Citation: 2012 TCC 25
Date: 20120120
Docket: 2009-2129(IT)G
BETWEEN:
HENNING E. JACOBSEN,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
REASONS FOR JUDGMENT
Sheridan J.
Introduction
[1]
The Appellant, Henning Jacobsen,
is appealing the reassessment by the Minister of National Revenue under the Income
Tax Act of his 2003, 2004 and 2005 taxation years. During those years, the
Appellant was a self-employed aerospace consultant with a particular expertise
in analysis and management of data in electronic form.
[2]
The 2003 taxation year was
reassessed after the normal reassessment period; penalties were assessed in
respect of all three taxation years. The Minister had the onus of justifying
the 2003 reassessment and the imposition of penalties pursuant to subsections
152(4) and 163(2), respectively. Subsection 163(2) carries a greater
burden of proof than subsection 152(4) of the Act.
[3]
In reassessing the 2004 and 2005
taxation years, the Minister assumed the Appellant had not reported income of
$33,886 and $33,127, respectively, and in respect of 2005 only, had not remitted
the attendant Goods and Services Tax. In all three taxation years, the Minister
disallowed certain business expense claims on the assumption that they were
personal expenditures and therefore, not deductible under paragraph 18(1)(h)
of the Act.
Analysis
[4]
At the commencement of the
hearing, the Appellant admitted his failure to report income and to remit GST
but denied this omission was sufficient to trigger the imposition of penalties.
Leaving aside that issue and the matter of the statute-barred year, the
question is whether the various amounts claimed for interest, meals and
entertainment, motor vehicle, office supplies and services, travel,
subcontracting and business use of home were incurred for the purpose of
earning business income as required by paragraph 18(1)(a) of the Act.
[5]
I regret to say that the Appellant
did not meet his onus of disproving the Minister’s assumption that the amounts
claimed were personal in nature. This had mainly to do with his trial strategy.
Rather than forging a link between the amounts claimed and source documents
substantiating them or calling witnesses to corroborate his oral evidence, the Appellant focused on the manipulation of data he
had compiled in an electronic database (“Database”). He sought and was
granted leave to use the Database as an aid to his testimony. The Database
showed the raw expense figures taken from
the Appellant’s credit card and bank statements which he had entered, long after the fact, under
various categories of business expenses: travel, promotion, entertainment,
motor vehicle and so on. The great weakness of the Database was that the totals
shown as business expenses were entirely dependant upon the Appellant’s subjective determination as to whether
they were business-related or personal.
[6]
The other difficulty was that the
Appellant did not produce the invoices or receipts underlying these expenditures.
Without these source documents (or others such as contemporaneously recorded
vehicle logs or social events diaries), the Appellant’s bare assertion of their
business use could not be verified. In addition to its subjective basis, the Appellant’s
system of categorization was further flawed by certain misconceptions he held:
for example, that expenditures made in the course of his consulting work which,
under the terms of their agreement a particular client might agree to
reimburse, were properly deductible under the Act. He also seemed to
believe that as long as there was some link, however remote, to his business,
an expenditure was a legitimate business expense. The Appellant further
complicated matters for himself by not having maintained separate accounts for
his business and personal affairs.
[7]
As for the inaccuracies in his returns,
the Appellant blamed these on his accountant; specifically, her advice to
under-report his losses in 2003 to avoid attracting the attention of the Canada
Revenue Agency which he said resulted in other errors in his 2004 and 2005 returns (Exhibit A-1). However, the Appellant admitted he provided the data used by
the accountant and knowing the returns to be inaccurate, he filed them. Furthermore, the
accountant was not called as a witness.
[8]
In a similar vein, the Appellant
felt the auditor in charge of his file was wrong in having used the erroneous
information filed in his returns
as the basis for her analysis. Had she been willing to use the revised
information in an earlier iteration of what by time of trial was the Database,
there would have been no basis for the reassessments. Counsel for the Appellant
also argued that she had not properly understood the nature of the Appellant’s
consultancy business.
[9]
The auditor assigned to the
Appellant’s file, Nadia Sglavo, was called by the Respondent. She explained her
methodology and made a thorough review of the materials she relied on in
disallowing the Appellant’s expenses. Her first step was to examine the expense
amounts reported by the Appellant in his returns (Exhibit A-1). Next, she
looked at the amounts under each category of expense itemized in a spreadsheet
of expenses generated by the earlier version of the Database and tried to
correlate them with the few receipts and invoices provided to her by the
Appellant. In this regard, the auditor had an advantage over the Court. She had
for her review at least some of the source documents, mainly from 2003. Most of
the 2004 and 2005 papers had been lost when the Appellant’s basement flooded in
2006. The auditor then prepared her working papers and met with the Appellant
and his accountant to permit them to respond to her findings. As a result, some
adjustments were made in the Appellant’s favour; the remaining disallowed
amounts were confirmed on objection and are the subject of these appeals.
