[o]ug Halleen who was in the real estate business told the appellant that he should be able to sell Drysdale for him on favourable terms. Because of the losses already incurred, the appellant agreed and an auction of the property was scheduled for April 21, 1982. The reserve bid of $400,000 was not met and there was no sale. The high bidder was close to the reserve bid and Halleen assured the appellant that he could persuade the high bidder to buy the property if he was given an opportunity to negotiate with him. These negotiations put the round-up in abeyance. In the first week of July the appellant was notified that there would be no sale. They proceeded to round up some cattle, but they were not in good enough condition to send to market. The statement of farming losses included in the appellant's return of income for 1982 shows no income and expenses of $69,481.

He left Canada for Australia on December 18, 1982, and ceased to be resident in Canada at that time. The evidence about what happened in 1983 is very brief:

Q. All right. What did you do when you got there?

A. Well, I went out to the station and tried to motivate and set up a plan for the'83 operating period.

Q. Okay. And you say—did you live on the station, or what did you do?

A. For periods. I was back and forth. I was in the United States a fair amount during 1983 and in Australia.

Q. Okay. And what was your dealings with the ranch at that time? What did you do in ‘83 vis-à-vis the ranch?

A. We carried on a fairly conservative muster, and basically we were on a breakeven basis.

Q. In'83?

A. Yes.

The appellant not being resident in Canada in 1983, he did not file a return of income under the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the "Act") with respect to that year.

He returned to Canada at the end of 1983. Before doing so he entered into an agreement with a Mr. Roger McFarlane to operate Drysdale on a profit- sharing basis. McFarlane assumed management of Drysdale at the beginning of 1984. He failed to account to the appellant for the operation of Drysdale in 1984 and 1985. In his return of income for 1984 the appellant claimed farming losses of $19,155. No income is reported. This is the evidence in chief about these losses:

Q. And this $19,000 loss you claimed in 1984, what does that primarily relate to?

A. That primarily relates to interest and my expenses in Canada. I did not have expenses—any responsibility for the expenses—he ran the operation and generated enough income to cover his operating expenses. He may have made—well, I don't know whether he made additional profit, because he failed to account to me for his activities during 1984 and ‘85.

The evidence given about investment and capital is this:

Q. Mr. Jahnke, this is a final comment I guess on your farming operation. About how much capital or money did you end up investing in the thing overall?

A. I think the order of between five and six hundred thousand dollars.

In 1985 the appellant filed a return of income that included a statement of farm losses. The income was nil and expenses were stated to be $3,508.

When the appellant was asked what, apart from the difficulties with managers, he identified as significant in relation to the overall losses, he referred to the 1981 recession in Canada and the United States. He said the United States responded by again restricting the importation of beef from Australia. Also involved was a significant slump in prices for beef in 1982, 1983 and 1984.

I will dispose of the dispute pertaining to 1984 first. The appellant says that he entered into a profit-sharing agreement with McFarlane in respect of that year. It is also his evidence that McFarlane met expenses, but he does not know if he made a profit. What is deductible in computing income from other sources are farming losses which are derived by deducting expenses from revenue. Expenses are not per se deductible. It is clear that the appellant does not know what the revenue was in 1984 and consequently does not know whether, even if the expenses of $19,155 are taken into account, there were losses in that year. The appeal cannot succeed in this regard.

With reference to 1981 and 1982, my conclusion is that there was no reasonable expectation of profit in those years. This was not a start-up undertaking. Twelve years of the term of the head lease had expired when the appellant acquired Drysdale. The property was, as previously stated, equipped with buildings, water towers, stockyards, etc. There were some 6,000 head of cattle on the station. The appellant’s evidence indicated that inquiries into the past performance of the operation at Drysdale was at best cursory. More care in this regard might well have uncovered what must have been some basic business problem. Even allowing for the distraction from his performance as manager suffered by Dickson because of his wife's illness and the unfavourable comments about Dickson's successor Maclnnes, the losses for 1979, 1980 and 1981 are inconsistent with the undertaking at Drysdale, when objectively tested as it must be, having had a reasonable expectation of profit. In 1979 and 1980 the expenses projected by the appellant, Dickson and Gibson were a mere 20 per cent of what was actually incurred. In those years income was only 30 per cent of expenses. In 1981 income was 27 per cent of expenses. In 1982 there was no income, only expenses because of the appellant's desire to dispose of Drysdale because of the losses that were being incurred. The losses during the period 1979 to 1982 are 91 per cent of the purchase price for Drysdale as a going concern.

