Date: 19981229
Docket: 96-4034-IT-G; 96-4035-IT-G
BETWEEN:
JACOB ERLICH, 649476 ONTARIO LIMITED,
Appellants,
and
HER MAJESTY THE QUEEN,
Respondent.
Reasons for judgment
Sarchuk, J.T.C.C.
[1] These are appeals by Jacob Erlich (Erlich) and 649476
Ontario Limited (the Corporation) from assessments of tax for
their respective 1992 and 1993 taxation years, and in addition,
in the case of the Corporation, for the 1994 taxation year. By
consent, these appeals were heard together on common
evidence.
[2] The Minister of National Revenue (the Minister) assessed
Erlich on a net worth basis for the years 1992 and 1993. This
assessment revealed a discrepancy between the income reported by
Erlich and his net worth as calculated by the Minister. More
specifically in reporting income for those two years, Erlich
failed to report the amount of $400,932 and $38,701,
respectively, as a shareholder benefit or as other income derived
from the Corporation.
[3] In so assessing him, the Minister relied on, inter
alia, the following assumptions:
a)
at all material times hereto, the Appellant was both a
shareholder and employee of the Corporation;
b)
in a series of transactions in April 1992, the total sum of
$366,950.00 was deposited in the Corporation to the credit of the
Appellant's shareholder loan account;
c)
the Appellant's explanation of the source of the funds that
were deposited in the Corporation is not supported by the
available evidence;
d)
the sales figures reported to the Minister by the Corporation for
the years 1988 to 1991 were understated by $378,044.00;
e)
the Appellant destroyed the cash register tapes and sales records
of the Corporation that would have disclosed the
Corporation's sales prior to 1992;
f)
the funds deposited by the Appellant in the Corporation in April
1992, were the unreported sales of the Corporation for the years
1988 to 1991 which had been appropriated by the Appellant;
g)
the Appellant had previously appropriated the unreported
corporate sales of a predecessor company, during the taxation
years 1981 to 1985, which the Appellant had deposited, in part,
to the credit of the Appellant's shareholder loan account in
the predecessor company;
h)
the Appellant's sales appropriations account for a
substantial portion of the net worth discrepancy referred to in
paragraph 5 above;
i)
the remainder of the discrepancy is attributable to the following
inclusions in the Appellant's net worth:
i)
a standby charge and benefit relating to the Appellant's use
of an automobile owned by the Corporation, as provided for in
j)
s. 6(l)(a), 6(1)(e), 6(l)(k) and 6(2.2)
of the Income Tax Act (the Act);
(ii)
personal living expenses of the Appellant and members of his
family that were paid for by the Corporation;
(iii)
revenue of the Corporation appropriated by the Appellant in the
1992 and 1993 taxation years and deposited to the credit of the
Appellant's shareholder loan account in 1993;
j) throughout the 1992 and 1993 taxation years, the
Corporation provided the Appellant with the use of two vehicles
having a combined cost of $13,226.00, in respect of which a
reasonable standby charge would be $3,174.00 in each year;
k) the Corporation paid all operating expenses incurred with
respect to the Appellant's use of the vehicles provided by
the Corporation;
1) a benefit was conferred on the Appellant by the Corporation
with respect to the operating expenses of the vehicles provided
by the Corporation to the Appellant which related to the personal
use of the vehicles by the Appellant in 1992 and 1993, in the
amount of $1,587.00 in each year;
m) the Corporation paid for personal expenditures incurred by
the Appellant, Susan Lynch, Roma Erlich and Chana Erlich, in the
amount of $5,471.86 in 1992 and $16,950.40 in 1993;
n) at the time the Corporation paid the personal expenditures
incurred by Susan Lynch and Roma and Chana. Erlich, Susan Lynch
was the Appellant's spouse, Roma Erlich was the
Appellant's sister and Chana Erlich was the
Appellant's mother;
0) the amounts paid by the Corporation with respect to
personal expenditures made by the Appellant, Susan Lynch, Roma
Erlich and Chana Erlich were a benefit conferred on the Appellant
by the Corporation;
p) the Corporation conferred a benefit on the Appellant in the
capacity of shareholder, in the amount of $400,932.00 in the 1992
taxation year and in the amount of $38,701.00 in the 1993
taxation year;
q)
the Appellant did not report or include in income in the
Appellant's return for the taxation years in question any
amount in respect of the benefits referred to herein; and
r)
in the alternative, the Corporation conferred a benefit on the
Appellant in the Appellant's capacity as an employee, in the
amount of $400,932.00 in the 1992 taxation year and in the amount
of $38,701.00 in the 1993 taxation year
[4] In reassessing the Corporation for the 1992 taxation year,
the Minister added to its income the amount of $390,699 as
unreported income from a business and denied the deductions
claimed with respect to certain club fees in the amount of $660
and with respect to the personal expenditures of Erlich in the
amount of $5,472.[1]
[5] In reassessing the Corporation for the 1993 taxation year,
the Minister added to its income the amount of $16,990 as
unreported income from a business, reduced the capital cost
allowance by the amount of the excess and denied the deductions
claimed by the Corporation with respect to club fees in the
amount of $390;[2]
with respect to personal expenses of Erlich in the amount of
$16,950 and with the deduction of a capital outlay of $3,500. The
Minister also increased the cost of sales by the amount of $5,172
to correct an accounting error.