[10]
Regardless of the auditor’s
conclusions, the Appellant’s task at the hearing was to meet his onus of justifying
the business nature of the amounts claimed. However, because the Appellant (and
his counsel) so frequently criticized the auditor’s analysis I would add the
following: given the self-reporting basis of the Canadian tax system, the
auditor can hardly be faulted for having relied on the information the
Appellant himself provided to her in returns he knew to be erroneous. As for
the use of the Database at the audit stage, it did not then exist in the form
presented at trial. Furthermore, the auditor did accept and review a paper copy
of an earlier version of the Database. When that failed to convince, the
Appellant continued to massage the data throughout the objection stage and up
to the moment of trial; indeed, when during his testimony the Appellant spotted
an error in one of the sub-categories, he amended it on the spot. While its
ease of alteration may be an asset in the realm of electronic data management, it
did nothing to enhance the Database’s reliability as an aid to the Appellant’s
testimony.
[11]
At the close of the Appellant’s
testimony it became clear that what the Appellant really wanted was to file
amended returns based on the Database which, he asserted, showed he was entitled
to far more business expenses (Exhibit A-7) than those originally claimed in
his returns, during the audit or at the objection stage. I denied counsel for
the Appellant’s request to amend the Notice of Appeal accordingly. However, even
if I had allowed the amendment, it would not have changed the outcome as overall,
the Appellant failed to establish the business purpose of the amounts claimed.
[12]
Given this conclusion, it is not
necessary to do a line-by-line analysis of the Appellant’s claims; however, the
approach taken in the consideration of his evidence, together with some
examples, are set out below.
[13]
Having heard the Appellant’s testimony, I
cross-referenced the bank and credit card statements for 2003, 2004 and 2005
(Exhibits A-3, A-4 and A-5, respectively) with the corresponding Database printouts
for each financial institution (Exhibit A-6). I had intended to check these
against the source documents which I understood the Appellant to say were
included with the exhibits. Upon discovering otherwise, I focused on the 2003
taxation year as at least some copies of receipts and invoices were available
in the Respondent’s documents (Exhibit R-2).
[14]
One of the first items listed in
the 2003 Database printout (Exhibit A-6) is “Belair” on January 3, 2003, categorized
generally as a business expense and under the sub-category “Travel &
Living”. Under the Appellant’s system, that meant living expenses incurred while
traveling on business. Cross-referencing the dates and amounts shown with the
MBNA statements (Exhibit A-3) shows “Belair” to be the Appellant’s shorthand
for “Nettoyeur Belaire”, identified by the auditor as a dry cleaning company. There
are numerous similar charges throughout 2003. The Appellant explained that he categorized
his dry cleaning charges as a business expense on the basis that as a
consultant, he had always charged back such costs to his clients. While it is
open to the parties to make such an agreement, it does not serve to convert dry
cleaning costs, which are on their face personal in nature, into business
expenses.
[15]
The 2003 Database printout also
categorizes under “Ent” (entertainment) or “PR” (promotion), expenditures for
liquor store purchases, ski resorts, gift shops and grocery stores, all of
which can be found in the MBNA statements (Exhibit A-3). The Appellant said
these were properly classified as business expenses because as a consultant he
had to make social connections with existing or potential clients. He also used
social occasions to get advice from lawyers, accountants and those with
expertise or connections in the aerospace industry. In furtherance of this
objective, he often invited them for Friday night drinks at his home, took them
to restaurants or resorts, and sent them thank you or birthday gifts. The
grocery store purchases, he said, reflected purchases made to prepare elaborate
dinners at his home for business guests.
