Sunys Petroleum Inc. v. The Queen, 96 DTC 1759, [1996] 3 CTC 2931 (TCC)

Bell J.T.C.C.: — The appeal is from notices of reassessment for its 1987 and 1988 taxation years in which the Minister of National Revenue (“Minister”) denied the deduction of the penalty in the amount of $1,169,738 imposed on the Appellant pursuant to subsection 50(4) of the Excise Tax Act.

Issue

The issue is whether the penalty is deductible as an expense incurred for the purpose of gaining or producing income from the Appellant’s business and, if so, whether the deduction would be against public policy.

Facts

The Appellant is a taxable Canadian corporation which at all material times carried on the business of operating gas stations. For reasons outlined below the Appellant failed to pay federal sales and excise taxes in the amount of $13,214,784 for the period between August 1984 and September 1985. The Minister, because of such failure, assessed a penalty for the 1987 taxation year in the amount of $1,367,423. It was subsequently reduced to $1,169,738.

The Appellant deducted the amount of the penalty for income tax purposes for its 1987 taxation year and deducted resulting non- capital losses for its 1988 taxation year. By reassessment, the Minister disallowed the deduction of both the penalty and the losses, such disallowance resulting in this appeal.

Kenneth John McCrimmon (“McCrimmon”) and Bertram Loeb (“Loeb”) incorporated the Appellant, as Cencan Petroleum Limited (“Cencan”), in January, 1982. McCrimmon was president of the company from then until his departure in 1987. Loeb was chairman of the company. McCrimmon had been associated with the oil and gas business, including gas bar operations, for many years. Cencan commenced business by leasing one small retail gas outlet and supplying large wholesale customers. At the end of 1982 it had 16 retail outlets with a substantial wholesale business producing annual sales revenues in excess of $70,000,000. McCrimmon testified that a Mr. Robillard, president of Sunys, sold about 44 outlets to Cencan. He said that John Dilworth (“Dilworth”), managing partner of Price Waterhouse, had told Mulligan and Loeb that the company was growing and was now in a position to have a senior financial official. McCrimmon said that although the Brantford, Ontario operation, the base of Sunys’ business, had a financial person, he and Loeb wanted someone in Ottawa. The Appellant, on Dilworth’s recommendation, hired Brian Mulligan (“Mulligan”), a chartered accountant. He stated that Mulligan was with Price Waterhouse and had worked on the Appellant’s financial affairs, that Mulligan’s credentials were impressive and that no one else was interviewed. Mulligan’s duties involved the overall financial management of the company, being in charge of all records, accounts payable including taxes, accounts receivable and banking and financial statements. He said that he went over all these duties with Mulligan. Mulligan reported personally to McCrimmon on the petroleum operation and to Loeb respecting certain real estate holdings of Loeb.

On August 28, 1984 the Appellant changed its name from Cencan to Sunys Petroleum Inc. The Appellant’s business, by virtue of acquisition and expansion, grew to 131 outlets at the end of 1984. Previously, the Appellant was purchasing some product without the obligation to pay excise and sales taxes. However, McCrimmon testified that by the end of 1984 the Appellant was required to pay those taxes on all purchases.

McCrimmon said that he had no concerns whatever about the Appellant meeting its sales and excise tax obligations and that the payment of same was so fundamental that he assumed it was being paid on a timely basis, Mulligan being aware of procedures and being responsible for such payment. He said that he was constantly pressing Mulligan to get the financial information in order, that the Brantford operation was semi-computerized, that the Ottawa operation was manual and that they were to be coordinated.

