Bowman J.T.C.C.:—The appellant, Farm Business Consultants Inc., appeals to this court from eight reassessments under the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the "Act") for the taxation years ending April 30, 1983 to April 30, 1987, inclusive and August 31, 1987 to August 31, 1989. Essentially three issues are raised.
(a) Whether the Minister of National Revenue was correct in treating a purported consulting agreement as being in substance a sale of goodwill giving rise to a deduction of a portion of the amounts paid by the appellant as an eligible capital expenditure rather than a fully deductible current expense.
(b) Whether the Minister was entitled to assess the years up to and including those ending August 31, 1987 beyond the normal reassessment period, by reason of a misrepresentation of the type described in subparagraph 152(4)(a)(i).
(c) Whether the Minister was justified in assessing penalties under subsection 163(2).
A procedural issue arose at the opening of trial. Since the Minister has assessed the years up to and including August 31, 1987 beyond the three-year period from the date of mailing the notice of original assessment, the onus was upon the respondent to establish that the appellant had made a misrepresentation of the type described in subparagraph 152(4)(a)(i). In addition to contending that the assessments were out of time the appellant also contended that, on the merits, they were incorrect.
Counsel for the appellant contended that, with respect to the years alleged to be statute-barred, the respondent should present evidence and argument first on this point in order to establish the Minister's right to assess those years beyond the normal reassessment period.
The matter was fully argued by both counsel, and with some hesitation, I ruled that the Minister should open. The authorities on the point are not easily reconciled. The leading case is M.N.R. v. Taylor, [1961] C.T.C. 211, 61 D.T.C. 1139. In that case Cameron J. stated at page 214 (D.T.C. 1141):
After giving the matter the most careful consideration, I have come to the conclusion that in every appeal, whether to the Tax Appeal Board or to this Court, regarding a reassessment made after the statutory period of limitation has expired and which is based on fraud or misrepresentation, the burden of proof lies on the Minister to first establish to the satisfaction of the Court that the taxpayer (or person filing the return) has "made any misrepresentation or committed any fraud in filing the return or in supplying any information under this Act" unless the taxpayer in the pleadings or in his notice of appeal (or, if he be a respondent in this Court, in his reply to the notice of appeal) or at the hearing of the appeal has admitted such misrepresentation or fraud. In reassessing after the lapse of the statutory period for so doing, the Minister must be taken to have alleged misrepresentation or fraud and, if so, he must prove it.
[Emphasis added.]
Counsel for the respondent pointed out that in that case no issue was taken with the correctness of the assessments apart from their timeliness, and she sought to distinguish it on the basis that other cases had decided that where there are issues both as to whether the assessments are statute-barred and as to whether they are otherwise correct the taxpayer must proceed first, in accordance with subsection 135(2) of the Tax Court of Canada Rules (General Procedure). She contends that I should draw this conclusion from a decision of Teitelbaum J. in Levy v. The Queen, [1989] 2 C.T.C. 151, 89 D.T.C. 5385. Evidently there were two issues there—whether the assessment was correct and whether there was misrepresentation to justify its being made beyond the normal reassessment period. Teitelbaum J. held that if the appellant succeeded in establishing that the assessment was wrong, the issue of misrepresentation became a non-issue. He therefore ordered the appellant to proceed first. With respect, I am unable to accept that the conclusion necessarily follows from the premise. It could as easily have been said that if the respondent is unable to establish that the Minister was entitled to assess beyond the normal reassessment period the correctness of the assessment becomes a non-issue. Before the court can consider whether an assessment is correct it must first decide that it was validly made.
