Isaza v. The Queen, docket 2000-4820-IT-I (Informal Procedure)

Date: 20020118

Docket: 2000-4820-IT-I

BETWEEN:

GUILLERMO ISAZA,

Appellant,

and

HER MAJESTY THE QUEEN,

Respondent.

Reasonsfor Judgment

Tardif, J.T.C.C.

[1]            This is an appeal from an assessment for the 1997 taxation year. The reassessment, to which a penalty was added, was made on the basis of facts and circumstances similar to those noted in the following cases:

MARLENNE HOULE (2000-3526(IT)I);

JOSÉ MARTIN (2000-4251(IT)I);

RAYNALD TURCOTTE (2000-4627(IT)I);

MARIO THERRIEN (2000-4773(IT)I); and

DONALD BENOIT LAFLÈCHE (2000-4792(IT)I).

[2]            All the appellants thus agreed that the evidence brought by all parties would be common to all the appeals. All the appellants, without exception, also admitted that the reassessments issued against them were correct, but they continued to dispute the validity of the penalties added to the assessments.

[3]            Thus, the issue in this appeal, as in all the others, is whether the Minister of National Revenue (the "Minister") was justified in assessing a penalty against the appellant for the 1997 taxation year pursuant to subsection 163(2) of the Income Tax Act (the "Act").

[4]            In this appeal, the respondent made the following assumptions of fact in justifying the reassessment and penalty:

[TRANSLATION]

(a)            for the 1997 taxation year, the appellant worked for Pratt & Whitney Canada Inc. and received from that employer a salary of $64,580.97 and a total amount of $1,389.97 as other income;

(b)            in his return of income for the taxation year in issue, the appellant reported, inter alia, gross business income of $650 and claimed a net business loss of $11,889.90;

(c)            the initial audit was conducted by a Revenu Québec auditor;

(d)            the following facts were noted in the course of the audit conducted by Revenu Québec:

(i)             the appellant is a member of a group of individuals each of whom acquired a computer and a distributor's licence from Ordinateurs Highway Inc. (hereinafter the "Corporation");

(ii)            the Corporation specializes in the sale of computers and security systems;

(iii)           to make its products more accessible, the Corporation offers its potential buyers whose main source of income is employment the opportunity to become distributors so that they may be considered "self-employed workers" for tax purposes and thus enjoy numerous benefits;

(iv)           among those benefits, the Corporation held out to its potential buyers the prospect of being able to claim a business loss and thus receive a sizeable income tax refund;

(v)            the Corporation subsequently took it upon itself to prepare its distributors' returns of income and ensured that the business losses claimed generated a sufficient tax refund to cover the acquisition cost of the property, in this instance a microcomputer, in their so-called first year of operation;

(vi)           the information prepared by Revenu Québec explained in detail the procedure used and showed that the losses claimed consisted in large part of fictitious expenses and that they could not be deductible in principle since the distributor's work was in fact non-existent;

(vii)          in theory, the purpose of the distributor's licence was to authorize those individuals to sell the Corporation's computer products and its distribution licences in exchange for a commission on sales;

(viii)         the Corporation also made it possible for an individual to enjoy no-interest financing through a financial institution for a period not exceeding one year;

(ix)            this method of financing a computer purchase was called the "Highway Concept";

(x)             the contract for the sale to the appellant by the Corporation of the licence and computer, as well as the document entitled "Distributor's Contract", indicate that the transaction took place on December 22, 1997;

(xi)            an application to join a credit plan with the National Bank of Canada is dated February 27, 1998;

(xii)           the purchase of the computer from the Corporation was made by MasterCard on March 3, 1998, but according to the credit card statement, payment was deferred until July 3, 1998 (see Appendix A);

(xiii)          the Distributor's Contract and the application for financing were signed by the appellant;

(xiv)         the appellant kept no books or records;

(xv)          the appellant was unable to provide relevant supporting documents to justify a number of expenses claimed;

(xvi)         there is no indication that the appellant carried on any activity whatever related to the sale of computers or licences or took steps to start up a business activity in 1997;

(xvii)        the appellant paid the sum of $1,200.00 to acquire a distributor's licence and the breakdown of the purchase price was as follows:

                Description                                                            Amount

                Licence vendor                                                              $500

                Vendor's sponsor                                                          $300

                Highway Corporation                                                 $400

                Total                                                                           $1,200