McCrimmon said that although statements would normally be prepared by late April or early May of the following year, the December 31, 1984 statements were not ready by that time. He said he was given various reasons for the delay and that he pressured Mulligan and then dealt directly with Price Waterhouse, probably in July, 1985, about the delay. McCrimmon testified that he was disturbed by Mulligan’s performance and, in spite of that, agreed with Loeb that Mulligan should be given an increase on the basis that he should not be penalized because of his workload. McCrimmon discussed matters with Bill Parrish (“Parrish”), Audit Manager of Price Waterhouse, advising him that he was not satisfied with Mulligan’s explanations, and enquired as to why there was a delay in completion of the financial statements. He said he was advised that they were near completion and would be ready in two weeks. When that did not happen Loeb convened a meeting in August, 1985 to discuss why the statements were not ready. That meeting was attended by Loeb, Mulligan, McCrimmon, Robert French (“French”), vice-president of marketing, Dilworth, Parrish and another person from Price Waterhouse. McCrimmon testified that several problems were discussed and that Parrish said they “were almost there” and had only the tax issue to resolve. McCrimmon said that when he asked what the tax issue was they responded that there was a September, 1984 problem they were trying to resolve. McCrimmon then said that he did not concern himself with that because he felt Parrish and Mulligan were working it out. He said that he had no knowledge that the excise and sales tax had not been paid.

Mulligan then testified that the financial statements were not completed shortly thereafter, that he became very concerned and felt that Price Waterhouse was delaying matters. He said that he talked to Parrish twice by telephone and was advised not to worry, that they “were almost there”. In September he was advised by Parrish that everything was complete except that he had to deal with Mulligan on a tax issue and was awaiting information from Mulligan. McCrimmon then said he met Mulligan and asked what problem was holding up the financial statement completion. He testified that Mulligan’s response was that the problem involved the payment of excise tax, about $200,000 and that it did not affect the “bottom line” but was just a balance sheet item. McCrimmon said that he thought the Brantford office was paying taxes for its division and the Brantford personnel thought that he, McCrimmon, was paying same. McCrimmon then said that he challenged Mulligan and was told, to his astonishment, that the taxes had not been paid. According to McCrimmon, he then stormed into Loeb’s office and had Mulligan tell Loeb about the default. They decided to have French commence immediately to determine the amount of the liability. He said further that Loeb called Price Waterhouse and advised them that the company would contact the Department of National Revenue (“Department”) the next day and tell them about the problem. A copy of McCrimmon’s letter of September 18, 1985 to Mr. R. McCloskey (“McCloskey”) at the Department attached

... a detailed analysis of the amounts of Federal Sales Tax and Federal Excise Tax owing by the Brantford branch of Sunys Petroleum Inc.

Messrs. Loeb, McCrimmon, French and Dilworth met with McCloskey and two other officials of the Department, that meeting taking place about September 19, 1985 - in any event, two days after learning of the default. Arrangements were made, satisfactory to both parties, to pay the tax over a 22 month period. Initial payments totalling approximately $2,293,319 were made in the month of default discovery followed by monthly payments of $375,000 until the obligation was retired.

McCrimmon testified further that he learned from McCloskey that the Department wished to conduct an audit and that Mulligan had never so advised him. He described the excuses that Mulligan had advanced to McCloskey for not being able to meet with the Department and then asked McCloskey why he did not contact McCrimmon or Loeb with the information that he was having difficulties with Mulligan.

McCrimmon finished his testimony by stating that Mulligan’s only comment was that he thought that the Brantford office was paying the tax in question and that the Brantford office thought that the Ottawa branch was paying same. McCrimmon was clear in his statement that he had no suspicion before the meeting with Mulligan that the tax had not been paid.