To the same effect counsel relied upon the decision of Rouleau J. in The Queen v. Taylor, [1984] C.T.C. 436, 84 D.T.C. 6459, where two issues were before the Court, the correctness of the assessment and the imposition of penalties. Rouleau J. held at page 6463 that "when there is an onus on each party, the taxpayer shall begin first". That case differs I believe from this case and from Levy. In the 1984 decision in Taylor the timeliness of the assessment was not in issue. It is essential that before the court hears evidence on the correctness of the assessment it be satisfied that the Minister had the right to assess at all. The distinction made in Levy was not made by Cameron J. and I can see reason, as a matter of logic or procedural fairness, for making it here. It may well be, as Rouleau J. said that where there is an onus on both parties the taxpayer should open. Until the validity of the assessment that is otherwise statute-barred is established by the
1 It is somewhat difficult to see how it can be said that the onus imposed on the Minister under section 163 can be met without the Minister showing that the amount of tax giving rise to the penalty was properly exigible. See also Can-Am Realty Ltd. v. Canada, [1994] 1 C.T.C. 1, 94 D.T.C. 6069.
Minister under subparagraph 152(4)(a)(i) the taxpayer's only onus is to show that the reassessment was made outside the normal reassessment period. I should think it would be a rare circumstance in which counsel for the appellant would willingly yield to the Crown the tactical advantage of going first. Counsel for the Crown can, of course, call as a witness the appellant, if the appellant is an individual, or an officer or director of the appellant, and, under subsection 146(3) of the Rules, may cross-examine that person. In this particular case, however, it does not appear to have made one iota of difference who went first.
The facts that were established or admitted are the following. The appellant, a wholly owned subsidiary of Datatax Business Services Ltd., carried on the business of providing financial, accounting and tax services to farmers. Agricultural Tax Service Ltd. and Agricultural Tax Service (Canada) Ltd. carried on the same type of business. These latter two companies, collectively referred to as "Agricultural", were owned by Maxwell Earl Whalls and his wife Nyla Whalls.
The Whalls wished to sell the business of Agricultural; Datatax and the appellant wished to buy it. The only asset of significant value to Datatax and the appellant was Agricultural's goodwill which consisted substantially in its approximately 3,200 customers. The appellant and Datatax therefore entered into an agreement with Agricultural and the Whalls whereby Agricultural and the Whalls agreed to sell to Datatax and the appellant the business and undertaking of Agricultural, including the goodwill and certain other assets. Clause 4 of the agreement provided as follows:
4. THE purchase price payable for the assets hereby agreed to be purchased and sold shall be as follows:
(i) Stationery, office supplies and office equipment—"Datatax" will pay to "Agricultural" the sum of $45,000 which is represented to be the fair market value of the above.
(ii) Good will—"Datatax" will pay to "Agricultural" the sum of one dollar which will include the name and customer list.
(iii) "Datatax" will pay to “Agricultural” the sum of $96,000 per year for a term of seven years pursuant to the terms of a consulting contract. Payments will be made commencing May 24, 1982 and thereafter on a weekly basis until May 17, 1989 when the said consulting contract shall expire.
(iv) “Agricultural” and Maxwell Earl Whalls will cause to be delivered to the customer list on closing a letter in a form similar to Schedule "D" attached hereto.
The agreement also provided that Mr. Whalls would write to Agricultural’s clients a letter in the form of Schedule D to the agreement. The letter read as follows:
Dear Client:
Since 1968, Agricultural Tax Service has been pleased to represent its clients to the best of its ability and has always searched for ways to improve the quality of service.
Today's complicated tax laws make old-fashioned tax preparation obsolete and we feel that to serve you best, the latest in computer technology is essential.
The future servicing of your income tax affairs has been assigned to FBC which is the largest farm tax consultant in Canada with over 22,000 members and highly sophisticated computerized tax preparation.
I have no doubt that you will receive the highest level of service from FBC and I thank you for your continued support.
Yours sincerely,
Earl Whalls
President
The consulting agreement contained the following covenants:
1. During the term of this agreement Agricultural and Whalls shall serve the company and shall perform such duties and exercise such powers as may be from time to time assigned to or vested in them by the president of the company.
