Citation: 2011 TCC 480
Date: 20111116
Docket: 2008-2700(IT)G
BETWEEN:
STÉPHANE GAGNON,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
[OFFICIAL ENGLISH
TRANSLATION]
REASONS FOR JUDGMENT
Favreau J.
[1]
The appellant is appealing
from reassessments under the Income Tax Act, R.S.C. 1985, c. 1 (5th
Supp.), as amended (the Act), dated April 17, 2007, in respect of the 2003 and
2004 taxation years.
[2]
By these reassessments,
the Minister of National Revenue (Minister) added to the appellant's income
business income of $45,293 for 2003 and $97,296 for 2004. In addition, the
Minister imposed penalties under subsection 163(2) of the Act on the business income
added to the appellant's income, which penalties totalled $4,225.57 for 2003
and $10,241.33 for 2004.
[3]
In making the
reassessments for the years in issue, the Minister assumed the following facts
set out in paragraph 22 of the Amended Reply to the Notice of Appeal:
[Translation]
(a)
During the taxation years at issue, the
appellant operated as sole owner a construction and renovation business under
the name Construction Stéphane Gagnon.
(b)
This business was the appellant’s sole source of
income, except for $428 in rental income for 2004.
(c)
The appellant handled all aspects of the
business’s operation.
(d)
The appellant calculated his business income using
the cash basis of accounting; he did not do a bank reconciliation of his monthly
income; he did not keep an inventory of materials; and he did not keep copies
of bids made by the business.
(e)
The appellant made deposits to his bank accounts
of amounts greater than the sales he reported.
(f)
The appellant himself provided to his accountant,
for accounting purposes, the amounts of sales and business expenses.
(g)
In his income tax returns, the appellant reported
a total income of $32,305 for 2003 and $44,749 for 2004.
(h)
In her income tax returns, the appellant’s spouse
reported a total income of $14,382 for 2003 and $12,816 for 2004.
(i)
The appellant’s spouse did not have any income
other than that reported on her 2003 and 2004 income tax returns.
(j)
The appellant and his spouse incurred personal
expenses of $36,047.20 for 2003 and $32,586.90 for 2004 (see Appendix 4 of Annex
A attached).
(k)
Following a net worth audit, the Minister
determined that the appellant had failed to report taxable income for the 2003
and 2004 taxation years of $45,293 and $97,296 respectively, as can be seen
from the tables created using the net worth method, found in Annex A attached
hereto and forming an integral part of this Reply to the
Notice of Appeal.
(l)
These discrepancies consist in particular of unreported
business income of $29,369.89 for 2003 and $27,177.65 for 2004.
(m)
The balance of each net worth discrepancy,
namely, $15,923.13 for 2003 and $70,118.76 for 2004, can be explained by specific
adjustments set out in Appendix 6 of Annex A attached hereto:
(i)
The appellant himself identified unreported
income for 2004 of $25,200 among the deposits to his bank accounts.
(ii)
For 2003, the appellant claimed $1,024.93 for
professional fees of a notary as a reduction of his reported income; this
amount was disallowed because it had to be capitalized.
(iii)
Consequently, the appellant’s capital cost
allowance under category 1 was increased by $1,024.93 for 2003.
(iv)
For 2004, the appellant claimed twice $4, 663
in business expenses against his reported income; this amount was disallowed.
(v)
Also for 2004, the appellant claimed $15,444 in business
expenses against his reported income; this amount was disallowed because it was
supported by unjustified adjusting entries.
(vi)
The appellant claimed against his reported
income business expenses of $14,898.20 for 2003 and $24,812.16 for 2004; these
were personal expenses and were disallowed.
(n)
As for the amount of $33,000, the Canada Revenue
Agency auditor allowed an increase in the value of the appellant’s residence of
$13,000 for 2003 and $20,000 for 2004 on the basis of the appellant’s
submissions that renovations were done on his residence. These amounts were
subtracted from the net worth calculation for the appellant (see Appendix 1 and
Appendix 5 of Annex A).