[6 In reassessing the Corporation for the 1994 taxation year,
the Minister disallowed its claim for an alleged
non-capital loss incurred in 1991 in the amount of
$68,587.00.[3]
[7] In so assessing the Corporation, the Minister relied on,
inter alia, the
following assumptions:
a) in a series of transactions in April 1992, the total sum of
$366,950.00 was deposited to the shareholder loan account of
Erlich;
b) Erlich's explanation of the source of the funds that
were deposited is not supported by the available evidence;
c) the sales figures reported to the Minister by the Appellant
for the 1988 to 1991 taxation years were understated by
$378,044.00;
d) Erlich destroyed the cash register tapes and sales records
of the Appellant that would have disclosed the Appellant's
actual sales prior to 1992;
e) the funds deposited to the credit of Erlich's
shareholder loan account in April 1992 were unreported sales of
the Appellant and Erlich had appropriated;
f) Erlich had previously appropriated unreported corporate
sales of a predecessor company and deposited a portion of those
funds to the credit of his shareholder loan account in the
predecessor company.
g) a portion of the funds deposited in Erlich's
shareholder loan account in June 1993 also represent unreported
sales of the Appellant;
h) the Appellant paid for certain personal living expenses
incurred by Erlich, by his spouse Susan Lynch and by his mother
and sister, Chana and Roma Erlich, in 1992 and 1993, a portion of
which were not deducted from the shareholder loan account bearing
the name of the individual concern, but rather were expenses from
the general company account and claimed as an expenditure
incurred for the purpose of producing income form a business;
i) the Appellant paid to Erlich's fitness club membership
fees in 1992 and 1993 through its general expense account and the
said fees were treated by the Appellant for income tax purposes
as an expenditure incurred for the purpose of gaining or
producing income from a business;
j) the cost of the Appellant's sales in 1993 was
understated by the amount of $5,172.06 due to a credit that was
posted by the Appellant to the cost of goods sold in error;
(k) the cost allocation between the land and building situated
at 726 Queen Street in Kincardine, Ontario was $68,974.00 and
$188,233.00 respectively, rather than $30,000.00 and $227,197.00,
as reported by the Appellant in the 1993 taxation year;
1) an amount expensed by the Appellant for the purchase of new
signage represented the acquisition of a capital asset (class
8);
m) with respect to the 1994 taxation year, there was no
'non-capital loss' as defined in s. 111(8) of the
Income Tax Act (the Act) in 1991, that the
Appellant could carry forward and apply against its taxable
income in 1994; and
n) the Appellant did not report or include in income in the
Appellant's return for the 1992 and 1993 taxation years, any
amount in respect of the business income referred to herein.
[8] The primary issues to be determined are:
In the case of Erlich, whether he received a benefit in the
amount of $400,932 in the 1992 taxation year and in the amount of
$38,701 in the 1993 taxation year from the Corporation in the
capacity of shareholder or, alternatively, in the capacity of
employee.
In the case of the Corporation, whether the amount of $390,699
in the taxation year 1992 and the amount of $16,990 in the
taxation year 1993 represent the unreported revenue of the
Appellant.
[9] Erlich's father had carried on a clothing business at
various locations in Ontario for a number of years prior to 1972.