2. The engagement shall be until May 17, 1989.
3. Agricultural and Whalls will during the period of the agreement devote their time, attention and ability to the business of the company and will well and faithfully serve the company and use their best efforts to promote their interests and will not disclose the private affairs of the company or any secret of the company to any person other than the officers or directors of the company or to those persons authorized in writing by the board of directors of the company, and will not use for their own purposes or for any other purposes other than those or the company any information they may acquire with respect to the company’s affairs.
4. The remuneration of Agricultural and Whalls for their services hereunder shall be at the rate of $86,580 per annum which payments will be made weekly in the amount of $1,665 commencing May 24, 1982 and terminating on May 17, 1989, when the said contract shall expire.
Before the closing Mr. Whalls became concerned that he and his wife might have somewhat onerous obligations under the consulting agreement and at closing an amendment of the consulting agreement was made and signed by all parties. It read as follows:
1. The parties hereto agree to amend their consulting agreement dated May 17, 1982, as follows:
The company agrees that Agricultural and Whalls will only be required to devote a maximum of five days’ service per year to the company.
The Minister disallowed the deduction of the so-called consulting fees, allowed a deduction of a portion as an eligible capital expenditure and a further portion as an interest component. He took this reassessing action with respect to all years under appeal, including those that were statute-barred, and imposed penalties under subsection 163(2) for all years which he reassessed.
I have set out the agreements to show what the parties purported to agree to. The agreements do not reflect the legal reality. Apart from the obligation to make the weekly payments of $1,665 the consulting agreement was never intended to be acted upon. The Whalls were not expected or intended by the appellant to render any consulting services and in fact they did not do so. If the concept of substance over form has any meaning whatever, it applies here. The form of the legal relationship between Agricultural and the Whalls and the appellant, insofar as it purported to create a consulting agreement or an agreement for services, did not reflect the true relationship, which was the sale of a business. The $86,580 per annum payable to Agricultural and the Whalls was not for services but rather for the list of customers which was valued at $26.64 per customer per year for 3,250 customers. The original agreement of purchase and sale assumed that there were 3,600 customers; hence the figure of $96,000 as the alleged fee for consulting services.
There is no need to repeat the jurisprudence on substance over form. That has been done in other cases. The essential nature of a transaction cannot be altered for income tax purposes by calling it by a different name. It is the true legal relationship, not its nomenclature, that governs. The idea of dressing up the payments for the customer list in the garb of consulting fees was the idea of Mr. Ibbotson, the president of the appellant, because he wanted to turn the payments for goodwill into currently deductible expenses. Evidently the Whalls were prepared to go along with this suggestion but their acquiescence, and the fact that they were prepared to include the payments in income, does not assist the appellant, nor indeed does the fact that the Minister did not question the Whalls’ inclusion of the payments in income. After all, why would he?
It follows, therefore, that on the merits of the assessments the appeals fail.
2 There were, it seems, a couple of telephone calls and one meeting but I regard these as completely insignificant.
The more difficult questions are whether the Minister was entitled to reopen the earlier statute-barred years under subparagraph 152(4)(a)(i) and to impose penalties under subsection 163(2). Subparagraph 152(4)(a)(i) permits the Minister to assess beyond the normal reassessment period if the taxpayer or person filing the return:
(i) has made any misrepresentation that is attributable to neglect, carelessness or wilful default or has committed any fraud in filing the return or in supplying any information under this Act.
The French version of this provision reads as follows:
(i) soit a fait une présentation erronée des faits, par négligence, inattention ou omission volontaire, ou a commis quelque fraude en produisant la déclaration ou en fournissant quelque renseignement sous le régime de la présente loi.
