Citation: 2011 TCC 527
Date: 20111117
Docket: 2009-695(IT)I
2008-3659(GST)I
2008-3079(GST)I
2009-696(IT)I
BETWEEN:
ARTHUR LUCAS,
1112114 ONTARIO INC. and MYRA LUCAS,
Appellants,
and
HER MAJESTY THE QUEEN,
Respondent.
REASONS FOR JUDGMENT
McArthur J.
[1]
These appeals are from
net worth assessments under the Income Tax Act (ITA) for the
years 1996, 1997, 1998 and 1999 and GST assessments under the Excise Tax
Act (ETA) for the period from January 1, 1997 to December 31,
1999. The GST appeals for Myra Lucas and the corporation are related. The
position of the Minister of National Revenue (the Minister) is that Arthur and
Myra Lucas and the corporation, 1112114 Ontario Inc. (corporation) of which
Arthur is the sole shareholder, understated their income, as a unit, in the
amounts of $19,700, $67,11, $78,300 and $70,000 for the four years under
appeal.
[2]
Mr. and Mrs. Lucas are
husband and wife. From their home, they operated a bookkeeping and income tax preparation
business. Arthur operated through his wholly owned corporation. Myra carried on business under the sole proprietorship A-1
Accounting. For the most part, Myra’s clients were not GST registrants while clients
of Arthur’s corporation were.
[3]
This was a difficult case
that should never have gone to trial. Having done so, it should not have lasted
almost two weeks. All parties, Mr. Lucas in particular, were dedicated to their
positions and efforts towards compromise failed. Mr. Lucas was convinced that
the Minister’s method at arriving at a net worth was incorrect. He set out to
establish that his method was accurate, leaving no room for settlement. Mrs. Lucas
appeared more conciliatory but ultimately supported her spouse.
[4]
At least three of the
Minister’s auditors reviewed the net worth, making various concessions and
correcting several errors. In their evidence, the auditors reviewed their net
worth statements in great detail, including Exhibits A-12, A-14, A-42 and R-20.
[5]
In her summary, Minister’s
counsel went over the Minister’s final net worth statement line by line. The
amounts are not estimates, nor are they based on information from Statistics
Canada. They are derived from banking records, accounting records, the ledgers
of corporation, and the ledgers of Mrs. Lucas’ sole proprietorship.
[6]
Mr. Lucas believes that
Canada Revenue Agency (CRA) targeted him for audit. In the course of operating
the business, he had successfully represented some 80 clients at the objection
and Tax Court stages. The Minister answered to the effect that many of his
clients may have been audited because of the amount and types of deductions
claimed. I found no evidence of bias. In any event, I give this evidence no
weight.
[7]
Five character
witnesses testified to the effect that the Appellants were giving and
compassionate people. Unfortunately, the Appellants’ admirable human behaviour
does not assist them in the present appeals. Witnesses to corroborate their
evidence with respect to monetary gifts Mr. and Mrs. Lucas claimed to have
received from their daughter Lyanna, and Arthur’s sister Sheila, would have
been more relevant. The letters from Lyanna and Sheila, submitted without the
presence of the authors were of little assistance.
History of the Assessment
[8]
In 1999, the Appellants
advised CRA auditor Kristine Davis that their personal bookkeeping records were
mistakenly sent to a land fill and a virus erased their computer records. With
no records available, Ms. Davis performed a net worth audit. Through some
banking records, she found a substantial discrepancy between the audit amounts
and the Appellants’ reported income. She then transferred the file to Special
(Criminal) Investigations.
[9]
With warrants, Special
Investigations, searched the Appellants’ home in 2002 removing 10‑12 boxes
of books, records, and banking statements relating to both the sole
proprietorship and corporation. With the new information, CRA performed a
reassessment and laid criminal charges against the Appellants for tax evasion.
The CRA dropped the charges after Mr. Lucas had a serious heart attack,
pursuing civil remedies instead.
[10]
The trial for all
appeals proceeded for a week in January 2010 and was adjourned. A month before
the scheduled May 2010 resume date, Arthur had another heart attack, causing a further
delay. In June 2011, the trial was finally concluded after three days of
hearing in the Appellants’ home.