(xviii)       at the time he acquired his distributor's licence, the appellant received a kit which included the following items: a video cassette, a binder containing information on the "Highway Concept" and ten or so personalized business cards;

(e)            in light of the above, the Minister concluded that the appellant had not operated a business nor had he started up a business activity during the 1997 taxation year;

(f)             the appellant knowingly, or under circumstances amounting to gross negligence, made or participated in, assented to or acquiesced in the making of, a false statement or omission in the income tax return filed for the taxation year in issue, as a result of which the tax he would have been required to pay based on the information provided in that return was $2,674.80 less than the amount of tax actually payable for that year;

(g)            consequently, in the notice of reassessment of March 11, 1999, for the taxation year in issue, the Minister assessed the appellant a penalty of $1,337.40 under subsection 163(2) of the Act.

Facts

[5]            After learning of the existence of an entity known and carrying on business as Ordinateurs Highway Inc. ("Highway"), the appellant became interested in that company's concept. What was involved was a scheme under which anyone wishing to acquire a computer and computer equipment could do so from Highway. The company offered as well the possibility of obtaining a distributorship at substantial cost.

[6]            To convince interested persons, Highway explained to them that, by becoming distributors, they would receive generous commissions through the recruitment of other buyers and would also be entitled to all the tax benefits accruing to self-employed workers. In other words, they would thus be creating a small business which would give them the opportunity to earn additional income and to deduct a large number of otherwise non-deductible expenses from their total income.

[7]            Those interested generally acquired a computer and computer equipment as well as a licence entitling them to carry on business as self-employed workers.

[8]            To heighten interest, Highway prepared the prospect's income tax return, claiming fictitious and ludicrous expenses. The tax refund thus considerably reduced the amount of the outlays required. To obtain the tax refund quickly, Highway, through its own personnel, antedated the contract so as to produce effects for the previous fiscal year.

[9]            Once they had signed on, people could also receive a commission by recruiting a new prospect. Indeed, the appellant was recruited by someone in his circle in whom he had complete trust.

[10]          So, like all the others, the appellant went to Highway's place of business. After hearing the convincing pitch, he accepted the proposal that was made, signing all the required documents for becoming a distributor.

[11]          The Highway representative answered all questions and reassured all those who had concerns. The greatest concern appears to have been the fact that the date on the contract was earlier than the actual date of signature. People thus feared that it was illegal and improper to date the contracts December 22, 1997, when they were actually entered into later, in 1998.

[12]          Each time this apparently very worrying question was raised, the same answer was given: according to Highway, the arrangement involved the same principle as that for registered retirement savings plans. To make the answer even more credible, it was said that the membership contract had to be signed in the first four months of the year in order to have some of its effects in the previous fiscal year. Highway further stated that this was the same deadline as that given taxpayers to file their income tax returns, that is to say, the end of April.

[13]          For the more sceptical, the Highway representatives added that the arrangement was quite normal since, before signing, people reflected on, thought about and thoroughly analyzed their planned participation during the last months of the year preceding the transaction.

[14]          As an additional persuasive element, those interested watched a video in which a known and credible artist added his voice and arguments to those of the Highway people.

[15]          All the appellants that the common evidence concerned, including, obviously, this appellant, were persons without experience in the business world. All had their tax returns completed by third parties, and all were interested in the Highway concept, in which they saw first and foremost an opportunity to improve their financial situation by earning additional income. I have no doubt that the appellants' motivation in this regard was sound, reasonable and normal.

[16]          Considering their lack of experience and their limited knowledge and financial resources, they made fairly serious progress, although, I admit, they were not an example to be followed. One thing is certain, however: the appellant's behaviour cannot, on the evidence, be characterized as careless, thoughtless and grossly negligent.

[17]          The false and untruthful information sent for and on behalf of the appellant was forwarded by a Highway employee, who did this electronically so that, as a result, in most cases those concerned did not know the exact content of the information transmitted. As to the conventionally processed returns, copies were given to them, and when they asked questions, they were told that everything was in order, proper and legal, that they now had their own business and that they were accordingly entitled, as self-employed workers, to deduct the stated expenses.

[18]          Some contacted Revenue Canada, Revenu Québec and the consumer protection bureaus to check whether the scheme was legal or whether it was under investigation or known to be likely to bring trouble.