(o)
In 2004, the appellant’s spouse purchased a 2005
Subaru Impreza 2.5 RS automobile for $39,328.28. The payments for this
asset were made from a joint account the couple had at the Caisse populaire de
Saint-Gabriel (account #4767), and the appellant did not demonstrate that the
payments were made in part by his spouse’s son.
[4]
In imposing the penalty
provided for in subsection 163(2) of the Act on the appellant, the Minister
relied on the following facts set out in paragraph 23 of the Amended Reply to
the Notice of Appeal:
[Translation]
(a) The facts set out in paragraph 22 of this document.
(b) The unreported income established by the net
worth method is significant in comparison to the income reported for each of
the taxation years at issue, as shown below:
|
Taxation year
|
2003
|
2004
|
|
Total reported
income
|
$32,305
|
$44,749
|
|
Total unreported
income
|
$45,293
|
$97,296
|
|
Percentage of
adjustment
|
140%
|
217%
|
(c) The appellant was well aware of his business
income since he took the orders, tendered the bids, carried out the work,
received the payments and made the deposits for his business.
(d) The income reported by the appellant for the
taxation years at issue does not correspond with the increase in his net worth
and his personal expenses.
[5]
At the beginning of the
hearing, the respondent admitted (a) that the discrepancies mentioned at
paragraph 22(l) of the Amended Reply to the Notice of Appeal should read as $28,561.69 for
2003 and $22,478.24 for 2004, (b) that the revised discrepancies in total
income according to the net worth method should be $44,484.82 rather than $45,386.48 for
2003 and $92,597 rather than $98,483.66 for 2004, and (c) that the
unidentified bank withdrawals should be $25,709.83 rather than $26,342.50 for
2003 and $63,980 rather than $66,383.43 for 2004.
[6]
The Canada Revenue
Agency (CRA) auditor, Mélanie Lévesque, testified at the hearing at the
appellant's request. Her notes for the file (T2020), her audit report (T20) and
the report recommending the assessment of a penalty were filed. The audit began
on February 8, 2006, and took place over 413 days. The draft assessment was
sent to the appellant on July 27, 2006, while the final adjustments were sent
to the appellant by mail on March 26, 2007.
[7]
The context of the
audit is described as follows in the audit report:
[Translation]
Expenses and income were entered from invoices. However, the cash
method of accounting was not followed. There was no bank reconciliation at the
end of each month and a number of transactions were entered. It should be noted
that internal controls are non-existent since the tp and his spouse control
everything from order taking to receipt of payments.
We conducted a summary analysis of the deposits. We found that there
were more deposits than reported sales. We chose the largest deposits and asked
the tp to identify them. Unreported income was traced. We therefore did a net
worth outline. Discrepancies were traced. So we chose this method in carrying
out the assessment.
[8]
According to the CRA auditor,
the appellant's business was selected for a general audit following a review of
the appellant's tax returns and the financial statements (notice to reader) of
Construction Stéphane Gagnon for the 2003 and 2004 taxation years and following
the appellant's purchase of two rental properties in 2004. In his tax returns
for the 2003 and 2004 taxation years, the appellant reported the following
amounts as gross and net business income:
|
|
2003
|
2004
|
|
Gross business income
|
$376,232
|
$718,102
|
|
Net business income
|
$32,305
|
$44,321
|
[9]
The CRA auditor noted
that the gross income reported by the appellant increased each year while the
net profit decreased, which led her to conclude that the appellant was minimizing
his income and exaggerating his expenses.
[10]
During her testimony, the
CRA auditor confirmed that she had had access to everything she needed to
conduct the audit. Even though the bank authorizations were not provided, she
had access to the statements for the following accounts at the Caisse populaire
Desjardins de St-Gabriel for 2003 and 2004:
- account number 6413 (business account);
- account number 4767 (joint personal account);
- account number 4986 (joint personal account);
- account number 6404 (business account for Équipements d’érablière MJD);
and
- account number 5795 (personal account).
[11]
The CRA auditor also
had access to supplier invoices, to credit card statements and to information
about loans as well as to the persons who had prepared the income tax returns
and adjustment reports and to the person who did the bookkeeping, namely, Christine
Gagnon, the appellant's sister.