It is important to determine precisely what "misrepresentation" if any, the appellant is alleged to have made. The "representation" that was made in the financial statements was that the appellant paid "management fees" of $86,580 each year. This amount varied in some years where other fees were deducted or where there was a short fiscal period. It is quite true that what was deducted was consistent with the purchase agreement and the consulting agreement but the substance of those agreements was a purchase of goodwill, the customer list. The origin of the depiction of the payments in the return of income as management fees was the arm's length agreements between the parties. Does this make their description in the return any the less a misrepresentation? I think not. The agreements and the claim for a deduction were integral parts of the arrangement.
I think therefore that there was a misrepresentation. The second question is this: To what was the misrepresentation attributable?
The types of misrepresentation by a taxpayer that will permit the Minister to reopen a statute-barred year run the entire gamut from innocent carelessness to fraud. Although the reply to the notice of appeal refers to neglect, carelessness or wilful default counsel for the respondent relied principally upon the words “wilful default”, alleging that Mr. Ibbotson knew what he was doing in portraying the payments for goodwill as consulting fees. Her point is not without merit. Mr. Ibbotson is not altogether unsophisticated in income tax matters. He may have believed that where the parties to a transaction have chosen to describe or misdescribe it by a particular formula of words that description is conclusive.
I place no weight on the fact that the financial statements of the appellant were audited or that expert testimony was adduced to the effect that the deduction of the so-called management fees was in accordance with generally accepted accounting principles. That is not germane to the question here. Whether they are deductible is a question of law. If they had really been management fees, they would have been deductible and accounting evidence would not have been necessary. Moreover the expert accounting witness assumed that services were in fact being performed, which of course they were not.
I have no difficulty in concluding that the Minister was justified in opening up the statute-barred years on the basis that a misrepresentation was made that was attributable to neglect, carelessness or wilful default. Fraud is not suggested. The reasons for the misrepresentation fall within the broad range covered by those three words and if the only issue before me related to subparagraph 152(4)(a)(i) it would not be necessary to decide which of those words applied. It is one or the other. The issue under subparagraph 152(4)(a)(i) is not however unrelated to the third issue, that of penalties. If the misrepresentation is attributable to simple neglect or carelessness not amounting to gross negligence the penalties under subsection 163(2) cannot be supported. If, however, it is misrepresentation attributable to “wilful default" it is much more difficult to conclude that it is not equally a "false statement" which the appellant made "knowingly" within the meaning of subsection 163(2). On one view of the matter the action was wilful, in the sense that it was deliberate. From a different perspective it might be said that it was based upon a wholly erroneous view of the effect of the description or misdescription adopted by the parties. In one sense the misrepresentation can be seen as attributable to Mr. Ibootson's failure to recognize that such arrangements, however prevalent they may be, were ineffective. Had he taken the trouble to speak to a moderately competent tax lawyer or accountant he would unquestionably have been told that the scheme did not work.
The question then is whether the conduct on the part of the appellant justifying the Minister’s reopening of the statute-barred years under subparagraph 152(4)(a)(i) equally justifies the imposition of penalties under subsection 163(2). That the two provisions are not coterminous is obvious. "Neglect, carelessness, wilful default or. . . fraud" (négligence, inattention, omission volontaire ou. . . fraude) cover a wide range of non-feasance or misfeasance, innocent or intentional, to which a misrepresentation in a return may be attributable. There is no hiatus between the words in this series, which starts with ordinary neglect and proceeds by gradual degrees to fraud which would justify a penalty under subsection 163(2). The type of carelessness or neglect encompassed by subparagraph 152(4)(a)(i) may include, but is not as extensive as, that contemplated in the words "gross negligence" in subsection 163(2) ("faute lourde") which implies conduct characterized by so high a degree of negligence that it borders on recklessness. It would be difficult to conclude that the state of mind required for “wilful default" ("omission volontaire") is not the same as that implicit in the word “knowingly” ("sciemment").
Subsection 163(2) provides:
Every person who, knowingly, or under circumstances amounting to gross negligence in the carrying out of any duty or obligation imposed by or under this Act, has made or has participated in, assented to or acquiesced in the making of, a false statement or omission in a return, form, certificate, statement or answer (in this section referred to as a "return") filed or made in respect of a taxation year as required by or under this Act or a regulation, is liable to penalty of. ...
