Citation: 2013 TCC 11
Date: 20130211
Docket: 2010-2575(IT)G
BETWEEN:
GREGORY GEORGE SCHMIDT,
appellant,
and
HER MAJESTY THE QUEEN,
respondent.
REASONS FOR JUDGMENT
Hogan J.
Introduction
[1]
By notices of
reassessment dated October 14, 2008 and varied on May 5, 2010, the Minister of
National Revenue increased the income tax liability of Gregory George Schmidt,
the appellant, for his 2003 and 2004 taxation years. The Minister used the
deposit method to add $49,499 and $38,901 to the appellant’s income for the
2003 and 2004 taxation years. The Minister also imposed gross negligence
penalties under subsection 163(2) of the Income Tax Act, Canada (the
“Act”). The reassessments were issued beyond the normal 3-year limitation
period.
Issues to Be Decided
[2]
The issues to be
determined in this appeal are:
(a)
Whether the Minister
properly revised the appellant’s taxable income for the 2003 and 2004 taxation
years;
(b)
Whether the Minister
properly reassessed the appellant beyond the normal reassessment period under
subsection 152(4) of the Act; and
(c)
Whether the Minister
properly assessed penalties pursuant to subsection 163(2) of the Act.
Background
[3]
The appellant is a
contractor who is engaged in road building, demolition and snow removal. He is
married with three children. He and his family live in a modest 800-square-foot,
two-bedroom house in Regina. According to the appellant, his home is situated
in a tough neighbourhood in that city.
[4]
The appellant filed for
bankruptcy in 2001. He transferred certain of his road‑building equipment
into a new company, 101050094 Saskatchewan Ltd., which was used to do
contracting work.
[5]
The appellant reported $4,325.00
of income on his 2003 personal tax return. It came from a project he had completed
that year. According to the appellant he worked very little in 2003 and spent
most of his time looking after his two little girls, who were age three and
five at the time. His wife worked full-time in 2003, earning $21,419.16. For
2004 the appellant reported income of $12,000.00.
[6]
The CRA concluded that
most deposits made in the appellant’s bank account in 2003 and 2004 constituted
unreported business income from his snow removal and road-building activities.
[7]
The appellant provided
three explanations for the deposits into his bank account.
[8]
First, the appellant’s
brother would loan him money from time to time. This explanation applies to the
2003 period.
[9]
Second, the appellant
would cash cheques for his brother, Bernard Schmidt, on whose account there was
a hold and who was thus unable to immediately withdraw from his account funds from
cheques that he (Bernard Schmidt) received from customers of his (Bernard
Schmidt’s) business.
[10]
There was not a similar
hold on the appellant’s bank account. He could withdraw up to $500 for each
cheque he deposited to his account. As the appellant could access funds
quicker, he was able to assist his brother’s company by providing access to the
cash flow needed in that business. The speedier access to cash allowed his
brother’s company to continue to operate. The appellant did not work for his
brother’s company during the periods in question. In cross-examination, the
appellant said that he had explained the above-described practice to the CRA
auditor “12 ways to Sunday”.
[11]
The appellant’s brother
corroborated the appellant’s evidence. He explained the hold on his account:
whenever he deposited a cheque in his account, it would take five to ten
business days before he could withdraw the cash. He also explained that, as
brothers, they exchanged money back and forth and that there were never any
terms of repayment.
[12]
The auditor, Mr.
Michael Dean Curley, testified that the appellant did not provide him with any
explanations for the deposits. The auditor also testified that he did not conduct
a net worth assessment in conjunction with the deposit method because he did
not think there would be enough asset information to justify the use of that
method.
[13]
On cross-examination,
the auditor admitted he had had little contact with the taxpayer.
Appellant’s Position
[14]
The appellant submits
that there is no evidence to suggest that he knowingly misrepresented his
income.
[15]
The primary source of the
funds at issue was the appellant’s brother’s company, as indicated by the
cheque stubs and bank statements showing that the money went in and then out.
There were 90 occasions on which money was deposited and withdrawn on the same
day.
Respondent’s Position
[16]
The respondent submits
that I should not accept the explanation offered by the appellant with regard to
the deposits made into his personal bank account. The respondent points out
that approximately 200 deposits were considered in the CRA’s deposit analysis,
while the appellant has provided only 175 cheque stubs in support of his
explanation. Thus, the respondent submits, at the very least there are 25
deposits for which no explanation has been given and those should be considered
as unreported income of the appellant.
