Johnson v. The Queen, 94 DTC 1009, [1994] 1 CTC 2025 (TCC)

Beaubier, J.T.C.C.:— This appeal was heard in Calgary, Alberta on October 25,1993 pursuant to the general procedure of this Court.

The appeal is in respect to a penalty imposed upon the appellant by the Minister of National Revenue pursuant to subsection 163(2) of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the"Act") for the appellant's 1986 taxation year.

On the appellant's motion at the opening of trial, the Court ordered the respondent to proceed with its case first. This Court takes its jurisdiction pursuant to provisions of the Tax Court of Canada Act and the Income Tax Act. Subsection 163(3) of the Income Tax Act reads:

Burden of proof in respect of penalties

(3) Where, in any appeal under this Act, any penalty assessed by the Minister under this section is in issue, the burden of establishing the facts justifying the assessment of the penalty is on the Minister.

[Emphasis added.]

Section 14 of the Interpretation Act, R.S.C. 1985, c. 1-21, reads:

Marginal notes and historical references

Marginal notes and references to former enactments that appear after the end of a section or other division in an enactment form no part of the enactment, but are inserted for convenience of reference only.

There is no procedural obstacle in this Court to prevent the Crown from establishing the facts justifying the assessment of a penalty. Under the general procedure it has a right to examine the appellant for discovery. Under the informal procedure it has a right under section 18.11 of the Tax Court of Canada Act to apply to transfer an appeal from the informal procedure to the general procedure if it is of the opinion that an examination for discovery of the appellant is necessary to establish the facts justifying the assessment of a penalty.

The Oxford English Dictionary defines the word “ establish” as "to render stable or firm". To establish facts in Court is to prove those facts, not merely to assume them. Thus, once the appellant has launched an appeal, it is necessary for the Crown to prove the facts justifying the assessment of a penalty. In these circumstances, it is the view of the Court that the Crown should proceed first in an appeal when a penalty is the sole issue.

Counsel for the Minister read in parts of the examination for discovery of the appellant pursuant to common law procedure and closed his case. Counsel for the appellant called the appellant's chartered accountant (the "CA") who was examined and cross-examined.

At all material times the appellant was a dentist practising in Alberta as an employee of Roger Johnson Professional Corporation ("RJPC"). He was also a shareholder of RJPC which is a taxable Canadian corporation with a fiscal year end of January 31. Its only business is the practice of dentistry.

During RJPC's 1986 fiscal year, which spanned the appellant's 1985 and 1986 taxation years, $181,211.48 was withdrawn from RJPC by the appellant. This sum was recorded by RJPC as a dividend to the appellant; however no T5s were prepared or filed and the dividend was not reported by the appellant as income. The Minister reassessed, included the sum in the appellant's income as a dividend and assessed the penalty in question pursuant to subsection 163(2) of the Income Tax Act on account of this omission to report.

Dr. Johnson is a shareholder in "a lot of corporations". He also owns another corporation ("Ken-Rar") that invests in oil and gas. He has been an investor in 40 or 50 oil and gas partnerships and in joint ventures. He has also owned real estate from time to time.

At the times in question the appellant had a part-time bookkeeper who came in twice a month and entered all accounts in the records and made and handed out most of the cheques. The appellant stated that he personally wrote RJPC’s cheques for investment purposes "probably 90 per cent of the time”. The appellant had the only signing authority on the cheques. The appellant described his personal attendance and record keeping and his relationship with his CA,"David", as follows:

A. Well, the way that worked it was all kept in the basket in my back room. Everything was sort of stacked in the basket. Anything that came in I thought was pertinent to the tax year I threw them on the basket. And then just, I don’t know, anywheres from three weeks to four weeks before the tax year-end David would come up to my office and we would go through this basket. And he would have a box and put it all in a box, and he would look at it. And he would take it to his office. He never did in my office. He took all the stuff to his office and then he separated it all. David separated it all himself, what went to Ken-Par, what went to the professional corporation. And he did my personal. He did all my Ken-Par, you know. So he did the whole thing, and he separated it all.

He might make the odd phone call because he wasn't maybe sure of something, you know, or he would even phone my broker and say what about this? What about that? Because I couldn't answer the questions, and I would say well, phone. Phone the broker, and he would do that.

Q. And the net result of all of that work by him was that he would produce financial statements for each of your corporations and from that produce corporate tax returns?

A. The whole — yeah, he did the whole thing.

Q. Okay. And then he would also in April of each year, or whenever, in the spring of each year he would produce your personal tax return showing your income for that year?

