Citation: 2010 TCC 218
Date: 20100504
Dockets: 2006-3485(IT)G
2006-3693(GST)I
BETWEEN:
BASIL CHRONIS,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
REASONS FOR JUDGMENT
Hogan J.
[1]
The Minister of
National Revenue (the “Minister”) by Notices of Reassessment dated May 18, 2004
increased the income tax liability of Basil Chronis (the “Appellant”) for
the 2000, 2001 and 2002 taxation years through the addition of undeclared
income. The Minister used the net worth method to add $45,807, $114,325 and
$11,832 to the Appellant’s income for the 2000 (the 2000 undeclared income),
2001 (the 2001 undeclared income) and 2002 (the 2002 undeclared income)
taxation years respectively. Details of the net worth calculations are set out
in Schedule A to this judgment. The Appellant was also assessed under Part IX
of the Excise Tax Act (“ETA”) for the period from January 1, 2000
to December 31, 2002, the amounts assessed being $31,039.30 in tax, $1,630.06
in interest and a $3,577.65 penalty in respect of goods and services tax/harmonized
sales tax (GST/HST) on sales and/or services in respect of which the Appellant
allegedly failed to collect GST/HST. The Appellant’s appeals from these
assessments were heard on common evidence.
[2]
The issues to be
determined in these appeals are as follows:
(a)
Is the Appellant liable
for the additional income tax determined by the Minister on unreported income in
the amounts of $45,807, $114,325 and $11,832 for the 2000, 2001 and 2002
taxation years respectively?
(b)
Is the Appellant liable
pursuant to subsection 163(2) of the Income Tax Act (the “ITA”)
for penalties in the amounts of $13,413.45 and $733.25 for the 2001 and 2002
taxation years respectively?
(c)
Did the Minister
properly assess the Appellant for unreported GST/HST in the amount of $26,573.20
for the period from January 1, 2000 to December 31, 2002?
[3]
The evidence shows that
the Appellant was engaged in the business of programming satellite smart cards
(“Smart Cards”) for the purpose of decoding US-based satellite television signals
(the “Satellite Piracy Business”). The Appellant would sell the Smart Cards to
clients located in and around North Sydney who would access the satellite
signals emitted from the US satellites without paying a monthly charge
for the service. The two satellite television providers, Direct TV and Dishnet,
were not authorized to offer satellite services in Canada.
[4]
In October of 2001, the
Appellant’s home was searched by the Royal Canadian Mounted Police (the “RCMP”),
and various Smart Cards, computer equipment and satellite receivers were seized.
Most of the equipment was later destroyed or returned to its manufacturer. The
Appellant was charged with a criminal offence, and subsequently convicted, in
relation to his activities in carrying on the Satellite Piracy Business.
Adjustments to the Appellant’s Undeclared
Income
(i) 2000
Undeclared Income
[5]
The evidence shows that
the Minister failed to take into account two specific gifts totalling $24,000
received by the Appellant in his 2000 taxation year. The first gift was the
forgiveness by his mother of a personal loan in the amount of $15,000 made by
her to facilitate the Appellant’s purchase of a joint interest in a 1995 Jeep Grand
Cherokee (“1995 Jeep”). The Appellant’s mother loaned him the funds to pay his
share of the purchase price. The evidence shows she gave her undivided share of
the vehicle to her son in 2001 and forgave the loan. The forgiveness of the
loan gives rise to a non-taxable gift to the Appellant. The Appellant’s
testimony on this matter was corroborated by his ex-wife. The Minister wrongly
assumed that the loan was repaid by the Appellant with undeclared income.
[6]
The evidence also shows
that the Appellant’s father paid $9,000 of the purchase price of a 2000 Honda
RVT1000R/RC51 motorcycle acquired by the Appellant for $15,604.35. The
Appellant’s testimony on this point was corroborated by the testimony of the
salesman who sold him the motorcycle. To take into account the tax-free nature
of these two gifts, the Appellant’s 2000 undeclared income should be reduced
from $45,807.27 to $21,807.27.