[11]
During the hearing,
three CRA officials testified. The Respondent also presented a revised net
worth assessment with some concessions, yet still demonstrated considerable
unreported income. The Appellants presented their version of the net worth
assessment attempting to nullify the Minister’s version.
Position of the Parties
[12]
The Appellants reject
the accuracy and methodology of Exhibit R-20.
They submit their assets are double-counted when included in the personal
expenditure section of the assessment; liabilities owed by corporation to the
sole proprietorship were not included in the assessment; receipt of windows and
meat pursuant to a barter scheme with clients should be in taxation year 2000
instead of 1999; and non-taxable income was not included in the Exhibit.
[13]
In a document entitled
Judgement, page 4, the Appellants wrote the following:
Why the justice should give justice to Arthur and Myra Lucas
An appeals officer for CRA said in his testimony if the discrepancy
of Net Worth was negative we would not owe any money, neither tax, gst, penalty
or interest. We presented our corrected net worth shoeing in 1996, a negative
discrepancy. Our net worth showed discrepancy of (40,790.01). In 1997,
discrepancy of (76,257.31). The Crown upon cross examination had no questions
towards the net worth instead they concentrated on Windows, meat and Lyanna’s
rent. On Lotus A-1 Accounting spreadsheet in March of 2000, $3000 was posted in
Revenues for the windows. Meat was posted as adjusting entry in May 31, 2000 in
the amount of 1256.69 as revenue, was put in Lotus 1112114 Ontario Inc.
spreadsheet. EFT was family allowance for Arthur Lucas Jr. which was payable in
those years to age 21 as long as they were in school. My son was still in
university in 1999. Since the Crown had no questions about our revised net
worth in the cross examination of the defence, it is likely that the new net
worth is correct and we showed a negative discrepancy in all the years. That
would indicate that we owe no money, either tax, gst, penalty and interest.
[14]
The Appellants objected
to having received 788 documents from the Minister only three days before the
hearing, on the basis that they could not prepare for the hearing. These appeals
are under the Tax Court’s informal procedure where there is no obligation to
disclose documents. The Minister should not be penalised for being too thorough.
In any event, I believe the Appellants had access to most if not all the
documents at some point during the past 10 years.
[15]
The Minister assessed
Myra for failing to report income and added that she deliberately understated
her income to avoid having to report and remit GST under paragraph 240(1)(a)
of the ETA. Registration is required if a supplier’s revenue exceeds
$30,000.
[16]
When the Minister
assessed the Appellants, time had already exceeded the statutory three-year
period. I have no difficulty in finding that the Minister was justified in assessing
the Appellants beyond this period. The Appellants made misrepresentations
attributed to neglect, carelessness or wilful default when filing their income
tax returns pursuant to subparagraph 152(4)(a)(i) by
under-reporting income and taxable supplies pursuant. At the outset of the
Minister’s efforts, the Appellants misled efforts to obtain documents. There
was clear evidence of unreported bartering and efforts to conceal sales over
$30,000. As a last resort, the Minister proceeded by the net worth method.
[17]
The Minister spent
months, if not years, auditing, correcting and revising their audit. The result
was Exhibit A-14, and was subsequently modified by the concessions set out in
Exhibit R-20. Similarly the Appellants obviously made a major effort to
demonstrate how the Minister was incorrect, including filing Exhibits A-1 to
A-44.
[18]
The net worth method is
based on the assumption that if one deducts a taxpayers net worth at the
beginning of the year from that at the end, adds the taxpayer’s expenditures in
the year, and deletes non-taxable receipts, the net result, less any amount
declared by the taxpayer, must be attributable to unreported income unless the
taxpayer can demonstrate otherwise. Obviously, a net worth assessment is
somewhat arbitrary and inaccurate, but presently it is the best way of arriving
at the Appellants’ approximate income.
Analysis
[19]
The Appellants have the
onus of proving that the Minister’s assessments are wrong. Counsel for the
Minister carefully reviewed Exhibit R-20, line by line, explaining the
differences between the Minister’s position and that of the Appellants.