[19]          All such steps produced negative results, showing no irregularity or abnormality in the scheme's legitimacy.

[20]          The appellants' attitude and conduct were certainly not a model of prudence. They were of course negligent, imprudent and, indeed, even somewhat naive, but I do not believe that the evidence showed—and the burden of proof in this regard was on the respondent—that this particular appellant crossed the threshold or the fine line separating negligence and gross negligence.

[21]          The evidence does not show any recklessness, carelessness, indifference or lack of concern tantamount to gross negligence. On the contrary, it was shown on a balance of probabilities that the appellant had been cautious and had had a concern for the honesty of the procedure. One thing is certain: there was no evidence that the appellant knowingly chose to make a false return. He of course confirmed by his silence the information communicated by Highway, as he believed that everything was consistent with his new status as a self-employed worker.

[22]          The evidence showed that the Highway concept had been formulated and introduced by one or more persons with little concern for compliance with tax laws. They prepared a kit entitled [TRANSLATION] "Highway to Success", containing a series of documents and including, in particular, a video cassette, a binder with information on the Highway concept and ten or so personalized business cards.

[23]          To reinforce the seriousness, quality and credibility of the concept, they got a well-known artist involved, thus giving the swindle an even greater aura of authority and morality and even wider scope.

[24]          In the circumstances, given that one was dealing with novices who, although not reckless, were prepared to do what was necessary to increase their modest incomes, it was relatively easy to recruit and enlist them by taking advantage of the vulnerability of persons already influenced by a previous victim (their recruiter).

[25]          Instead of prosecuting the victims and teaching them a lesson by assessing a penalty against them, I believe the Minister should instead turn his efforts toward prosecuting those who designed the scheme and took advantage of the taxpayers' naiveté and assessing highly deterrent penalties against them.

[26]          In the instant case, it was not shown or established—and the burden was on the respondent to do so—that the appellant's negligence was so great as to constitute gross negligence justifying the assessment of a penalty.

[27]          The statutory provisions regarding the penalties that the respondent wishes to assess against the appellant are to be found in subsection 163(2) of the Act, which provides as follows:

163(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 . . . .

[28]          Counsel for the Minister cited the judgments in Udell v. M.N.R., [1970] Ex. C.R. 176, Venne v. Canada, [1984] F.C.J. No. 314 (Q.L.) and Findlay v. Canada, [2000] F.C.J. No. 731 (Q.L.).

[29]          The term "gross negligence", as used in subsection 163(2) of the Act, was defined in Venne, supra, by Strayer J. of the Federal Court of Canada, at page 10 of the judgment, as follows:

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

[30]          In Udell, supra (followed by Strayer J. in Venne), the matter involved penalties assessed under subsection 56(2) of the Act, now subsection 163(2). Having found that the taxpayer was not guilty of gross negligence, the Court had to determine whether the negligence of the taxpayer's agent could be attributed to the taxpayer. The Court held as follows at page 192:

                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.

[31]          The Court held that the accountant's gross negligence could not be attributed to the taxpayer since the taxpayer was not privy to his accountant's gross negligence.

[32]          The principles established in Udell were echoed by the Federal Court of Appeal in Findlay, in paragraphs 17 and 18. In that judgment, Isaac J.A. held that the Tax Court of Canada judge had erred in concluding that the gross negligence of the tax preparer could be attributed to the taxpayer. Isaac J.A. wrote as follows in paragraph 27 of his judgment:

His answer to the third question is inconsistent with his answer to the second question. If the respondent did not, for the purpose of the second question, show on a balance of probabilities that the appellant had knowledge of the omission by the tax preparer and did nothing about it, then, in our respectful view, it is difficult to understand how it could be said that the gross negligence of the tax preparer could be attributed to the appellant. There was no evidence that the appellant was privy to the actions or omissions of the tax preparer. The Tax Court Judge referred to the decision of Cattanach J. in Udell v. The Queen, but he misapplied the principles laid down in that case. Similarly, although referring the decision of Strayer J., as he then was, in Venne v. The Queen, he misapplied the definition of gross negligence laid down in that case. A failure to apply the correct test amounts to an error of law which warrants intervention by an appellate court. Furthermore, contrary to subsection 163(2) of the Act, the learned Tax Court Judge appears to have shifted to the appellant the burden of showing that he was not liable for the gross negligence of the tax preparer. Subsection 163(2) imposes that burden on the Minister; but the Tax Court Judge based his conclusion as to liability not on a proof by the respondent of gross negligence on a balance of probabilities, but on the absence of a reasonable explanation by the appellant or the tax preparer. This is, as I have already said, contrary to the provisions of subsection 163(2) of the Act.