In that year, as a result of his father's illness, Erlich
took control of all of his business affairs. In the fall of 1973,
he opened the Hanover store and since then has had "many
different stores in small towns in southwestern Ontario, as many
as 12, or 13, or 14 at one point...”...At all relevant
times, Erlich was the president and sole shareholder of the
Corporation. It and its predecessors carried on business as
retailers of clothing and footwear and were also involved in the
leasing of commercial and residential properties. During the
taxation years in issue, the Corporation's clothing business
was predominantly operated in Kincardine and in Hanover.
[10] In 1994, the Special Investigations Branch, Revenue
Canada (S.I.), received information with respect to the
Corporation to the effect that certain revenue had not been
reported. The matter was referred to the Audit Division and
assigned to John Douglas Bain (Bain). In September 1994, Bain
spoke to Barry Reid, the Appellants' accountant at that time,
and reviewed the manner in which the 1992 and 1993 financial
statements and corporate returns were prepared. He then met
Erlich at the Kincardine store and following a short discussion,
began his audit. He spent approximately one week reviewing the
available books and records of the Corporation during which he
discovered that there were no source documents relating to the
expenses and revenues for the 1991 taxation year. For 1992,
"there was a box of records containing invoices for the
expenses" but he said, "there were no cash register
tapes or anything of that nature to verify anything else".
With respect to the 1993 taxation year, some records including
three general ledgers were provided but his examination disclosed
that "on the revenue side, there was nothing to look at, I
couldn't verify sales". Expense invoices were available
but the cash register tapes had been destroyed and no inventory
records for any of those years could be located. As a result,
Bain sought further information and documentation from the
Appellants but received very little and that was incomplete.
[11] In addition to the documents obtained from the
Corporation and Erlich, Bain had available to him a copy of three
pages of computer-generated information (the Sales Records)
given to S.I. by John Michael O'Malley (O'Malley), a
former employee of the Corporation.[4] According to O'Malley, Erlich was
the source of this document and the information contained therein
represented the weekly sales at the Kincardine and Hanover stores
from 1987 through to 1992. Subsequently, in the course of his
audit, Bain compared the sales reported in these documents as
against the sales reported in the financial statements. His
analysis led him to conclude that the sales figures reported by
the Corporation for the years 1988 to 1991 were understated by
$378,044.
[12] As there were no records to verify sales and since an
allegation had been made that there were unreported sales in the
Corporation and that cash was being taken out, Bain proceeded to
perform a net worth audit of the shareholder, Erlich, for the
1991, 1992 and 1993 taxation years. The audit disclosed a net
worth discrepancy in excess of $400,000. Included in the net
worth calculations were sizable shareholder's loans due from
the Corporation to Erlich. In particular, Bain noted that the sum
of $366,950 had been deposited in the Corporation by Erlich in
April 1992 to the credit of his shareholder loan account.
[13] When the audit was completed in March 1995, Bain
telephoned Erlich and informed him of the discrepancies. Erlich
"wanted a letter sent out on the net worth ... " and
Bain forwarded a proposal letter to him for review. He received
no response. At a later point of time, representations were made
on behalf of both Appellants by their solicitors which were based
in part on the assertion that Erlich's mother had found the
amount of $366,950 in two boxes in a closet in her residence,
which monies were turned over to Erlich in 1989. The position
taken by Erlich was that this was the source of the funds he
deposited in the Corporation in April 1992.
[14] As a result of these representations, Bain reviewed all
of the personal income tax return information of Erlich's
parents, Chana and Leon, for the period 1972 to 1986.[5] The review of the
information available led Bain to conclude that they did not
appear to have "a source of funds for that amount of
money".
[15] Evidence was also adduced on behalf of the Respondent
from O'Malley. He first met Erlich when engaged as a
consultant for the Corporation with respect to a sales promotion.
Shortly thereafter, in the summer of 1992, he was hired to manage
the Kincardine and Hanover stores. The relationship quickly
soured and on November 5, 1993, his employment was terminated.[6]
[16] Shortly after his engagement both stores were closed, the
old stock was liquidated and the premises refurbished. In early
1993, they were opened under a new name, Brands Central. Although
given cheque-signing authority, it was not on the
Corporation's account into which the sales proceeds were
deposited but was for a separate account which had been opened
and into which Erlich deposited all funds necessary to pay the
ongoing expenses of the business. O'Malley was to manage the
stores but was not in any way involved in the financial
management of the Corporation, had no access to its main bank
account, was not responsible for the books and records of the
Corporation and was not involved in the preparation of its
financial statements. O'Malley
maintained that he did not deal directly with the accountant,
Barry Reid, other than occasionally responding to a telephone
request for specific information. With respect to other
information such as sales data, accounts payable, payroll and
reconciliations, it would have been provided to Erlich who in
turn, or so O'Malley believed, passed it on to the
accountant.