A. H'mm.

Q. Okay. Did you have a meeting after he prepared those documents to discuss them with him, or how did he then deal with them?

A. No, no, never any meeting. The fact was the way it almost routinely worked every year is he came in 4:30, 5:00 at the end of my day. And you know I I basically trusted him. He got all the information to make sure — I did a lot of investments, that he would have everything, you know, to put in its proper place. He came up and he even had the little pages tagged with something like that so he would know where my signature goes, and he would just lift it up and say sign here, and I would sign, sign here. It would — basically look sort of at the bottom line, you know, just in a cursory sort of way. And that was basically it.

And he would often say to me I will mail them if you want because we were often on a deadline, had to go out that night, and he offered me that service rather than — make sure I wasn't late filing. And so I would say well, you go ahead, David, you know, because he had other clients that he was doing the same service for, so I guess he took them all down. That's basically it. There wasn't much more.

Q. Okay. You said that the cursory examination was directed primarily at the bottom line?

A. Yeah, I would say that. And it wasn't maybe much of an investigation or a discussion. He said this is what you owe. This is the taxes you owe, and I often didn't know how a lot of these things worked. I just trusted him that there are different vehicles within the tax things that are available to me, and I trusted his judgment to work those out for me because I don't know. That's why I hire him, and I trust his judgment. And he would do that. And I figure however he does it he is trying to reduce my bottom line however I can within the law, and that's the way I approached it every year.

Q. Okay. Would you at that time have been expected or do you recall being expected that at that meeting you would also write a cheque for whatever balance was left owing?

A. To be frank I don’t really remember, but if I was to guess I think I would have raised a cheque at those times, and he would send it with it because I think they always — the regulations, they want the money with it, and I think if I owed money he would say— I think he did say that, that I would send a cheque with it.

The CA essentially agreed with the appellant's testimony and added that his firm would have mailed the appellant's income tax return for 1986 and that RJPC’s declaration of dividend would have been prepared by the lawyers. RJPC’s income tax return for fiscal 1986 would show approximately $400,000 being paid to the appellant. This in turn should have been reported by the appellant in his 1986 income tax return filed in April of 1987. That return left out the $181,211.48. The appellant's income tax return reported about the same income in 1986 as in 1985. The CA admitted that the appellant expected him to prepare the TS’s for the unreported dividend.

For 1986, subsection 163(2) of the Income Tax Act reads:

False statements or omissions. — 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 a penalty of

The question before the Court is whether, the appellant

. . .knowingly, or under circumstances amounting to gross negligence. . .has made or has participated in, assented to or acquiesced in the making of, a false statement or omission in a return. . . .

In Venne v. The Queen, [1984] C.T.C. 223, 84 D.T.C. 6247 (F.C.T.D.) at page 226 (D.T.C. 6249), Strayer, J. said:

It will be noted that for the penalty to be applicable there appears to be a higher degree of culpability required, involving either actual knowledge or gross negligence, than is the case under subsection 152(4) for reopening assessments more than four years old where mere negligence seems to be sufficient.

At page 229 (D.T.C. 6252) he reviewed various criteria particular to the case before him, and said:

First, there is ample evidence that the taxpayer did not read his returns before signing them. . . in my view he cannot absolve himself from all responsibility by hiring what he now says to be a patently inadequate bookkeeper and leaving matters entirely in the latter's hands. . . . Secondly, the errors in the income tax returns should have been sufficiently obvious that a reasonable man of even limited education and experience, especially one who was apparently a very successful business man and investor, should have noticed.

On page 233 (D.T.C. 6256) Strayer, J. quoted Cattanach, J. in Udell v. M.N.R., [1969] C.T.C. 704, 70 D.T.C. 6019 at page 714 (D.T.C. 6025-26):

In my view the use of the verb "made" in the context in which it is used also involves a deliberate and intentional consciousness on the part of the principal to the act done which on the facts of this case was lacking in the appellant. He was not privy to the gross negligence of his accountant. This is most certainly a reasonable interpretation.

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.

With that in view, Strayer, J. went on to deal with the ph rase "gross negligence" at page 234 (D.T.C. 6256):

With respect to the possibility of gross negligence, I have with some difficulty come to the conclusion that this has not been established either. "Gross negligence" must be taken to involve greater neglect than simply a failure to use reasonable care. It must involve a high degree of negligence tantamount to intentional acting, an indifference as to whether the law is complied with or not. I do not find that high degree of negligence in connection with the misstatements of business income. To be sure, the plaintiff did not exercise the care of a reasonable man and, as I have noted earlier, should have at least reviewed his tax returns before signing them. A reasonable man in doing so, having regard to other information available to him, would have been led to believe that something was amiss and would have pursued the matter further with his bookkeeper.