The French version is as follows:
Toute personne qui, sciemment ou dans des circonstances équivalant a faute lourde dans l’exercice d'une obligation prévue à la présente loi ou à un règlement d'application, fait un faux énoncé ou une omission dans une déclaration, un formulaire, un certificat, un état ou une réponse—appelé "déclaration" au présent article—rempli ou produit pour une année d'imposition conformément à la présente loi ou à un règlement d'application, ou y participe, y consent ou y acquiesce est passible d'une pénalité. . . .
The type of conduct envisaged by subsection 163(2) may overlap portions of subparagraph 152(4)(a)(i) and I think that it does so in this case. I nave made a great effort to put the appellant’s conduct in as benign a light as possible, and to attribute it to a naive and foolish belief that schemes of the type involved here actually work rather than to a wilful misrepresentation of the true state of affairs. I have been unable to do so. The appellant either knew what it was doing or was reckless as to the legal efficacy of the arrangement. I am cognizant of the fact that subparagraph 152(4)(a)(i) has as its purpose the opening up of returns for statute- barred years where items of income, for a wide variety of reasons, are omitted or misstated, whereas subsection 163(2) is a penal provision and that in applying it if there is doubt as to the type of conduct to which the misrepresentation is attributable the benefit of that doubt should be given to the taxpayer. In Udell v. [1969] C.T.C. 704, 70 D.T.C. 6019, Cattanach J. said at page 6025:
There is no doubt that subsection 56(2) is a penal section. In construing a penal section there is the unimpeachable authority of Lord Esher in Tuck & Sons v. Priester, (1887) 19 Q.B.D. 629, to the effect that if the words of a penal section are capable of an interpretation that would, and one that would not, inflict the penalty, the latter must prevail. He said at page 638:
We must be very careful in construing that section because it imposes a penalty. If there is a reasonable interpretation which will avoid the penalty in any particular case, we must adopt that construction.
and at page 6026:
I take it to be a clear rule of construction that in the imposition of a tax or a duty, and still more of a penalty, if there be any fair and reasonable doubt the statute is to be construed so as to give the party sought to be charged the benefit of the doubt.
See also Holley v. M.N.R., [1989] 2 C.T.C. 2152, 89 D.T.C. 366 at page 2157 (D.T.C. 369); De Graaf v. The Queen, [1985] 1 C.T.C. 374, 85 D.T.C. 5280.
A Court must be extremely cautious in sanctioning the imposition of penalties under subsection 163(2). Conduct that warrants reopening a statute-barred year does not automatically justify a penalty and the routine imposition of penalties by the Minister is to be discouraged. Conduct of the type contemplated in paragraph 152(4)(a)(i) may in some circumstances also be used as the basis of a penalty under subsection 163(2), which involves the penalizing of conduct that requires a higher degree of reprehensibility. In such a case a court must, even in applying a civil standard of proof, scrutinize the evidence with great care and look for a higher degree of probability than would be expected where allegations of a less serious nature are sought to be established. Moreover, where a penalty is imposed under subsection 163(2) although a civil standard of proof is required, if a taxpayer's conduct is consistent with two viable and reasonable hypotheses, one justifying the penalty and one not, the benefit of the doubt must be given to the taxpayer and the penalty must be deleted. I think that in this case the required degree of probability has been established by the respondent, and that no hypothesis that is inconsistent with that advanced by the respondent is sustainable on the basis of the evidence adduced.
Had I been able to construe the statute, or to view the evidence, in a manner that permitted me to give the appellant the benefit of the doubt I would have done so. That course of action is not open to me. The appellant’s depiction of the legal relationship between it and Agricultural as that of a consulting arrangement went beyond simple negligence.
The appeals are dismissed with costs.
Appeals dismissed.