[17] O'Malley described the Sales Records provided to S.I.
as "a history of the sales in his store from 1987 through to
1992 when I joined him".[7] These documents had been given to him by Erlich
to enable him to prepare an annual sales plan. O'Malley
testified the Sales Records were utilized in their discussions as
to when sales and promotions should occur and formed the basis of
future sales forecasts. Certain notations on the first page were
in his writing while others were made by Erlich. With specific
reference to the column headed "93", the
hand-written numbers were entered by him and represented
the actual sales which he entered at the end of each week for
comparison purposes to the same period in the previous years.
[18] According to O'Malley, all of Erlich's previous
records, "all the business records, all the previous boxes
of tapes, ledgers, everything" were stored in the basement
of the Kincardine store. During the renovation of the premises in
January and February, 1993, that space was required and Erlich
said he would take them home. O'Malley testified that he
assisted in loading them into Erlich's car but beyond that
had no personal knowledge as to what happened to the records
thereafter.
[19] Evidence was also adduced on behalf of the Respondent
from David Wesley Glazer (Glazer), who performed an audit
for Revenue Canada in respect of both Appellants' 1981 to
1985 taxation years.[8] It commenced with a detailed analysis of the growth of
the shareholder's loan to the Corporation and ultimately led
to a net worth audit of Erlich. The substantial increase in the
shareholder's loan balance was initially explained by Erlich
as representing "loans from his parents". Glazer
continued his audit but found no evidence to support Erlich's
claim. Erlich also told Glazer that he had to put the money in to
keep his corporations afloat financially. However, Glazer's
analysis of the Corporation's books and records disclosed a
substantial number of improper entries and, as he observed, the
problem was that the source of these funds were not Erlich but
rather were the proceeds of corporate sales which should have
been recorded as such and should not have been credited to the
shareholder's loan account. "So it was really
understated sales and overstated shareholders loans".
Adjustments were proposed by Revenue Canada in respect of a
number of such items and were accepted by Erlich and the
Corporation.
Evidence adduced on behalf of the Appellants
[20] The Appellant, Erlich, concedes that he made cash
deposits to the Corporation totalling $366,950 but says these
funds came from his mother. More specifically, he says that at a
family gathering in 1989, his mother revealed that she had found
two boxes containing a total of $366,950 in Canadian currency.
According to Erlich, his mother had no idea as to the source of
the money. These monies were turned over to him and they were
kept in his home in various hiding places until approximately
1992 when they were deposited in the Bank (somewhat piecemeal)
and then transferred to the Corporation.
[21] When asked by his Counsel to respond to the
Minister's assumption that the source of these funds was the
Corporation, he said:
I categorically disagree. In the systems that I painstakingly
tried to show that were in place, in my mind make it very clear
that everything was balanced and cross-balanced and I
don't know how this could have happened. Further, I believe
that the report that is being used here to create the extra
numbers is a cross between gross sales and net sales and there is
some incorrect numbers being put in to the system.[9]
With respect to the Sales Records, Erlich maintains that he
did not create these documents and implied that O'Malley or
his son, Robert, were responsible. He further stated that the
information in the Sales Records was "absolutely"
inaccurate in that it "did not match the information that
the accountants were provided with".[10] According to Erlich, the
Corporation's financial statements were prepared by the
accountants on the basis of that "information", and
accurately reflected its financial affairs and more particularly,
accurately reflected its actual sales and expenses in the years
1986 to 1993. That was he said, because in 1984 a program was
developed which enabled him to keep inventory control and
permitted him to measure its gross sales, net sales, costs of
goods sold and "a number of items such as this that are
important retail tools that will help me to measure performance
and hence the future, potential future performance". He
detailed at great length the manner in which the business records
were kept and said that:
Through all the cumbersome system I had, the mechanical system
and the little bit of computer system that we had, we kept as
accurate records as was humanly possible, referenced,
cross-referenced and cross-checked to be able to come
up with these sales numbers that are across the top. So
everything had to balance, cross-balance and check and
cross-check.
He asserts that at all relevant times, the Corporation's
books were maintained in this manner and all required information
was regularly provided by him to the accountants.