[33]          The onus was on the Minister to show that the appellants had knowledge of the acts committed by the agents who prepared their tax returns, and that onus must be discharged in order for the appellants to be able to be penalized for the acts committed by those agents.

[34]          In the instant case, the Minister admits that the appellants did not knowingly make a false statement in their income tax returns.

[35]          The respondent argues that the appellants were highly negligent and careless. In the Minister's view, a reasonable person would have shown greater prudence and especially would have done more thorough research to ensure that the work done by Highway's agents was consistent with the law.

[36]          The burden of proof with respect to the assessment of penalties under subsection 163(2) of the Act is a heavy one. In Farm Business Consultants Inc. v. Canada, [1994] T.C.J. No. 760 (Q.L.), Judge Bowman (now Associate Chief Judge) set out a highly interesting approach to penalties. I think it helpful to reproduce a passage from that judgment:

28             A court must be extremely cautious in sanctioning the imposition of penalties under subsection 163(2). Conduct that warrants reopening a statute-barred year does not automatically justify a penalty and the routine imposition of penalties by the Minister is to be discouraged. Conduct of the type contemplated in paragraph 152(4)(a)(i) may in some circumstances also be used as the basis of a penalty under subsection 163(2), which involves the penalizing of conduct that requires a higher degree of reprehensibility. In such a case a court must, even in applying a civil standard of proof, scrutinize the evidence with great care and look for a higher degree of probability than would be expected where allegations of a less serious nature are sought to be established. Moreover, where a penalty is imposed under subsection 163(2) although a civil standard of proof is required, if a taxpayer's conduct is consistent with two viable and reasonable hypotheses, one justifying the penalty and one not, the benefit of the doubt must be given to the taxpayer and the penalty must be deleted. I think that in this case the required degree of probability has been established by the respondent, and that no hypothesis that is inconsistent with that advanced by the respondent is sustainable on the basis of the evidence adduced.

[37]          When it comes to assessing penalties under subsection 163(2) of the Act, the taxpayer must be given the benefit of the doubt. In the instant case, there is no doubt in my mind, based on the evidence, that the appellant was not guilty of gross negligence within the meaning of subsection 163(2) of the Act. At most, he was imprudent, negligent and indeed somewhat naive, which is not sufficient grounds for assessing a penalty.

[38]          Consequently, the appeal is allowed, essentially with respect to the penalty, which is cancelled. As to the assessment, it is confirmed on the basis of the appellant's consent and admission.

Signed at Ottawa, Canada, this 18th day of January 2002.

"Alain Tardif"

J.T.C.C.

Translation certified true on this 28th day of February 2002.

[OFFICIAL ENGLISH TRANSLATION]

Erich Klein, Revisor

[OFFICIAL ENGLISH TRANSLATION]

2000-4820(IT)I

BETWEEN:

GUILLERMO ISAZA,

Appellant,

and

HER MAJESTY THE QUEEN,

Respondent.

Appeal heard on common evidence with the appeals of

MARLENNE HOULE (2000-3526(IT)I), JOSÉ MARTIN (2000-4251(IT)I),

RAYNALD TURCOTTE (2000-4627(IT)I),

MARIO THERRIEN (2000-4773(IT)I) and

DONALD BENOIT LAFLÈCHE (2000-4792(IT)I)

on December 4, 2001, at Montréal, Quebec, by

the Honourable Judge Alain Tardif

Appearances

For the Appellant:                                The Appellant himself

Counsel for the Respondent:                Alain Gareau

JUDGMENT

          The appeal from the assessment made under the Income Tax Act for the 1997 taxation year is allowed with respect to the penalty, which is cancelled. As to the assessment, it is confirmed on the basis of the appellant's consent and admission in accordance with the attached Reasons for Judgment.

Signed at Ottawa, Canada, this 18th day of January 2002.

"Alain Tardif"

J.T.C.C.

Translation certified true

on this 28th day of February 2002.

Erich Klein, Revisor