[20]
The primary difference
between the parties is that the Appellants reduced all personal expenditures to
zero. The Minister added their personal expenditures in the years under appeal
as provided in he case of Bigayan v. The Queen.
[21]
To succeed, the
Appellants must establish that the Minister’s assessments are wrong and why.
The Appellants have not grasped the net worth concept. By not including their
personal expenditures they are ignoring Bowman J.’s definition of net worth in Bigayan.
Bowman J. described how a taxpayer may successfully appeal a net worth
assessment, stating the following at paragraphs 2, 3 and 4:
[2] The net worth method, as
observed in Ramey v. The Queen, 93 DTC 791, is a last resort to be used when all else fails.
Frequently it is used when a taxpayer has failed to file income tax returns or
has kept no records. It is a blunt instrument, accurate within a range of
indeterminate magnitude. It is based on an assumption that if one subtracts a
taxpayer's net worth at the beginning of a year from that at the end, adds the
taxpayer's expenditures in the year, deletes non-taxable receipts and
accretions to value of existing assets, the net result, less any amount declared
by the taxpayer, must be attributable to unreported income earned in the year,
unless the taxpayer can demonstrate otherwise. It is at best an unsatisfactory
method, arbitrary and inaccurate but sometimes it is the only means of
approximating the income of a taxpayer.
[3] The best method of
challenging a net worth assessment is to put forth evidence of what the
taxpayer's income actually is. A less satisfactory, but nonetheless acceptable
method is described by Cameron, J. in Chernenkoff v. Minister of National
Revenue, 49 DTC 680 at page 683:
·
In the absence of
records, the alternative course open to the appellant was to prove that even on
a proper and complete 'net worth' basis the assessments were wrong.
[4] This method of challenging a
net worth assessment is accepted, but even after the adjustments have been
completed one is left with the uneasy feeling that the truth has not been fully
uncovered. Tinkering with an inherently flawed and imperfect vehicle is not
likely to perfect it.
[22]
For the personal
expenditures, the Minister used the Appellants’ own records retrieved in the
2002 search. He correctly included personal expenses paid for by corporation,
such as food. The Appellants argued the food was purchased primarily for clients
and not for the Appellants and, therefore, should not be included in the net
worth assessment. I do not accept this argument. No clients testified that they
were offered food when visiting the Appellants on business. Some clients were
possibly offered a non alcoholic beverage and a biscuit, but this was
unsubstantiated.
[23]
The Appellants claim
they received non-taxable income from their family and friends. The primary
sources were Lyanna, Sheila and Arthur’s mother. While Arthur’s mother has
passed on, Lyanna and Sheila are alive and I believe, available. Instead of
testifying, letters from both women were presented as evidence of the income.
It is difficult to assign any weight to these letters, since they are hearsay
and otherwise unsubstantiated. I believe the relatives could have appeared at trial
since it was scheduled well after the date on the letters. The Minister did
concede $1,200 per year in gifts from Arthur’s mother, but did not concede
either the $8,000 loan from Arthur’s mother or the payments from Lyanna and
Sheila. The Appellants did produce a receipt they created for the $8,000 loan
but it is difficult to substantiate without other evidence, particularly since
they had 10 years to produce this evidence.
[24]
Included in Exhibit
A-42 are trips by Myra and Arthur to three food banks. The
monetary value of these trips cannot be included in a net worth assessment
unless cash was received from the food bank. The money saved from going to the
food bank for groceries is reflected elsewhere in the net worth assessments. It
does not affect the discrepancy being taxed. A similar conclusion is drawn from
the “Christmas sharing” and “Salvation Army” line items. In any event these
amounts are somewhat insignificant while considering the overall amount but it
does accentuate the effect the audit had on the Appellants’ business.
[25]
They submitted a line
item called “Myra’s Drawing (A-1 Accounting)”. This item
appears to reflect money drawn from the sole proprietorship accounts by Myra. If I understand correctly this information is
already reflected between the personal expenditures and the assets in the net
worth assessments. I do not pretend to have accounting expertise, but hearing
both submissions, I accept that of the Minister’s in most instances.