On cross-examination McCrimmon stated that the number of outlets owned by Sunys increased, in 1983, from 14 to 63 stations and that by virtue of the acquisition of Gains the Appellant had 131 outlets at the end of 1984. He then said that in February, 1985 the Appellant acquired about 5 stations in Toronto. He also said that he regarded the payment of sales and excise tax as an extremely basic part of doing business and he never thought it was not being paid. He saw the requirement to pay these taxes, unemployment insurance premiums, Canada Pension Plan premiums and other tax deductions as “etched in stone”. He also referred to a change in the arrangement with Imperial Oil from the purchase from Imperial Oil on a tax paid basis to the obligation to pay taxes on everything purchased by Sunys. He said that Mulligan was involved with Imperial Oil in negotiations. He said that there were about seven accounting personnel including clerks and a receptionist in the Ottawa office and reiterated that although Parrish had referred to a tax problem he did not mention sales and excise tax but had said it related to September, 1984 when the Gain operation was taken over by Sunys. He stated that he had not since spoken to Price Waterhouse about the extent of their knowledge on this matter because, even though advisable, it might have been harmful and disruptive to the relationship with that firm and that that was undesirable. He said that he did not know about any of the appointments and changes of appointments made by Mulligan with the Department.

Loeb, Chairman and CEO of M. Loeb Ltd. from 1952 to 1978, a professor of English for two years at Carleton University and a member of the Armed Forces from 1941 to 1945, gave evidence with respect to the matters in question. He outlined the history of obtaining an IGA franchise in 1956 and that the operations were taken over by a Quebec company in 1978. He said that he and McCrimmon started Top Value stations and that McCrimmon reported to him. He said that after the formation of the Appellant his duties were financing and negotiating with banks and with Imperial Oil and Sunoco. He said that he received regular financial statements and ensured that the accounts payable and receivable were in order. He described the acquisition of stations from Robillard and the “overnight” quadrupling of volume in business. He testified that the growth did not cause him concern because Sunys’ personnel in Brantford had been retained.

Loeb said that he was directly involved in hiring Mulligan, that he had been advised by Dilworth that the business had grown fast and needed a vice-president of finance and he agreed. He said he knew Mulligan because he was with Price Waterhouse and had looked after the Sunys account. He also said that the Loeb grocery company had used the services of Price Waterhouse for 40 years. He stated that Mulligan was to oversee preparation of financial statements and all credit matters, was to ensure that accounts were paid on time and was to handle the other chores of a vice- president of finance. Loeb said he was satisfied that Mulligan had the capabilities to perform these services, having come well recommended by Price Waterhouse. He then related the events surrounding the discovery by McCrimmon that taxes had not been paid and that he was appalled by this information. He said that he had no reason to believe that Mulligan was not capable because he knew that remittances were mandatory based on sales of the prior month. He said that Mulligan had supervised the operation as an auditor. He also said that remittances to the Department were in his view “religious”, that he did not even want to be one day late and that he had, in the past, had cheques delivered by courier to the Department. He stated that his companies had an impeccable record of remitting all required payments on time.

Loeb stated that Mulligan made excuses for not having performed appropriately, his mother-in-law having died and then his mother having died, et cetera. He said that French had made a quick calculation of the tax in arrears and that he called McCloskey on an urgent basis and arranged a meeting with him the next morning, disclosing the circumstances to him and presenting him a cheque for over $2,000,000 as an act of good faith. He described the payment arrangements that were made and said that payments had been made in accordance with that arrangement.

Loeb stated that he learned about the “stonewalling” efforts of Mulligan respecting a departmental audit at the first meeting with McCloskey or at a slightly later meeting. He said that he asked McCloskey why he did not “go over Mulligan’s head” and talk to him, Loeb, or to McCrimmon. He also said that Mulligan was “terminated” in one or two weeks, it being, in his view, necessary to keep him around for a while in case information which could more readily be supplied by Mulligan, was needed. He produced a copy of the letter that he had written to McCloskey setting out all the circumstances, as he knew them, surrounding the non-payment of tax. It concluded with this paragraph,

We conclude this submission with the assurance and re-. iteration that this default occurred without malice or intent or our knowledge, that it will not recur in the future, that the individual responsible for it is being terminated, and that Sunys Petroleum Inc. is operated by responsible and competent businessmen fully aware of their obligations to suppliers, bankers and Government.

He said that one of the reasons that management of Sunys could not determine that taxes were not being remitted was that Mulligan was not providing financial statements on time, that he had advised Mulligan that that was unacceptable and that he had expressed his concern both to McCrimmon and Mulligan “in no uncertain terms”.