In reassessing the appellant in respect of 1981 the respondent added $133,753 to income. During the course of the trial counsel informed the Court that even if it should be decided that there was no reasonable expectation of profit in that year that amount should be reduced by $36,595 because it had been added to income in error.

Finally 1 will deal with the submission regarding onus of proof that was made by the appellant prior to any evidence being called. The background of this submission is as follows. The notice of reassessment in respect of each year is dated October 13, 1987, and the reason given for disallowing the deductions of farming expenses is the same in the three notices, namely, the expenses were " unsubstantiated”. These reassessments, except for 1984, dealt with matters in addition to the farming expenses. The appellant objected to these reassessments by notices dated November 10, 1987. On February 24, 1989, the respondent reassessed in respect of 1981 and 1982, but not regarding the farming expenses. On this date he also issued a notice of confirmation regarding the reassessment for 1984. It reads:

It has not been shown that the farm expenses amounting to $19,154.89 claimed as a deduction from income in the year were made or incurred by you for the purpose of gaining or producing income from a business within the meaning of paragraph 18(1) (a) of the Act.

If confirmation of the reassessments had been issued respecting 1981 and 1982 I believe it is safe to assume it would have been couched in the same language. The appellant then instituted his appeal against the three reassessments as he was entitled to do under paragraph 169(a) of the Act.

Paragraphs 13 and 20 of the notice of appeal read:

13. The appellant incurred the following expenses in operating his ranching business in the years under appeal.

1981	$133,752.68
1982	$ 66,406.96	[sic]
1984	$ 19,154.89

20. The appellant submits that he incurred the expenditures described in paragraphs 13 and 14 (the latter is no longer relevant to this appeal) herein for the purpose of gaining or producing income.

Paragraphs 5(h), 6 and 18 of the respondent's amended reply to notice of appeal read:

5. In reassessing the appellant for his 1981 and 1982 taxation years, and in confirming the reassessment of his 1984 taxation year in the manner set out in paragraph 18 (reassessment of 24 February 1989) of the Notice of Appeal, the Minister of National Revenue relied, inter alia, upon the following assumptions:

(h) the disallowed farm expenses were not incurred for the purpose of earning income from a business or property in the 1981, 1982 and 1984 taxation years.

6. The farming operation in Australia in respect of which the appellant claimed losses in his 1981, 1982 and 1984 taxation years did not constitute the conduct of a business carried on in those years with a reasonable expectation of profit, and the expenses reported in respect of the said operation, if incurred, were not incurred for the purpose of earning income from a business or property.

18. The respondent submits that he properly reassessed the appellant for his 1981, 1982 and 1984 taxation years, and correctly disallowed the farm losses claimed by the appellant, as the losses, if incurred, were in respect of expenses that were not incurred for the purpose of earning income from a business or property, as required by the provisions of Paragraph 18(1)(a) of the Income Tax Act, and as the said farming operation did not, in the years under appeal, constitute the conduct of a business carried on with a reasonable expectation of profit within the meaning of Subsection 248(1) of the Income Tax Act.

The appellant's contention was that the onus of proof was on the respondent because he was now seeking to establish the correctness of his reassess ments on grounds different than that on which they were previously based. When that occurs it is correct that the onus shifts as indicated. A number of cases in this regard are gathered in Baggs v. M.N.R., [1990] 1 C.T.C. 2391; 90 D.T.C. 1296 at 2393 (D.T.C. 1297).

Counsel for the appellant argued that the reassessments were made on the basis that the expenditures were never incurred and now the respondent is taking the " fall-back position” that there had been no reasonable expectation of profit in the years under review. Immediately upon the conclusion of his submission he indicated his intention of calling his client as a witness and proceeded to do so. What remained in issue in this appeal was canvassed with considerable thoroughness both in examination-in-chief and in cross- examination.

During argument the question of onus of proof was raised again, but its importance had been greatly diminished if not nullified because the appellant's testimony and the documents placed in evidence while he was testifying created a considerable body of evidence from which it could be affirmative[ly] concluded that a reasonable expectation of profit did not exist in 1981 and 1982. Also that evidence established that the appellant did not know if there had been farming losses in 1984 and that he was trying to deduct expenses in computing his income from other sources without relating them to business income. This alone afforded grounds upon which to dismiss the appeal regarding that year.

The appeal is allowed and the matter is referred back to the respondent for reconsideration and reassessment on the basis that the $133,753 added to the appellant's income in reassessing regarding his 1981 taxation year be reduced by $36,595. The appellant is entitled to no other relief regarding 1981. The appeals are dismissed in respect of the appellant's 1982 and 1984 taxation years.

Appeal allowed in part.