The appellant retained the same chartered accountant to do the accounting, preparation and income tax return for both RJPC and himself. His personal method of record keeping is quoted from his Examination for Discovery. On the evidence it is clear that the chartered accountant had all the material, knew of the dividend in fiscal 1986, recorded it in RJPC's records, and simply missed completing the T5 and entering it in the appellant’s 1986 income tax return of April of 1987. It is also clear that the appellant relied completely on his chartered accountant. The appellant merely sat down with the chartered accountant and signed the income tax return where it was flagged for his signature. The appellant omitted to see that the dividend was not included in his 1986 income tax return.

The appellant's evidence is that he simply wrote cheques out of RJPC's cash flow. Then, to quote his Examination for Discovery:

Q. Okay. You don’t recall that you would have been surprised by the fact that you were only reporting some $114,100, $115,000 in income?

A. No, I don't think I would be surprised whatsoever. I go back to David, you know, sort of juggles the books, looks after my interest, and — within the framework as set by Revenue Canada what I can do and can’t do. And I I left it to his discretion — he is the expert, and that's all — I totally trusted his judgment on these things, and that’s the fact of it. And I had no reason to believe that this was not correct. How he managed it I really don't know.

sometimes we would, you know, discuss something — what I may do. For instance, I asked him one time why I was being audited, and he would say well, you know, because you are — raise and raise flags sometimes because when they are doing these things they see them coming through on your shareholders' loans. Well, I said I understood you can — don't have to put those through shareholders. You can take those as write-offs. You don't have to go through shareholders. I didn't quite understand that when you put through shareholders you are supposed to be withholding taxes or sending withholding taxes. He said that's what is raising these flags. And I never picked some of that up. I said well, if you are writing it off why do you have to write taxes? It’s all there. It’s all included. You do the juggling, and. . . .

He stated:

Q. So as I understand you for 1986 and indeed for any of your years you really wouldn't have any idea what you made out of your dentist practice or what you took out of the PC?

A. At the end of the year.

Q. At the end of the year.

A. At the end of the year. That's when I knew.

Q. Okay. But in knowing what that amount was you were relying on him to tell you what it was. You didn't personally have any idea what you made, is that correct?

A. That's correct.

Q. And when he told you an amount you relied on the amount that you got from him without having anything to, any sort of base mark that you personally kept track of out of your operations over the course of the year?

A. I don’t really think that I ever knew in my own head that I was earmarking myself for $10,000 a month. I had no idea like that at all.

Complete records were kept by the appellant and his staff and he relied on his chartered accountant, his professional adviser whom he paid for this service, to deal with tax matters. The respondent argued that the appellant was sophisticated. The evidence is that the appellant was involved in sophisticated financial and tax matters, but there is no clear evidence that the appellant was, himself, knowledgeable or sophisticated either in his investments or his tax affairs. Rather it appears to the Court that he practised dentistry and, for tax and financial matters, relied on the professional advice of others. In essence the appellant dealt with the CA the same way that a patient deals with a dentist. The CA's professional reputation was not questioned at any time.

In circumstances where the appellant's chartered accountant, with full knowledge of the appellant's financial affairs, missed the substantial dividend in question and where the appellant relied completely on that chartered accountant to do all the adjustments of his financial and tax affairs and had no reason not to place such reliance on his chartered accountant, the Court is asked to find the omission in the appellant's income tax return to constitute gross negligence by him.

The appellant had a system. His employee recorded the cash flow in RJPC’s records. The appellant personally went through the documents with the chartered accountant with respect to income tax matters and his income tax return and gave the documents to the chartered accountant. When asked by the chartered accountant, insofar as he had knowledge, the appellant reviewed them with his chartered accountant who was a qualified and reputable professional. If he did not have knowledge, the appellant referred the chartered accountant to his broker. This was the appellant's examination and review of his income tax affairs. After that the appellant relied on the chartered accountant completely and did what the chartered accountant told him to do respecting his income tax return. The chartered accountant was negligent. The appellant may have been negligent when he did not review his income tax return prepared by his chartered accountant. But in these circumstances the omission in the income tax return does not make the appellant grossly negligent.

The appeal is allowed with costs in favour of the appellant.

Appeal allowed.