Loeb described the difficulties with the financial statements and the discussions with Mulligan and with Price Waterhouse. He stated that he was surprised at the magnitude of profits but that McCrimmon had told him the company was doing a lot of wholesale business and without financial statements they did not know that payments were not being made to the Department. He said that the company was not late in any payments to Esso because if they were not paid on Friday, Esso would stop shipping product on Monday. He stated clearly that it never occurred to him that remittances were not made to the Department and that he had no reason to be suspicious about that. He also clearly stated, in response to a question on cross-examination about making payments to the Mercantile Bank out of remittances, that that was simply not the case. He described in some detail his unhappiness with Mulligan’s performance and with the recommendation of Mulligan by Price Waterhouse. Finally, on cross-examination Loeb stated that in all his years in the corporate jungle his companies had always remitted all taxes on time, that there were enough problems with competitors and that they tried to maintain an impeccable record of timely payments.

Dilworth described Mulligan as having knowledge of the Appellant’s business and said he felt there was an advantage in him joining that company. He said that he did not think that Mulligan came to him for advice after his engagement by the Appellant. He said that the 1984 audit for financial statements commenced later than normal, about June, 1985 and that they were told records and accounts were not sufficiently prepared. He suggested that because of the expansion of business the records were behind. He stated that he had not learned of the tax default problem until Loeb called him to go to a meeting to discuss same about mid-September 1985. He said that he did not think that Price Waterhouse knew anything about this matter because it was not presented to him.

French testified that the accounting system used in the Ottawa office of the Appellant was manual and that there was no integration with the accounting system in Brantford. It was part of his function to integrate those systems. He said that it was Mulligan’s responsibility to pay federal sales and excise taxes. He testified that the Price Waterhouse auditors said they required working papers from Mulligan respecting tax to complete the financial statements and that Mulligan had said he would have that information quickly. He stated that after the meeting when default was discovered Loeb and McCrimmon asked him to determine what taxes were unpaid. French worked with an assistant and completed that determination the next morning. He said that McCrimmon’s letter to McCloskey was delivered by him to McCloskey and that they met McCloskey the next day with several of his officials to discuss the matter. He described payment arrangements suggested by the Department which were totally unfeasible in these circumstances and the negotiation respecting arrangements ultimately made. He stated that expansion plans were stopped immediately, that raises and bonuses were frozen and that the Appellant tried to increase business in order to meet the tax obligation. French said that he was not aware that the Department was trying to do an audit and that neither Loeb, McCrimmon nor Dilworth was aware of that fact until McCloskey told them at the meeting. Mulligan’s excuses, including changing premises, bereavement and other matters, were accepted by McCloskey. He stated also that Mulligan was discharged because of these events.

Analysis and Conclusion

The most recent case dealing with the deduction of penalty is Amway of Canada Ltd. v. R., [1996] 2 C.T.C. 162, 96 D.T.C. 6135 (F.C.A.). In that case, in the words of Strayer, J.A., the appellant adopted a deliberate and elaborate scheme for defrauding the Canadian revenue by falsifying the value of goods imported by it into Canada. This resulted in the avoidance of payment of customs duties and excise taxes in the amount of approximately $28.8 million. On an issue not relevant to this case, the Court found that the $28.8 million, being part of a $45 million settlement, should be treated as a penalty as well as the $16.2 million which Amway had accepted as a penalty.

The Court said that there emerges in the jurisprudence and the literature a recognition of two possible criteria for deciding whether amounts expended for the payment of fines or penalties should be deductible as a business expense. The first test is whether it was an expense incurred for the purpose of earning income, meaning in essence that it must be deductible under paragraph 18(l)(a) of the Income Tax Act (“Act”) which provides,

In computing the income of a taxpayer from a business or property no deduction shall be made in respect of

(a) an outlay or expense except to the extent that it was made or incurred by the taxpayer for the purpose of gaining or producing income from the business or property...