(ii)
2001 Undeclared
Income
[7]
The evidence also shows
that the Appellant benefited from two other gifts, totalling $14,843, which were
not properly taken into account in the determination of the Appellant’s net
worth and undeclared income for his 2001 taxation year. The Appellant’s ex-wife
testified that she won $10,000 at a casino in the 1998 taxation year. She gave
the money to her husband and assumed he would eventually use it to make a down
payment on a house. Unbeknownst to the witness, the Appellant used the funds to
pay part of the purchase price of a Camaro that he acquired for $35,000 in
1998. The Appellant’s ex-wife testified that the $10,000 was intended to be a
gift and that she did not seek repayment of the amount as part of her divorce
settlement. The Minister assumed incorrectly that the Appellant owed his wife
$10,000 and that this loan was repaid with undeclared income in 2001.
[8]
The evidence also shows
that the Appellant traded in a 1995 Jeep for a 1998 Jeep Grand Cherokee (“1998
Jeep”) in 2001. The Appellant paid $29,843 for the 1998 Jeep. The cost of the
1998 Jeep was added by the Minister to the Appellant’s assets for his 2001
taxation year and the cost of the 1995 Jeep was deducted in the determination
of the Appellant’s net worth for 2001. The Minister’s treatment of the
two transactions resulted in a net increase of $4,843 in the Appellant’s
net worth.
[9]
The evidence shows,
however, that the Appellant traded in a second car, which he had inherited from
his father, along with the 1995 Jeep to acquire the 1998 Jeep. This means that
the increase in the Appellant’s net worth with respect to this transaction is
not attributable to a source of undeclared income. Therefore, the Appellant’s
2001 undeclared income should be reduced from $114,324.50 to $99,481.50 to take
into account these two gifts.
[10]
In No.
275 v. M.N.R., 55 DTC 439, at pages 441-42, 13 Tax ABC 279 (I.T.A.B.),
it was established that gains from illegal activities were taxable under the Income
War Tax Act.
[W]hen
the question in issue is whether profits arising from illegal sources are
liable to taxation or not, the courts are not concerned, either with the source
of the taxpayer’s income, or by the means taken by him to earn it, but merely
with the question as to whether or not the said income is liable to tax under
the provisions of the taxing statute. Once the courts are satisfied that the
income is liable to tax, it is immaterial that it comes from a legal or an
illegal business, or a business which is malum in se or malum
prohibitum.
[11] It
follows, then, that expenses incurred in order to earn business income, even if
the business is illegal in nature, are deductible. This position has been
upheld by the courts on numerous occasions, most notably in M.N.R. v.
Eldridge, 1964 CarswellNat 357, [1964] C.T.C. 545, [1965] 1 Ex.
C.R. 758 (QL), 64 DTC 5338. At issue in that case was whether a
taxpayer carrying on a call girl operation could deduct the expenses incurred
in order to generate business income:
24 The
respondent freely admits that she was engaged in an illegal and illicit
business, nor does she dispute the computation of the gross income received by
her. The substance of her objection to the assessments is that further
expenses were incurred by her in the operation of her business which should be
taken into account and her taxable income reduced to the extent of those
expenses.
25
At this point I would mention it is abundantly clear from the decided cases
that earnings from illegal operations or illicit businesses are subject to tax.
The respondent, during her testimony, remarked that she expressed the view to
the officers of the Taxation Division that it was incongruous that the
government should seek to live on the avails of prostitution. However, the
complete answer to such suggestion is to be found in the judgment of Rowlatt,
J. in Mann v. Nash, 16 T.C. 523, where he said at p. 530:
"It is said again: 'Is the State coming forward to take a
share of unlawful gains?' It is mere rhetoric. The State is doing nothing of
the kind; they are taxing the individual with reference to certain facts. They
are not partners; they are not principals in the illegality, or sharers in the
illegality; they are merely taxing a man in respect of those resources. I think
it is only rhetoric to say that they are sharing in his profits, and a piece of
rhetoric which is perfectly useless for the solution of the question which I
have to decide."
[Emphasis
added.]