[16]
Given the nature of the
Appellant’s business, none of this is beyond the realm of possibility. However,
what few source documents were available for the Court’s review did not support
his contention. Looking at the copies of receipts in Exhibit R-2, Tab 6, there
is no reason to think the grocery purchases were anything other than the
couple’s personal weekly shopping. The Appellant did not keep a diary of social
events showing the dates they occurred or the names of his guests. The
Appellant’s wife, who he said looked after the business’s social events, was
not called to corroborate his story. While the Appellant testified that he and
his wife entertained business guests once or twice a month, the grocery
purchases claimed as business expenses (Exhibits A-3 and A-6) occur on a much
more frequent basis. The auditor’s analysis (Exhibit R-2, Tab 5) also showed
the Appellant had the habit of taking cash back on many credit card purchases
and claiming the full amount as a business expense. The Appellant testified
that he always used these cash amounts for miscellaneous small purchases but again,
there was no evidence to substantiate their business purpose.
[17]
A review of Exhibits A-3 and A-6
also reveals that the Appellant frequently categorized certain travel
expenditures as business expenses. Such trips tended to occur during holiday
periods i.e., New Year’s or Labour Day or on weekends. The Appellant explained
that, as a self-employed person, he was able to organize his meetings with
clients so he and his wife (who often went with him to help with travel
arrangements and social duties) could combine business with pleasure.
[18]
Again, there is nothing wrong with
this as far as it goes. But given the dual nature of such excursions, it was
incumbent on the Appellant to document carefully his expenditures so he could
later justify the link to his business. This he did not do. Given the other weaknesses
in his evidence, more was required than his bare assertion as to the business
nature of the trip. At Tab 11 of Exhibit A-8 is a copy of what the Appellant
characterizes as a motor vehicle log. However, like the Database, it was created
after the fact. Rather than working from contemporaneous records of his travel,
for example, notes of his actual mileage, gas receipts and so on, the Appellant
worked backwards from what he said were client meeting dates to extrapolate business
expenses from generic information such as internet distance calculators and
average fuel prices indexed for the period. Using this method, the Appellant justified travel, restaurant and liquor
expenditures in respect of trips to Belleville and Toronto to see
a financial advisor and a lawyer, respectively. As it happened, these
individuals were old friends; the Appellant was not charged any amount for their
‘advice’. Without further evidence to corroborate his bare assertion of their business
purpose, such costs look much more personal than business-related.
[19]
In 2004, the Appellant claimed
travel expenses in respect of a trip to Florida. He and his wife left their home in Quebec on December
15, 2004 to spend a month in a condo in Naples. A review of the 2004 Database printout (Exhibit A-6)
and the MBNA statements (Exhibit A-4) shows the expensing of a number of
purchases during this period for groceries, gas, car rental, pharmacies and
restaurants. The Appellant claimed all of these amounts on the basis that the Florida
trip was necessary for his business: he had had to consult with an expert who,
as it happened, was in Florida. However, the Appellant later said that he never, in
fact, met with the expert because they discussed the project on the phone,
something he could just as easily have done from his home office in Quebec. As for
the expenses claimed, even if I accepted the business purpose of the trip, most
of the expenses are on the face of it, personal in nature. One receipt
identified by the auditor was from Marshall’s, a store in Naples, Florida, showing the item expensed was footwear. While one such receipt
would not be fatal to a taxpayer’s claim, it is typical of the Appellant’s
rather blasé approach to supporting documentation.
[20]
The Appellant also argued that he
ought to be entitled to significantly more of the interest paid on his various
credit cards and credit lines than the 50% allowed by the auditor. Yet again, the
Appellant is the author of his own misfortunes. By choosing not to establish
separate accounts for business and personal use and failing to provide corroborating
evidence of his claims, the Appellant made very difficult the task of
determining how much of the interest paid on those accounts could be attributed
to business expenditures.
[21]
Finally, the Appellant sought to
deduct various expenses incurred in respect of his residence out of which he
operated his consultancy business. Again, nothing in the Act prevents
the claiming of such expenditures, as long as they can be linked to a business
purpose. Unfortunately, the Appellant’s evidence fell short of the mark. A
review of Exhibit A-6 and the statements in Exhibits A-3, A-4 and A-5 shows
that in addition to claiming expenditures typically associated with office
supplies and services (paper, postage, computer equipment, technology support),
the Appellant also sought to deduct landscaping, pool maintenance and house
cleaning (interior and exterior) costs. His justification was that as the base
of his consultancy business, his residence had to be a show place; indeed, he
said he had bought the impressive home precisely for that reason. However, to
succeed in his claims, the Appellant still needed to establish a practical link
between the expenditures and a business purpose. Given the few times a year the
Appellant said he entertained at home relative to the costs incurred and the
overall lack of corroborating evidence, I am not at all convinced such claims
are viable. Indeed, I think the Appellant should count himself lucky that
certain gardening costs for bedding plants and so on, were allowed at the audit
stage.