Analysis
[17]
Subparagraph 152(4)(a)(i)
of the Act, which governs time limits for assessments, reads as follows:
(4)
Assessment and reassessment [limitation period] – The Minister may at any time
make an assessment, reassessment or additional assessment of tax for a taxation
year, interest or penalties, if any, payable under this Part by a taxpayer or
notify in writing any person by whom a return of income for a taxation year
has been filed that no tax is payable for the year, except that an assessment,
reassessment or additional assessment may be made after the taxpayer’s normal reassessment
period in respect of the year only if
(a)
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 the Act, or . . . .
[Emphasis added.]
[18]
The reassessments relating
to the 2003 and 2004 taxation years were issued after the expiration of the
normal reassessment period. Pursuant to subparagraph 154(4)(a)(i),
where the Minister issues a reassessment in relation to a taxation year after
the expiration of the normal reassessment period, the Minister has the onus of
establishing that the taxpayer has made a misrepresentation and that that
misrepresentation was attributable to neglect, carelessness or wilful default,
or that the taxpayer has committed fraud in filing his tax return or in
supplying information under the Act in relation to that taxation year.
[19]
The audit method
selected by the CRA to make the reassessments has a direct bearing on the
Court’s determination as to whether or not the respondent has discharged her burden
of proof under subparagraph 152(4)(a) of the Act. The CRA itself
recognizes this by outlining a hierarchy among the three indirect methods most commonly
employed to determine discrepancies between reported and unreported income. In
its audit manual dated March 2008, the CRA states that the net worth method
must be considered and used first unless it is impossible to obtain the
information required in order to complete the net worth statement showing the
evolution of the taxpayer’s assets and liabilities and personal living expenses
over the relevant period. On this subject, the manual states the following:
13.3.1
– General Comments
The
sections that follow discuss the CRA policy with respect to the use of Indirect
Verification of Income (IVI) as an assessing technique where a
taxpayer/registrant’s books and records are non-existent or inadequate, or
where audit findings indicate that revenue has not been accurately recorded in
the books and records.
The
IVI techniques discussed are:
13.4.0
Net Worth;
13.5.0
Auditing Unidentified Bank Deposits;
13.6.0
Assessments Based on Projections.
The
most frequently used IVI technique is the Net Worth Statement and is the
primary IVI technique used in the CRA. Auditors are expected to use the net
worth method whenever the information is available to allow proper preparation
of the document.
The
team leader must be consulted and approve the appropriate IVI technique for the
audit as part of the Audit Plan.
[20]
At trial, I asked the
auditor why he did not resort to the net worth method to determine the
appellant’s undeclared income. My question did not elicit a clear response from
the auditor. The CRA audit manual takes 25 pages to describe the methodology to
be applied by a CRA auditor in completing a net worth audit. Two pages are
devoted to describing the techniques for a deposit audit. It is obvious that
the net worth audit will produce a more reliable picture of the taxpayer’s
financial situation and of the discrepancies between his lifestyle and spending
habits and his reported income than will the other methods described in the
manual. Given the lack of a response to my question, I am left to conclude that,
for reasons that remain unclear, the auditor found the elaborate methodology of
the net worth method daunting in the circumstances of this case. I do not share
that view.
[21]
The appellant, whom I
found to be a credible witness, provided a plausible explanation for the
deposits, namely that his personal account was used to assist his brother in
his business operations since the appellant could withdraw immediately up to $500
for each cheque deposited in his account. The testimony of the appellant is
consistent with that of his brother, whom I also found to be a credible
witness. Further, the cheque stubs and bank statements also corroborate the
appellant’s explanation.
[22]
There were 175 stubs
provided in evidence, and they account for most of the 200 or so deposits made in
the appellant’s personal account during the periods in question. The other 25
were likely loans from the appellant’s brother, although a detailed explanation
of those deposits was not provided.
[23]
The credible
explanation offered by the appellant distinguishes this case from Lacroix,
a case in which the taxpayer was found to have made a misrepresentation of
facts.
There, the appellant was not able to provide a credible explanation for the
discrepancy that the CRA auditor found in doing a net worth assessment, and so the
Minister was found to have discharged the burden of proof placed upon him by subparagraph
152(4)(a)(i). In the case at bar, there is a credible explanation, and
the Minister has not provided any contrary evidence. Rather, the Minister has
relied on submissions pertaining to the appellant’s credibility without providing
any objective evidence to contradict the appellant’s evidence or to attack the
appellant’s credibility generally. The outcome in this case may have been
difference if the respondent had been able to show that the appellant’s
lifestyle did not correspond with the amount of income that his family reported
each year. For these reasons the appeals are allowed and the reassessments are
vacated.
Signed at Ottawa, Canada, this 11th day of February.
“Robert J. Hogan”
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