[12] Cattanach
J. continues with an analysis of the various expenses claimed by the Appellant,
and determines which of the proposed expenses may be deducted from gross income
by reason of their having been incurred for income-earning purposes.
[13] In 65302
British Columbia Ltd. v. Canada, [1999] 3 S.C.R. 804, the Supreme Court of
Canada confirms that expenses incurred to generate income from illegal acts are
tax deductible under the ITA. The issue before the Supreme Court was
whether or not it is appropriate to permit the deduction from income under the ITA
of fines, penalties and statutory levies. In reaching its decision, the
Court considered the public policy argument against allowing the deduction of
fines and penalties and drew an analogy with the tax treatment of income from
illegal activities:
56 . . . I note that in
calculating income, it is well established that the deduction of expenses
incurred to earn income generated from illegal acts is allowed.
For example, not only is the income of a person living from the avails of
prostitution liable to tax, but the expenses incurred to earn this
income are also deductible: M.N.R. v. Eldridge, [1964] C.T.C. 545 (Ex. Ct.). See also Espie
Printing Co. v. Minister of National Revenue, [1960] Ex. C.R. 422. Allowing a taxpayer
to deduct expenses for a crime would appear to frustrate the Criminal Code, R.S.C., 1985, c. C-46; however, tax
authorities are not concerned with the legal nature of an activity.
Thus, in my opinion, the same principles should apply to the deduction of fines
incurred for the purpose of gaining income because prohibiting the
deductibility of fines and penalties is inconsistent with the practice of
allowing the deduction of expenses incurred to earn illegal income.
[Underlining in original; emphasis added.]
[14] And
more recently, in Brizzi v. The Queen, 2007 TCC 226, [2007] 4 C.T.C. 2334:
5 It is important to mention that the tax
authorities are not concerned with the legality of an activity (see Canada
(M.N.R.) v. Eldridge, [1965] 1 Ex.
C.R. 758 (QL), at par. 25, and 65302 British Columbia
Ltd. v. Canada, [1999 CanLII 639 (S.C.C.)],
[1999] 3 S.C.R. 804, at par. 56). It is accepted that if a
taxpayer's income from an illegal business is taxable, that taxpayer should be
allowed the benefits of the Income Tax Act (the "Act")
in terms of deductions. It is also important to mention that this Court is only
concerned with determining the validity of an assessment after considering all
relevant facts and with ascertaining whether the assessment is in compliance
with the Act. Equitable considerations are not within our jurisdiction.
[Emphasis added.]
[15] Section 67.6 of the Act was enacted in 2005 to
deny a deduction for fines and penalties imposed under a law after March 22,
2004.
[16] In the case of R. v. Chronis,
[2002] N.S.J. No. 273 (QL), Constable Donald James Peters applied for
an order under subsection 490(5) of the Criminal Code for the
disposition of certain items seized from the Appellant’s premises.
[17] The Appellant intervened in the
proceedings for the purpose of having the Smart Cards returned to him. Ross
Prov. Ct. J. of the Nova
Scotia Provincial Court
concluded that the US satellite television provider had established
lawful entitlement to the Smart Cards. There is no evidence in the record herein
as to why the other seized equipment was not returned to the Appellant. Nevertheless,
there was testimonial evidence from the Appellant, corroborated in part by
Constable Peters’ testimony, that very few items were returned to the
Appellant. The Respondent did not lead any contrary evidence on this point. I
conclude, therefore, that the Appellant has established on a balance of
probabilities the accuracy of this fact.
[18] There is no evidence that would
allow me to conclude that the items in question were forfeited as the result of
the imposition of a penalty or fine after March 22, 2004. I therefore conclude
that the Appellant is entitled to claim a deduction in respect of the cost of
the forfeited assets.
[19] Exhibit A-6, tendered by the
Respondent at trial, is a detailed inventory of the items seized by the RCMP at
the Appellant’s residence. Bruce Mason, the Canada Revenue Agency (“CRA”)
auditor who prepared the list also estimated the cost of the seized assets for
the purpose of establishing the increase in the Appellant’s net worth over the
period at issue. The Appellant testified that only the items listed at numbers
4, 9, 10, 16, 20 to 23, 25 and 26, 28, 41 and 42, 49 to 51, 54, 61, 67 to 69,
72 to 74, 80, and 83 to 86 were returned to him.