[22]
The other serious flaw in the
Appellant’s claims in respect of the business use of his home was the
percentage of residential costs he sought to deduct. He originally claimed 25%
of such costs in his 2003 return, a good portion of which were accepted by the
auditor. Because he had no supporting documents for 2004 and 2005, the auditor
applied an averaged amount to those years. By the time of trial, however, the
Appellant took the position that he was entitled to claim a full 49% of his
residential expenses. This figure was based partly on what others, for lack of
a better expression, “got away with” as well as his continued revision of the
Database. In calculating the square footage of the area of his residence used
for business purposes, the Appellant took an expansive approach, effectively
including any space however remotely connected to a client visit i.e., all of
the kitchen area because he sometimes served clients a cup of coffee; all of
the basement because his consultancy files were stored there along with
household items. In all the circumstances, I can see no reason to interfere
with this aspect of the reassessments.
[23]
Overall, the Appellant’s evidence failed
to prove wrong the assumptions upon which the Minister’s assessments were
based; accordingly, his appeals must be dismissed.
Statute-Barred
Year: 2003
[24]
Turning, then, to the question of
whether the Minister was justified in reassessing the 2003 taxation year after
the normal reassessment period, subparagraph
152(4)(a)(i) of the Act requires the Minister to show a
misrepresentation attributable to the taxpayer’s neglect, carelessness, wilful
default or fraud. This is not a particularly heavy onus. It is easily satisfied
in the present matter given the Appellant’s admission that he filed his 2003
return knowing it to contain incorrect information. Even if I accepted his
testimony that he did so only at the instigation of his accountant, that would
not be sufficient to relieve him of the consequences of his actions.
Penalties
[25]
In Venne v. Canada,
[1984] C.T.C. 223 at page 233, Strayer,
J. set out the approach to be followed in determining whether the Minister’s imposition of penalties under subsection
163(2) of the Act was justified:
(4) Imposition
of penalties - As noted earlier in order for the [Minister] to levy penalties
under subsection 163(2) of the Income Tax Act it is necessary that the taxpayer
have "knowingly, or under circumstances amounting to gross negligence . .
. participated in, assented to or acquiesced in the making of" a false
statement in a return, etc. The similar language of sub-section 56(2) of the
former Income Tax Act was interpreted by Cattanach, J. in Udell v. Minister
of National Revenue (1969) 70 D.T.C. 6019 (Ex.Ct.). … In interpreting the
language now found in sub-section 163(2) of the present Income Tax Act,
Cattanach, J. said, at pages 6025-26.
Accordingly
there remains the question of whether or not section 56(2) contemplates that
the gross negligence of the appellant's agent, the professional accountant, can
be attributed to the appellant. Each of the verbs in the language
"participated in, assented to or acquiesced in" connotes an element
of knowledge on the part of the principal and that there must be concurrence of
the principal's will to the act or omission of his agent, or a tacit and silent
concurrence therein. The other verb used in section 56(2) is "has
made". The question, therefore, is whether the ordinary principles of
agency would apply, that is, that what one does by an agent, one does by
himself, and the principal is liable for the actions of his agent purporting to
act in the scope of his authority even though no express command or privity of
the principal be proved.
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.
In coming to
this interpretation the learned judge had regard to the fact that the
sub-section in question is a penal provision and it must be interpreted
restrictively so that if there is a reasonable interpretation which will avoid
the penalty in a particular case that construction should be adopted. He
concluded that the erroneous information in the returns was not included with
the knowledge of the taxpayer nor could the gross negligence of the accountant
be attributed to him.
It is also important to keep in mind in applying
this sub-section that by sub-section 163(3) the burden of proof is on the
defendant in justifying the assessment of a penalty.
[26]
Counsel for the Appellant argued
that no penalties ought to be imposed in 2003 as the Appellant’s only error was
the under-reporting of his business losses. As for 2004 and 2005, the failure
to report income was attributed to a ‘glitch’ in the computer program used to
create an earlier version of the Database.