The second criterion is whether, even if the expense was incurred to produce income, it would be contrary to public policy,

...to allow a taxpayer to reduce his net income, and thus save taxes, by virtue of having been obliged to pay a higher penalty for some wrong doing.

Respecting the first question, the Court accepted as correct the concept of avoidability of a penalty as a test of whether its payment was a business expense. In Day & Ross Ltd. v. R. (sub nom. Day & Ross Ltd. v. The Queen), [1976] C.T.C. 707, 76 D.T.C. 6433, the Court held that fines for trucks loaded above weight restrictions were deductible as a business expense. In that case the Court found that in the absence of constant control over the exact cargo weight carried in its trailers, that being impractical, unintentional violations of weight restrictions would be inevitable. It found that the fines were incurred for the purpose of earning income.

In TNT Canada Inc. v. R., (sub nom. TNT Canada Inc. v. The Queen) [1988] 2 C.T.C. 91, 88 D.T.C. 6334 (F.C.T.D.), fines under the Customs Act and the Excise Act for various trucking violations by the common carrier appellant were found to be unavoidable and met the test of being incurred for the purpose of earning income under paragraph 18( l)(a) of the Act.

In neither of the previous two cases did the Court find a violation of public policy.

In Amway, the Court stated that one legitimate test of whether fines should be deductible was that of avoidability of the offenses. It supported that finding by reference to Imperial Oil Ltd. v. Minister of National Revenue, [1947] C.T.C. 353, 3 D.T.C. 1090 (Ex. Ct.), in which a tanker owned by the appellant, collided with another vessel while carrying cargo. The Court found that the risk of collision was a normal and ordinary hazard of marine operations and that negligence on the part of the appellant’s servants in the operation of its vessels was a normal and ordinary risk and incidental to its business.

In Amway the Court found that the appellant had engaged in an intentional and cynical scheme to mislead Canadian customs officials as to the value of goods and that there was no evidence that chronic undervaluation of goods for importation purposes was unavoidable. The Court, in that case, then turned to the matter of public policy. It said that it is contrary to public policy to allow the deduction of a fine or penalty as a business expense where that fine or penalty is imposed by law for the purpose of punishing and deterring those who, through intention or a lack of reasonable care, violate the laws. The learned justice said, at page 173 (D.T.C. 6141),

It would frustrate the purposes of the penalties imposed by Parliament if after paying those penalties exigible by law a taxpayer were then able to share the cost of that penalty - and the higher his marginal rate of taxation the more he could share - with other taxpayers of Canada by treating it as a deductible expense and thus reducing his taxable income. Such a result would, I believe, clearly be contrary to public policy.

The learned justice, under the heading “Disposition” said,

The appeal should therefore be dismissed and the cross-appeal be allowed on the basis that the judgment below be set aside and the reassessment by the Minister be confirmed to the effect that the balance of $37,117,904 remaining after the deduction from the total settlement of $45,000,000 of the sum of $7,882,096 attributable to the settlement of a 1984 action, be regarded as the payment of a penalty and not deductible from gross income as an expense incurred for the purpose of gaining or producing income.

[Emphasis added. ]

It appears that the Court, although opining on the matter of public policy, based its decision on its conclusion that the undervaluation of goods was not unavoidable. Having regard to the stated ground for the nondeductibility of the penalty, it was not necessary for the Court, notwithstanding its comments on public policy, to make a determination based on that criterion.