[12]
According to the CRA
auditor, what was deposited into the business's bank account was reported in
the appellant's tax returns. From her analysis of the bank accounts she was
able to see that some transactions did not appear in the business’s account, hence
the appellant’s admission of the existence of unreported income of $25,200 for
2004.
[13]
Jean-Jacques Landry, C.G.A.,
testified at the hearing. He prepared the financial statements (notice to
reader) of the appellant's business for 2004 as well as the personal income tax
returns of the appellant and his spouse for the 2004 taxation year. He did not
conduct an audit, nor did he look at the deductibility of the expenses claimed;
he considered only the business's bank account and did not take into account
the cash transactions. He assumed that the business’s income was correct, which
assumption he based on the business’s invoicing. According to him, there was
nothing to lead him to believe that the appellant had unreported income. In his
testimony, he indicated that he had identified duplicate expenses in the net worth
determination and that if the CRA auditor had reconciled the expenses according
to the method of payment, the discrepancies would have been substantially lower:
$19,500 for 2003 and $20,714 for 2004.
[14]
Christine Gagnon, a bookkeeper,
testified at the hearing. She stated that she made accounting data entries on
the computer and filed invoices for the appellant, who was her brother. She did
that work at the appellant's family residence one day every two weeks. To her
knowledge, only one credit card was used by the business and two vehicles were
used for business activities. According to her, the appellant's spouse made all
the bank deposits and the appellant’s spouse indicated to her which expenses
were personal and which ones were business expenses. As far as Ms. Gagnon
knew, all the clients of the business paid by cheque. Ms. Gagnon also confirmed
that she never saw any bids that had been made to clients, nor did she see any
inventory.
[15]
Marie-Josée Deschenes,
the appellant's spouse, also testified. She explained that, during 2003 and
2004, she took care of invoicing clients, paying supplier accounts, making bank
deposits and transporting tools of her spouse’s business. She was also involved
in a lamb marketing business with her mother. She spent about 20 hours per week
at the lamb operation and 30 to 40 hours per week at her spouse’s construction business.
In addition, she owned a sugar bush equipment business that she closed in July
2004.
[16]
She explained that her
spouse’s business had about a hundred clients to whom roughly 130 invoices per
year were issued. Many of the business’s clients were farmers who paid for
everything by cheque because they could recover the taxes. In the busy season,
seven employees worked for the business, whereas there were only two or three
employees during the off-season.
[17]
Ms. Deschenes also
explained that her spouse prepared the bids for the work requested by clients
and that she used these bids to prepare the invoices, taking into account the
hours worked by the employees and the cost of materials from suppliers. When
the work was completed the bids were destroyed.
[18]
In her testimony, Ms. Deschenes
confirmed that in 2003, for the first time, she and her spouse took a southern
vacation, which was of two weeks’ duration, that she took a southern vacation
by herself for one week in 2004, and that she and her spouse did not travel in
2005.
[19]
The last witness was
Stéphane Gagnon. In 2006, he incorporated his business under the name Stéphane
Gagnon (2000) Inc. His business provided residential construction and
agricultural renovations services. According to him, the unreported income of
$25,200 represents only two simple errors stemming from the fact that these
amounts were not deposited in the right bank account. He stated that all of his
clients paid by cheque and he acknowledged that sometimes his suppliers were
paid in cash or by credit card.
[20]
The appellant explained
that he did not sign contracts with his clients and that the bids were not
usually signed by his clients. Occasionally, a copy of the bid was given to the
client.
[21]
The appellant also
explained that he did not keep an inventory of materials; unused materials from
work sites were returned to the suppliers in exchange for a credit.
[22]
The appellant asserted
that he did not discuss anything at all with the accountants who prepared his
income tax returns for the 2003 and 2004 taxation years, that he did not review
those income tax returns and that he had received no explanations or recommendations
from the accountants.
[23]
The appellant acknowledged
that it was possible that the business’s account was used to pay personal
expenses.
[24]
The appellant also
acknowledged that he made at least one snowmobiling trip per year with his clients
and friends and that he was a member of the Club populaire de la Métis so that
he could have access to the trails.