[22] Erlich testified that records for a current year, clearly
labelled and marked, were kept in a filing cabinet while those
from earlier years were stored in an area set aside for that
purpose in the Kincardine store. As for the missing documents,
Erlich said that while he understood that records for the
taxation years in issue were destroyed, he had no idea how that
occurred other than: I was told they were destroyed by a number
of people ... " and that to the best of his recollection
they were destroyed during the period of time that O'Malley
was employed as manager.
[23] The arrangement with O'Malley was terminated in
November 1993 because in Erlich's view, he did not perform in
certain areas with respect to the business. He alleged that sales
had dropped off and that while he repeatedly asked O'Malley
to maintain a proper record-keeping system, he was
dissatisfied with the progress that was being made. By the fall
of 1993, when Erlich dismissed O'Malley they were on very bad
terms. O'Malley sued the Corporation
and Erlich for wrongful dismissal. Counsel were retained,
further legal actions and counter-suits followed and
several years passed before the issues were resolved.
The Glazer Testimony
[24] Counsel for the Appellants objected to the introduction
of evidence of a previous audit conducted by Glazer on the basis
that it was similar fact evidence and in the context of this
particular case, was inadmissible. The position advanced was that
the similar facts were not logically relevant in determining the
matter in issue in the present appeals nor was there any
substantial connection between the actions of the Appellants
during the period of time previously audited and the
circumstances that are before the Court.[11]
[25] It is generally accepted that evidence of similar facts
is considered collateral and is generally inadmissible unless
there is, as Bull J.A. observed in MacDonald v. Canada Kelp
Co. Ltd.:[12]
... a real and substantial nexus or connection between the act
or allegation made, whether it be a crime or a fraud (but not, of
course, limited to those), and facts relating to previous or
subsequent transactions are sought to be given in evidence, then
those facts have relevancy and are admissible not only to rebut a
defence, such as lack of intent, accident, mens rea or the
like, but to prove the fact of the act or allegations made.
...
Bull J.A. went on to say at page 627:
... As I have indicated, the test is relevancy and relevancy
depends largely on nexus or connection of the other transactions
with the ones in issue - and a strong connection can well
be admissible as relevant to the fact of the actus reus.
...
[26] The question of the admissibility of similar fact
evidence was also dealt with by McIntyre J. in Sweitzer v. The
Queen.[13]
After reviewing the general principle set out by Lord Herschell
in Makin v. The Attorney-General for New South
Wales,[14]
McIntyre J. stated:
Over the years in seeking to apply this principle
judges have tended to create a list of categories or types of
cases in which similar fact evidence could be admitted, generally
by reference to the purpose for which the evidence was adduced.
Evidence of similar facts has been adduced to prove intent, to
prove a system, to prove a plan, to show malice, to rebut the
defence of accident or mistake, to prove identity, to rebut the
defence of innocent association, and for other similar and
related purposes. This list is not complete.
This approach has been useful because similar fact evidence by
its nature is frequently adduced for its relevance to a single
issue in the case under trial. It has however involved, in my
opinion, a tendency to overlook the true basis upon which
evidence of similar facts is admissible. The general principle
described by Lord Herschell may and should be applied in all
cases where similar fact evidence is tendered and its
admissibility will depend upon the probative effect of the
evidence balanced against the prejudice caused to the accused by
its admission whatever the purpose of its admission. ...
[27] With these principles in mind, I concluded that the
evidence tendered by the Respondent has substantial probative
value which outweighs any prejudicial effect on the Appellants
and is admissible. There is, in my view, a clear nexus between
the previous transactions and the matters before this Court. In
both instances, that is in the previous audit and the one
currently before this Court, the same Corporation and shareholder
are involved and in each instance, the issue was misappropriation
of corporate funds. On each occasion, representations were made
to officers of Revenue Canada with respect to the increases in
the shareholder loans. Glazer's evidence is relevant and
admissible to rebut the Appellants' assertions with respect
to the source of the funds and, as well, goes directly to the
issue of Erlich's credibility.
Conclusion
[28] In the absence of reliable records, whether they are
either non-existent, destroyed, or otherwise not produced,
the Minister may issue a net worth assessment to properly
determine a taxpayer's liability. The net worth assessment is
arrived at by determining the taxpayer's assets and
liabilities at the end of the taxation year and at the end of the
last previous year for which tax could be determined and assuming
that the taxpayer's income for the intervening period was
equal to the increase in his or her net worth in the period plus
the estimated amounts spent for personal and living expenses. The
onus rests on the taxpayer to satisfy the Court that the
assessment is wrong.