[26]
The next disputed point
is the child tax benefit the Appellants received through 1999. It was not
payable in 1998 and 1999 since Arthur Jr. turned 18 in 1997, and the child tax
benefit is not available the year after a child turns 18.
[27]
The Appellants included
interest received from their bank accounts in the non-taxable section of their
net worth assessments. This is taxable income and therefore should not be
included in the non-taxable section. The payments are reflected in the
Minister’s net worth assessments in the asset balance at year end and the personal
expenditures. The Appellants also added credit card liabilities to the
“non-taxable income” portion, in effect double-counting the liabilities. As a
result, the discrepancy is artificially lowered. The Minister has correctly
omitted the interest payments from its net worth assessments.
[28]
The income tax refunds
were incorrectly calculated by the Appellants. For example, for the taxation
year 1996, a tax refund was received by the Appellants in 1997. They included it
in their 1996 non-taxable income. When considering non‑taxable income in
a net worth assessment, the actual cash payments should be traced. The
Minister’s method in adding the income tax refunds is correct.
[29]
Further, the Appellants
submit they properly included the monetary value of the meat and windows
received through the barter scheme in the 2000 taxation year. However, the meat
was physically received, and consumed by the Appellants in 1998 and 1999.
Paragraph 12(1)(a) requires all receipts to be included in income
for a taxation year. It was properly included in the Minister’s assessments for
taxation years 1998 and 1999.
The window installer was billed for services in 1999.
The value of the windows should have been included in the 1999 taxation year,
as done by the Minister pursuant to paragraph 12(1)(b) of the ITA.
[30]
The next point of
contention is a discrepancy of $30.16 financing charge at the end of 1998. The
Minister was correct in not applying this charge in its assessment, since the
charge was not applied until January 1999.
[31]
In Exhibit A-42, the
Appellants included a loan from corporation to Mr. Lucas, the sole
shareholder of corporation. He was not liable for the liability of the
corporation. Therefore, the loan cannot be included in the assessment.
[32]
With reference to
Exhibit A-20 under “Long Term Fixed Assets”, the Minister included an amount
for equipment not referred to elsewhere. The Appellants submitted it should not
be included because it was worthless. This statement alone is insufficient to
refute the Minister’s assumption of value.
[33]
Finally, the Appellants
disputed the “Fixed Assets from corporation114” yet provided no contrary
evidence. The Minister’s assumption stands.
GST Registration
[34]
After adding the
unreported income determined in this appeal, Myra’s
gross revenues for 1998 and 1999 exceed $30,000. Pursuant to the sections 123
and 165 of the ETA, she is deemed to be a registrant and is liable to
remit GST to the Minister.
Conclusion
[35]
Since the Appellants
could not adequately refute the assumptions made by the Minister in the net
worth assessments, the appeals are allowed only to the extent the Minister
conceded certain line items at trial. Arthur and Myra
collectively owe a total of $16,468.55, $65,374.69, $73,825.57, and $59,541.20
in income tax for taxation years 1996, 1997, 1998 and 1999, respectively. Myra owes $576.40, $2,288.11, $2,583.89, and $2,083.94 in
GST for the same taxation years.
[36]
The Appellants’
position on many issues, primarily personal expenditures, is incorrect. For
many items they could not provide sufficient evidence, explanation, or were
simply wrong in their understanding of the law.
[37]
Overall, I found Mr.
and Mrs. Lucas to be very decent people. Gross negligence penalties should not
be imposed. Obviously, their tax filings were overly aggressive and
self-serving, both for their personal transactions and possibly on behalf of
their clients.
[38]
They have paid severely
for these transactions. I do not place blame on the Minister’s shoulders. With
greater cooperation from the Appellants, these appeals should have been
settled. With the cooperation of the Minister’s counsel, after the first two or
three days of trial, I urged the parties to have a settlement conference with
another Judge. Mr. Lucas was determined to complete the trial on the basis that
there was no room for compromise in that his method was the only correct one.
Signed at Ottawa, Canada, this
17th day of November, 2011.
“C.H. McArthur”
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