The appellant’s position
[25]
Counsel for the
appellant made the following submissions:
(a) Use of the net worth
method was not justified in this case for the following reasons:
(i)
The appellant was in
good faith and cooperated with the audit by allowing access to all of the documents
demanded by the CRA auditor.
(ii)
Precise information was
available.
(iii)
An accounting system was
in place even if it was flawed.
(iv)
All of the transactions
went through the bank accounts.
(v)
There were no cash
purchases of property.
(vi)
The appellant and his
spouse did not have an extravagant lifestyle and no substantial increase in the
value of their assets was identified.
(vii)
The couple had a lot of
loan or credit card debt and property that was financed at 100%.
(viii) The numerous bank transfers and payments by
credit card gave rise to distortions and duplications, which inflated the net
worth.
(ix)
It is a method of last
resort that is both arbitrary and imprecise.
(x)
The expense reconciliation
by method of payment carried out by the appellant’s accountant as an aide-mémoire
demonstrated that the CRA auditor’s data created duplication of expenses.
(b) The
penalty should be cancelled for the following reasons:
(i)
The unreported business
income of $25,200 for 2004 is attributable to only two clients who did not
request invoices and who represent only 2% of the business’s sales.
(ii)
What we have is a pure
and simple error resulting from the fact that the money was deposited in the
wrong bank account. Christine Gagnon was not able to catch the error
because she was not responsible for reconciling the couple’s personal bank
accounts.
(iii)
The appellant and his
spouse are credible and are not in bad faith; they hired competent people to
look after their affairs and cooperated fully with the audit.
(iv)
Hiding income is not
generally done through bank accounts.
The respondent’s position
[26]
Counsel for the
respondent made the following arguments:
(a) Use of the net worth
method was justified for the following reasons:
(i)
It was impossible that
there was no unreported income because the bank deposits were higher than
reported income and expenses were too high in relation to the reported income.
(ii)
Income was calculated
on the basis of invoices; if there were no invoices, the income was not
accounted for.
(iii)
The appellant’s accounting
had no internal controls and was not subjected to audit by an external
accountant.
(iv)
The appellant’s
testimony that his clients never paid in cash is not credible since some
expenses were paid in cash from amounts that were not deposited in the bank
accounts.
(b) Imposing
the penalty was justified for the following reasons:
(i)
The appellant did not
review his income tax returns to ensure that they were correct.
(ii)
The unreported income
of $25,200 was admitted by the appellant.
(iii)
The net worth audit identified
significant discrepancies between actual income and reported income.
Analysis
[27]
Subsection 152(7) of
the Act provides that the Minister is not bound by a return or information
supplied by a taxpayer and that he may assess the tax payable. Subsection 152(7)
reads as follows:
(7) Assessment not dependent on return or information – The Minister is not bound by a return or information supplied by
or on behalf of a taxpayer and, in making an assessment, may, notwithstanding a
return or information so supplied or if no return has been filed, assess the
tax payable under this Part.
[28]
Subject to the right of
appeal, an assessment made by the Minister is deemed to be valid and binding
under subsection 152(8)
of the Act, which provides as follows:
(8) Assessment deemed valid and binding – An assessment
shall, subject to being varied or vacated on an objection or appeal under this
Part and subject to a reassessment, be deemed to be valid and binding
notwithstanding any error, defect or omission in the assessment or in any
proceeding under this Act relating thereto.
[29]
When an arbitrary assessment
is made by the Minister, the taxpayer has the burden of demonstrating the invalidity
of the assessment and "demolishing" the assumptions of fact relied on
by the Minister in support of the assessment. In this case, the assumptions of
fact relied on by the Minister are set out in paragraph 22 of the Reply to the
Notice of Appeal.
[30]
On the evidence before
me, the appellant did not "demolish" the Minister’s assumptions of
fact and thus did not discharge his burden of proof.
[31]
The audit using the net
worth method showed that the appellant earned unreported business income of $28,561.69 in
2003 and $22,478.24 in 2004 in addition to the unreported income in 2004 that
was identified by the appellant himself.