[29] In brief form, the position which the Appellants take is
that the Minister in assessing erred in concluding that the funds
deposited by Erlich in the Corporation in 1992 were the
unreported sales of the Corporation for the years 1988 to 1991
which had been appropriated by him. The Appellants contend that
the Minister's conclusion is wrong because it ignores the
actual source of the funds which, they say, was the money found
by Erlich's mother. The Appellants assert that Erlich's
testimony regarding the system of record-keeping
established the accuracy of the corporate financial statements as
well as the accuracy of the sales reported and that the system
effectively prevented the type of appropriation asserted by the
Minister. It was further argued that the Sales Records which
formed the basis for the Minister's assumptions were created
by some person other than Erlich and have been shown to be
inaccurate and misleading.
[30] I propose to first deal with the testimony adduced on
behalf of the Appellants as to the source of the monies advanced
by Erlich to the Corporation in April 1992. Erlich's
testimony, and that of his mother, was clearly intended to
suggest that since his mother found the money in a box which also
held some of Leon Erlich's papers, he must have been the
original source of the funds. Called upon by his Counsel to
speculate as to how that might have come about, Erlich conceded
that his father's clothing business could not have generated
this type of money but said he bought and sold real estate and
that it was possible that he had bought and sold more than Erlich
was aware of. He also asserted (without any further explanation)
that his father was a "money engraver" and that on
several occasions, he had travelled to Europe, New York, Los
Angeles and Mexico.[15] These attempts to attribute the "found
money" to Leon Erlich are totally unconvincing. The evidence
is that he retired in 1972 and that Erlich took over the family
business at that time. It is also a fact that Leon Erlich
suffered from Alzheimer's for most of the 15 years prior to
his death in 1987. Chana Erlich testified that they had turned
over all of their property to Erlich in or about 1974 and Erlich
himself said that he had been paying the bills for his mother and
father since 1973 and that "my mother and father gave over
to me all their assets by 1984 and prior to that it was a staging
thing". [16]
[31] It is also a fact that both Glazer and Bain independently
reviewed the income sources of Leon and Chana Erlich and
concluded that they could not have been the source of these
funds. I note as well that Erlich was specifically asked whether
he had suggested to Glazer during the earlier audit that loans
from his mother were the source of capital going into the
business and his response was: "I can't recall all that
detail back then, I am sorry".
[32] The testimony adduced on behalf of the Appellants with
respect to the source of the funds is, in my view, simply not
credible.
[33] To support the Appellants' position that
appropriations from the Corporation were not the source of the
funds in issue, the validity, accuracy and origin of the Sales
Records were challenged. In this context, it became most evident
that the credibility of the witnesses, Erlich and O'Malley,
would be a critical factor. Counsel for the Appellant urged the
Court to disregard the testimony of O'Malley with respect to
the Sales Records and the missing corporate documents as that of
"a disgruntled individual who had reason to create some
difficulties in the life of Mr. Erlich and the company". As
previously observed, it was obvious that Erlich and O'Malley
have a visceral dislike for each other. While it would be naive
to assume that O'Malley was not motivated by his antipathy
towards Erlich when he turned over the Sales Records to Revenue
Canada, it would be equally naive to disregard Erlich's real
and substantial interest in the outcome of these appeals and to
accept without question Erlich's accusation that
O'Malley, or his son, fabricated the Sales Records and
deliberately misrepresented their import. The same comments apply
to his attempts to implicate O'Malley in the destruction of
records of the Corporation.
[34] Having had the advantage of hearing Erlich's
testimony first, I observed O'Malley with extra care during
the whole of his testimony including the vigorous
cross-examination to which he was subjected. While there
were aspects of his testimony, particularly as it related to his
dismissal and the subsequent law suits which were questionable
and not particularly convincing, I am satisfied that with respect
to the Sales Records and the missing corporate documents, the
evidence of O'Malley is to be accepted in preference to that
of Erlich.