With respect to this case, I accept fully the evidence of Loeb, McCrimmon, Dilworth, and French. Loeb had been in business for many, many years and had never been identified with a failure to pay taxes of any nature. He was very precise in his evidence that tax obligations had primacy and that he had even made remittances by courier to ensure their timely payment. He is obviously an outstanding businessman who had made remarkable achievements in his area. He stated that the sterling growth of the Appellant did not cause him concern because Sunys’ personnel in Brantford had been retained when that business was purchased. He relied upon Mulligan, a chartered accountant, who had worked on the Appellant’s account and who had been recommended by Price Waterhouse to become the financial vice-president of the Appellant. He was anxious to receive delinquent financial statements from Mulligan and actively pursued Price Waterhouse in that regard. He did not know of the attempts of the Department to arrange audit meetings with Mulligan and stated that it had never occurred to him that the remittances had not been made and that he had no reason to be suspicious about that matter.

McCrimmon, likewise, a man with extensive experience in business, in particular the gas station business, had reason to believe that Mulligan was attending to the basic matter of making appropriate tax remittances. He too had pressured Mulligan and then dealt directly with Price Waterhouse about the delay of financial statements.

Mulligan was a chartered accountant, he was an experienced member of Price Waterhouse, an internationally known accounting firm, knew the Appellant’s business because he had worked on its affairs and was aware that tax was payable. He had avoided and adjourned the commencement of audit meetings with the Department.

The failure to pay tax was not intentional, and was not known to Loeb, McCrimmon, Dilworth or French. It was occasioned by the sole act of Mulligan. In the context of the facts of this case, it is unreasonable to assume that the timely payment of customs and excise tax was avoidable. That was an obligation known to all witnesses, including Mulligan, and the failure to meet same was due entirely to Mulligan. Loeb and McCrimmon were astonished to learn that they had not been remitted.

I cannot agree with Respondent’s counsel when she said, with respect to the two tests,

Now, I should say at the outset that while the Courts have set out these two criteria, it looks simple on its face, but it’s not always clear that they haven’t been intermingled. My friend said that he couldn’t find a case where they got through the 18(l)(a) test, but they didn’t get through the public policy test.

Well, I think the reason for that is that in many of the cases, the public policy test is, in fact, mixed up with the question of whether it’s deductible under 18(1)(a). What the Courts have been saying is where it’s a penalty, then it can’t possibly be an expense that was incurred. So they are throwing it out under 18(1 )(a) but in effect, they are doing it on the reasoning that could be used for determining whether it’s contrary to public policy. So I think there is a mix, and that’s why it’s not so, there aren’t cases where you find it meeting the requirements of 18( 1 )(a) and then coming out under public policy.

It is my view that the matter of public policy need not be considered if the amount in question is not deductible under paragraph 18(1 )(a) of the Act.

Respecting avoidability of a penalty, a concept endorsed by the Amway decision [1] , I find that the Appellant could not reasonably have avoided the failure to make the required remittances. It had grown in business and had grown in accounting and tax expertise with the engagement of Mulligan. The test of avoidability of a penalty cannot be properly applied in a theoretical and therefore atypical set of circumstances. It must be considered with an appreciation of the business world with particular consideration of the facts surrounding the failure to remit. The acts of a servant of the company cannot constantly be monitored nor should they be in situations like those of the Appellant where a man with expertise was engaged to attend, among other things, to the very matters giving rise to the imposition of the penalty. I find, therefore, that the penalty assessed in this case is deductible under paragraph 18(1)(a) of the Act.

I must now deal with whether it would be contrary to public policy to allow the deduction of that penalty. I do not regard the Amway decision as authority for the proposition that it is contrary to public policy to allow deduction of any penalty as a business expense. The comments on the test of public policy were made by the learned justice in a case where, in his own words, Amway adopted “a deliberate and elaborate scheme for defrauding the Canadian revenue”. Further, the stated reason for his conclusion is that the penalty was not deductible as an expense incurred for the purpose of gaining or producing income and, in so concluding, there was no expressed incorporation of the public policy criterion influencing that conclusion. In the Amway decision, the penalty was clearly avoidable and that formed sufficient grounds for the conclusion reached by the Court. Therefore, it seems unnecessary for it to have incorporated any public policy considérant in that conclusion.

Accordingly, the appeal is allowed with costs.

Appeal allowed.