[27]
I do not find these arguments
persuasive. Starting with 2003, the Appellant admitted not having reported his
losses because he did not want to attract the attention of the Canada Revenue
Agency. But it was not simply a matter of choosing not to claim a genuinely
calculated “loss”; it was an overall misrepresentation of the details of his
expenses in the Statement of Professional Activities. Indeed, the Appellant
used the word “arbitrary” to describe the figures reported in the returns. The
same practice was applied in 2004 and 2005. In those years, however, the
Appellant also failed to report a significant amount of income and in respect
of the 2005 taxation year, to remit the GST. Given the Appellant’s facility
with the Database program (demonstrated, at his request, at the hearing), I
find it hard to believe such errors were the result of an internal ‘glitch’ or
that he was not aware of them prior to the audit in 2006. He himself testified
that he deliberately did not report the fees earned in 2004 because by year
end, he had still not received payment from his client and he was not about to
pay tax on money he might never get.
He did not pay the GST assessed for 2005 because he was sure on his
calculations that after his business expenses had been properly assessed, he
would not be in a position of liability. In these circumstances, it is
difficult to conclude that the Appellant did not know what he was doing when he
filed returns in respect of those two years.
[28]
In determining whether the
Minister had made out his case for penalties in Venne, Strayer, J. considered
the particular circumstances of the taxpayer in question noting first “… as it
is relevant to the whole question of the application of penalties under
sub-section 163(2), that there seems to be a certain element of subjectivity
recognized in the case law with respect to assessing the knowledge or gross
negligence of a taxpayer with respect to misstatements in his returns: see,
e.g., Howell v. Minister of National Revenue (1981), 81 D.T.C. 230 at
234 (T.R.B.); Joris v. Minister of National Revenue (1981), 81 D.T.C.
470 at 472 (T.R.B.)”.
Based on the findings set out below, the Court ultimately concluded that the
Minister had not met his burden of proving that the taxpayer had “knowingly”
made false statements in his return:
… The
taxpayer here is a man with a grade five education, working and paying taxes in
a language which is not his first language nor that in which he was educated, a
man who is more at ease in a garage than in an office. Not only do these
factors militate against a finding that the misstatements in his returns were
made knowingly by him, but also his entire course of conduct is not consistent
with that of a person who had deliberately set out to conceal large amounts of
taxable income. He kept what appear to be quite complete records of sales in
his business, then turned these over to his bookkeeper. As far as one can judge
from the evidence, all or most of the revenues from the business were deposited
in the bank where the monies could readily be traced. He also lodged all but
one or two of the mortgages on which he lent money with banks and trust
companies which kept careful records of the income earned from these
"escrow mortgages". It is unlikely that a person planning to conceal
income would have handled his affairs in this manner. Further it is hard to
believe that he was consciously and effectively supervising his bookkeepers
since a number of the errors made in his returns were to his disadvantage, even
though more of them were to his advantage. I am therefore not able to conclude
that the misstatements in the returns were made "knowingly" by the
plaintiff.
[29]
These facts are in stark contrast
to the Appellant’s situation. He is a well-educated man with an excellent
command of English and many years’ experience as a self-employed consultant. He
kept close control of his financial dealings and had an expertise in the
electronic management of such information. Notwithstanding these advantages, he
chose not to keep good records of his business activities or to maintain
separate accounts for his business and personal affairs. In these
circumstances, it is difficult to believe the Appellant was at the mercy of his
accountant. I did not have the benefit of the accountant’s testimony but I have
no reason to doubt the auditor’s persuasive description of her as the more reasonable
of the two during her meetings with the Appellant. Finally, unlike Mr. Venne’s,
the Appellant’s course of conduct shows a financial management style geared to
blur the line between business and personal expenditures to maximize deductions.
[30]
Counsel for the Appellant cited a
number of other penalties cases
in his submissions. In my view, each can be distinguished either on the taxpayers’
lack of sophistication, the credible nature of their evidence and/or the more
complex nature of the legislative provision involved.
Conclusion
[31]
The sad thing about this case is
that had the Appellant applied his formidable talents in electronic data
management to maintaining contemporaneous records of his business activities –
records based on receipts distinguishing business and personal expenditures,
notes of client meetings, motor vehicle and social activities logs and so on –
he might well have avoided the difficulties he now faces. Given the
unreliability of the data entered into the Database, its usefulness as an aid
to the Appellant’s testimony was minimal; indeed, it had the effect of further
weakening the Appellant’s oral evidence regarding the business nature of
specific expenses claimed. All in all, the Appellant has failed to meet his
onus of proving wrong the assumptions upon which the reassessments were based.
The appeals of the 2003, 2004 and 2005 taxation years are dismissed, with costs
to the Respondent.
Signed
at Ottawa, Canada this 20th day of January 2012.
“G. A. Sheridan”
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