[35] 1 was particularly unimpressed by Erlich's testimony
with respect to the Sales Records. Asked by Counsel to explain
how this document could come into existence, he said it formed
part of the information on the computer that was used at the
relevant time and he believes that it: "represents a
combination of gross sales, net sales and possibly some
mark-downs" for the period of time 1987 to
mid-1993, and that "someone extrapolated some of this
work incorrectly" from the computer records. He implied that
since the O'Malleys had access to the computer, they must
have been the source. Since Erlich was aware that O'Malley,
Sr. was computer-illiterate, he pointed the finger of
suspicion at the younger O'Malley.
[36] Erlich's assertion that the Sales Records were not
produced by him is on the whole unconvincing and difficult to
accept. The information contained therein admittedly came from
the 1987 to 1993 period, most of which predates
O'Malley's arrival. At all relevant times, Erlich had
access to the corporate files and records through a computer kept
at his home office. Furthermore, although he flatly rejected
O'Malley's assertion that the Sales Records were used as
a planning document, a number of comments written by him are
found on them. With respect thereto he equivocated on a number of
occasions, saying by way of example:
and so when I look at the numbers O'Malley
has written in his dark handwriting, if you look at week no. 36,
it is possible that I wrote this information at that point in
time, but again I do not know. I could have written this
information before any of this information was written. I
don't know.
Counsel for the Respondent suggested that the Sales Records
were in fact used in discussions with O'Malley and put the
following question to Erlich:
Q. Perhaps you could have been discussing with Mr.
O'Malley your targets for him for the next blank period
coming up ahead, something of that nature?
A. I would argue that Mr. O'Malley has pieced out here in
his own darker handwriting certain things. I can't comment
because I don't know why they are there. I can only tell you
and reaffirm in my handwriting that is faint, it looks clear to
me that we are strictly speaking about specific terms of time
that I have indicated for the best promotional activities, which
essentially were the May 24th weekend and the forward X number of
weeks and through the Christmas period, that is all I would agree
to.
With respect to the accuracy of the information in the Sales
Records, the following exchange took place:
Q. So, not in the course of planning, or perhaps in the course
of very loose planning Mr. O'Malley and yourself look at this
document. Would not you have said to him at that point, or if
these numbers are no approximately correct, said, what's this
nonsense. We can't plan on this basis, this overstates
everything, we are not going to do that well?
A. I remember having a conversation with Mr. O'Malley with
regards to thinking in terms of this planning, he talked about
20% mark-downs. When you are thinking about retail pricing
by the time it nets out to the consumer you have about a 20%
mark-down involved. What I mean is the regular price would
be 89.99 like that Nike for example, sold at 79.99 and that would
be an example of the leeway between regular and sale that he
needs to shoot for in terms of planning. That's all I could
read out of that.
Erlich's answers were, in my view, deliberately evasive
and unresponsive.
[37] With respect to the missing corporate records, Erlich
denied any knowledge of the circumstances under which they
disappeared or were destroyed and implied that O'Malley was
responsible. As for his assertion that he received certain
information regarding their destruction from a number of
individuals - I observe only that none of them were called to
testify. He also said that he never noticed that they were
missing since he "never had anything to do with the records
other than to know they were there". Since the evidence as a
whole strongly suggests that Erlich was a very hands-on
manager, this comment is, in my view, not plausible.
[38] One final observation. The foundation for Erlich's
characterization of the Sales Records as inaccurate is that they
disagree with the Corporation's financial statements.
Erlich's evidence as to who actually provided the information
to the accountants is inconsistent, saying at one stage that he
attended to this task, while on other occasions, suggesting that
it was his bookkeeper and while he was there, O'Malley. The
two accountants who acted for the Corporation and for Erlich in
the years 1987 to 1993, Schmidt and Reid, were not called to
testify. A fair inference for their absence is that their
testimony would not have assisted the Appellants.
[39] 1 have previously adverted to the fact that in an appeal
against an assessment for tax assessed on a net worth basis, the
onus lies on the Appellant to establish on a balance of
probabilities that taxable income was not as assessed. The
Appellant, Erlich, has failed to do so. Furthermore, on the
evidence adduced, both Appellants have failed to establish that
the discrepancies in issue are not the result of misappropriation
of corporate funds.
Collateral Issues
[40] In addition to sales appropriations the net worth
discrepancy of the Appellant, Erlich, was attributed, inter
alia, to such items as standby charges and benefits relating
to his use of an automobile owned by the Corporation and personal
living expenses of Erlich and members of his family.
Concurrently, in assessing the Corporation, the Minister
disallowed all personal expenses paid by the Corporation.