[32]
The audit appears to me
to have been well done and all of the representations by the appellant and his
advisors were given serious consideration. All the errors identified during the
audit were corrected. Duplications were avoided by subtracting the unidentified
withdrawals from the bank accounts for each taxation year at issue, namely; (i)
the disallowed personal expenses and (ii) the personal expenses estimated by the
appellant. The business expense reconciliation based on payment method
suggested by the accountant Landry does not seem relevant to me and, in any
case, it has no probative value.
[33]
The appellant has not satisfied
me that all of his sales were deposited in his bank accounts and that all of
his clients paid by cheque. These points could have been proven, however, if he
had kept the bids for the work he did.
The penalty
[34]
The penalty imposed on the
appellant is that set out in subsection 163(2) of the Act, which provides as
follows:
(2) False statements or omissions – Every
person who, 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, form, certificate, statement or answer
(in this section referred to as a "return") filed or made in respect
of a taxation year for the purposes of this Act, is liable to a penalty of the
greater of $100 and 50% of the total of
. . .
[35]
In Venne v. Canada (Minister of National Revenue – M.N.R.) (F.C.T.D.), [1984]
F.C.J. No. 314, 84 DTC 6247, Strayer J. gave the following interpretation of
the notion of “gross negligence”:
. . . "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. . . .
[36]
The following comment
by Pelletier J.A. of the Federal Court of Appeal in Lacroix v. The Queen,
2008 FCA 241, 2009 DTC 5029 is relevant to this case:
30 The facts in evidence in this case are such that the taxpayer’s tax
return made a misrepresentation of facts, and the only explanation offered by
the taxpayer was found not to be credible. Clearly, there must be some other
explanation for this income. It must therefore be concluded that the taxpayer
had an unreported source of income, was aware of this source and refused to
disclose it, since the explanations he gave were found not to be credible. In
my view, given such circumstances, one must come to the inevitable conclusion
that the false tax return was filed knowingly, or under circumstances amounting
to gross negligence. This justifies not only a penalty, but also a reassessment
beyond the statutory period.
[37]
Once the Minister establishes,
on the basis of reliable information, a substantial discrepancy between the
total income determined by the net worth method and the income reported by the
taxpayer, the Crown has discharged its burden of proof and it then falls upon
the taxpayer to identify the source of the income and show that it is not
taxable (see the comments of Létourneau J.A. in Molenaar v. The Queen,
2004 FCA 349, 2005 DTC 5307 (F.C.A.) at paragraph 4).
[38]
In the present case,
the unreported business income was identified by a net worth analysis and the
appellant himself identified $25,200 in such income for 2004. This additional
income could only have come from the appellant’s business since it was his only
source of income.
[39]
With respect to
expenses, the appellant claimed personal expenses totalling $14,898 in
2003 and $24,812 in 2004 and business expenses of $4,663 that were
claimed twice in 2004 as well as business expenses of $15,444 based on
unjustified adjusting entries.
[40]
The appellant’s income
tax returns are based solely on the information provided by the appellant.
Christine Gagnon entered all of the appellant’s expenses without identifying
which were deductible and which were not. Furthermore, the accounting data were
never verified by the accountants who prepared the income tax returns. Only the
information provided by the appellant was used.
[41]
The appellant was well
aware of his business’s income and knew very well which expenses were being
claimed. He knew or ought to have known that his income was being minimized and
that his expenses were being exaggerated. In my opinion, the appellant was
grossly negligent in not reporting all of his income for 2003 and 2004 and in
claiming personal expenses and non-deductible business expenses in calculating
his income for those years.
[42]
The CRA auditor recommended
in her report that a penalty be assessed and, at the meetings with the
representative of the appellant following the issuance of the proposed
assessment, no argument for not applying the penalty was put forward.
[43]
For these reasons, the
appeals from reassessments for the 2003 and 2004 taxation years are allowed,
without costs, and the reassessments are referred back to the Minister for
reconsideration and reassessment on the basis that the unreported business
income determined by the net worth method is $28,561.69 for 2003 and $22,478.24
for 2004. The penalties are upheld but must be adjusted accordingly.
Signed at Ottawa, Canada, this 16th day of November 2011.
"Réal Favreau"
Translation certified true
on this 22nd day of December 2011.
Erich Klein, Revisor
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