[20] The CRA determined that the total
cost of the business assets acquired by the Appellant under review (excluding
the replacement of hardware and software) was $77,815. The total cost
determined by the CRA for the assets identified by the Appellant as having been
returned to him was $16,075. The assets that were returned to the Appellant
were no longer suitable for use in the Satellite Piracy Business. The vast
majority of the assets that were not returned to the Appellant had been held by
him on income account. Arguably, some of the assets were held on capital
account. In any event, as regards these latter assets, as they were no longer
used in a business, the taxpayer should be entitled to a terminal loss with
respect to the capital cost of any depreciable assets that were destroyed,
since there were no depreciable assets remaining in the class. Therefore, the
Appellant is entitled to an additional deduction of $61,740, which represents
the cost of the assets that were not returned to him. As a result of this
deduction, the Appellant’s 2001 undeclared income should be further reduced
from $99,481.50 to $37,741.50.
[21] The Appellant’s father passed away
in November of 2000. While most of the assets of the estate were divided
equally between the Appellant and his sister, the family residence was
bequeathed to the Appellant. The Appellant tendered a letter at trial to
establish that he was also entitled to all the cash found in the family
residence.
[22] The Appellant claims that his
father left him $180,000, which was kept hidden in the basement of the house he
inherited from his father. He testified that he used these funds to pay his
personal living expenses in 2001 and 2002. He claims that his undeclared income
was overstated because the Minister failed to take into account this source of non-taxable
capital.
[23] Counsel for the Respondent points
out that the Appellant’s testimony on this point at trial differs from his
testimony on discovery. On discovery, the Appellant claimed that he had moved
the funds from the basement of his father’s home to the home of a family friend
immediately following a flood in the basement of his father’s home in January
of 2001.
[24] At trial, the Appellant claimed
that following the flood, the money was moved from the basement to the upstairs
laundry room, where it remained until discovered by his wife in May of 2001.
Only later was it moved to the home of a relative.
[25] The Appellant alleged at trial that
at least three family members were aware of the fact that his father kept large
sums of cash in his home prior to his death. The Appellant chose not to call those
relatives to corroborate his testimony, knowing full well that the Respondent
intended to dispute his allegation on this point. The Appellant’s decision not
to call the witnesses who would have been able to support his claim causes me
to seriously doubt the veracity of that claim. Furthermore, the evidence shows
that the Appellant’s father had marketable securities and term deposits
totalling at least $250,000 at the time of his death. This fact contradicts the
Appellant’s claim that his father did not trust banks and so kept large sums of
money at home. Thus, no further adjustment is required to be made to the
Appellant’s undeclared income. The penalty imposed by the Minister under
subsection 163(2) should be reduced to take into account the reduction in the
Appellant’s income tax liability as a result of the reduction in the amount of
undeclared income for the 2001 taxation year.
(iii) GST/HST Assessments
[26] The Minister assessed the Appellant
for $26,573 of additional GST/HST collectible for the period from January 1,
2000 to December 31, 2002. The Minister determined that the Appellant owed
additional GST/HST of $6,632.95 for the 2000 tax period, that determination was
based, inter alia, on the Minister’s estimate of a positive change of
$53,053, attributable to undeclared income, in the Appellant’s net worth. As
discussed earlier, $24,000 of that increase in the Appellant’s net worth is
attributable to gifts. Therefore, the Appellant’s unpaid net GST/HST should be
decreased from $6,632.95 to $3,502.52 for the 2000 period to take this
adjustment into account. The Appellant also received non-taxable gifts
totalling $14,843 in 2001. As a result, the Appellant’s net unpaid GST/HST
should be reduced from $16,726.71 to $14,790.71 for the period ending December
31, 2001.
[27] For these reasons, the reassessments
are referred back to the Minister for reconsideration and reassessment in
accordance with these reasons for judgment.
Signed at Ottawa, Canada, this 4th
day of May 2010.
"Robert J. Hogan"
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