Agreement has been reached on some of these items:
(a) Huron Ridge - personal residence - The
Appellants maintain that Erlich had an office in his residence
and that the expenses
so incurred were a deductible expense to the Corporation. The
parties have agreed that the amounts to be allowed as office
expenses are $1,100 for 1993 and $1,250 for 1992. The allowance
of these expenses to the Corporation will also have the effect of
reducing the shareholder's benefit to Erlich by the same
amounts.
(b)
Investment expenses - Erlich borrowed the sum of $100,000
by way of a personal line of credit. These funds were loaned to
the Corporation and invested in mutual funds by the latter.
During the relevant period of time, six payments of $600 each
were made on Erlich's line of credit. Four amounting to
$2,400 were reported on the shareholder's loan account while
two totalling $1,200 were expensed by the Corporation. It is
agreed that the amount of $1,200 which was added to Erlich's
benefit in the T1 return should be adjusted in his favour in
taxation year 1993. With respect to the same investment, the
parties have agreed that the Corporation is entitled to an
interest deduction in the amount of $2,170.79.
(c)
With further respect to the 1993 taxation year, the Appellant
Erlich is also to be allowed a deduction of $1,744 with respect
to interest incurred on the refinancing of his home, the proceeds
of which were used for investment purposes.
(d)
The Thornhill residence (sometimes referred to as the McMorran or
Vaughn residence) - This was a property owned by Erlich in
which his mother and sister resided. Erlich maintained that his
business brought him to Toronto several times a month and that he
conducted business at that residence at least one or two times a
month. There was no office in the residence per se, but
there was "a very private and quiet downstairs area"
which was used for that purpose. Substantial expenses were
claimed for both 1992 and 1993 including 100% of the property
taxes, water, gas, telephone and T.V. bills. In the course of his
examination-in-chief, Erlich conceded that many of
these items should not have been claimed as business expenses[17]. The parties
agree that if the Corporate Appellant is entitled to treat
certain items as deductible office expenses, the amount of $2,000
for each of 1992 and 1993 would be acceptable. I have considered
Erlich's testimony on this issue and am not at all satisfied
that it supports the deductibility of the amounts in issue.
Accordingly, the Corporate Appellant is not entitled to the
deduction of any of the amounts under this head.
(e)
Automobile expenses - The Corporation owned two vehicles.
It is not disputed that one was driven by his wife and the other
by Erlich, albeit on an interchangeable basis. The Minister in
assessing Erlich included in his income a standby charge of
$4,761 for each of taxation years 1992 and 1993. Erlich initially
testified that 99% of the use of the vehicle was business related
but when his Counsel observed that driving to and from work ought
not to be included, Erlich reduced the business use to 70%. No
logs were kept and Erlich's testimony provided little support
for his estimate. It is incumbent upon an Appellant to maintain
sufficient records of use of a corporate vehicle to permit the
Court to determine whether the Minister's inclusion of the
standby charge was sound. That has not been done. The evidence
adduced does not warrant any interference with the Minister's
assessment.
(f)
Signs - In the course of his audit, Bain examined an
invoice from Classic Sign & Design which appeared to reflect
the acquisition by the Corporation of three signs. The amount
expensed was $3,500. He concluded that these items should have
been capitalized as Class 8. The Minister in his assessment did
so and a capital cost allowance was given on the items in issue.
The question is whether the items were properly capitalized.
Erlich testified that these were signs which had been removed
from stores he previously owned and
which were subsequently taken out of storage and refurbished.
The Appellants' position is that the cost of refurbishing was
an appropriate expenditure and ought not to be treated as a
capital item. Sufficient question has been raised regarding the
validity of the Minister's conclusion. Accordingly, the
Corporation will be permitted to deduct the amount in issue as a
current expense in 1993.
[41] A number of other items were raised in the original
Notice of Appeal including the payment by the Corporation of
personal expenditures incurred by the Appellant, his spouse,
Susan Lynch, Roma Erlich and Chana Erlich. These have been
abandoned.
[42] The appeals are allowed to permit the Minister to
reassess with respect to the minor adjustments enumerated in
paragraphs 40(a), (b), (c), and (f). Beyond that, the Appellants
are not entitled to any further relief. The Respondent is
entitled to its costs.
Signed at Ottawa, Canada, this 29th day of December, 1998.
"A.A. Sarchuk"
J.T.C.C.
Email this Content