Citation: 2010 TCC 629
Date: 20101206
Docket: 2007-4705(IT)G
BETWEEN:
MIKHAÏL MEDVEDEV,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
REASONS FOR JUDGMENT
Hogan J.
Introduction
[1]
By notices of
reassessment dated November 9, 2005, the Minister of National Revenue (the
“Minister”) increased the income tax liability of the Appellant through the
addition of undeclared income together with interest and penalties. The Minister
used the deposit method to add $81,570, $87,533 and $168,403 to the Appellant’s
income for the 2001, 2002 and 2003 taxation years respectively.
[2]
The issues to be
determined in this appeal are as follows:
1.
Is the Appellant liable
for the additional income tax determined by the Minister on unreported income
in the amount of $81,570, $87,533 and $168,403 for the 2001, 2002 and 2003
taxation years?
2.
Is the Appellant
liable, pursuant to subsection 163(2) of the Income Tax Act, to
penalties for the relevant taxation years?
Factual Background
[3]
The Appellant, Mikhaïl
Medvedev, immigrated to Canada from Russia
in 1991. In Russia he worked as a civil engineer. He could
not find similar employment in Canada. He testified in Russian at trial and his
testimony was translated into English by a qualified Russian translator.
[4]
The Appellant explained
that he held various low-skilled jobs when he first arrived in Canada because of his limited English language speaking
abilities. In the late 1990s, he returned to Russia to explore whether there
were opportunities for him to start an import/export business between Russia and Canada. At that time, the Russian economy was
growing quickly as a result of the government’s adoption of free-market
measures.
[5]
Russians were quickly
acquiring a taste for Western-produced consumer goods. As an engineer, the
Appellant felt confident enough to launch a business involving the procurement
of used cars and spare parts in Canada for export to Russia.
According to the Appellant, competition in that field was very strong as his
Russian clients could also acquire used cars and spare parts through suppliers
located in the United States. The Appellant claims that his net margin
on sales was limited to a range of 4% to 5% because of the competitive market
conditions that the business operated in.
[6]
Initially, the
Appellant operated under a business name. On the advice of a customs broker, he
incorporated the business in June 2001 under the name 9105‑6085 Québec
Inc. (the “Company”) in order to limit his liability for product defects and
other things. He became the sole shareholder, officer and employee of the
Company.
[7]
The Appellant expressed
his frustration with the audit methods used by Aïcha Hkim, the Canada Revenue
Agency (the “CRA”) auditor who ultimately prepared the reassessments issued
against him. According to the Appellant, during or immediately after his
initial interview, he had explained to Ms. Hkim that he was receiving
financial help from his father-in-law, who was a successful businessman in Russia. According to the Appellant, his wife’s parents were
planning on joining their daughter in Canada. His
father-in-law encouraged him to acquire a home where the family could live.
[8]
In October 2001, the
Appellant found a townhouse listed for sale as a result of the recent
separation of the couple that owned it. Because the separation was not
friendly, the selling process was delayed. A court order had to be obtained to
allow the sale to go forward. The agreed purchase price was $210,000. The
Appellant quickly learned that his mortgage lender required a 50% cash down
payment to approve a $105,000 mortgage loan. He claims he turned to his father‑in‑law
for financial help. He opened a U.S. dollar personal bank account in early
October 2001 to receive wire transfers from his father-in-law. He received the
Canadian dollar equivalent of $105,000 through U.S. dollar wire transfers from
his father‑in‑law. When the funds were received they were
immediately withdrawn and the Appellant used local currency traders to purchase
Canadian dollars, which he deposited in his Canadian dollar account. He did so
because, he claims, independent currency traders offered better exchange rates
than banks.
[9]
The Appellant testified
that the townhouse he purchased was destroyed in a fire in April 2002. The
Appellant and his family were forced to relocate to an apartment that they
rented for $1,500 a month. According to the Appellant, the fire disrupted the
Company’s business activities because the business was carried on from his
home. All of the Company’s business records were destroyed by the fire. The
insurance company delayed payment of the insurance proceeds, causing the
Appellant and his family further financial hardship. The Respondent did not dispute
that the Company’s business records up to the date of the fire were destroyed
in that fire.
[10]
According to the Appellant,
his father-in-law continued to send funds to him in 2002 and 2003, which were
used by him to finance the Company’s operations. The money received in those
years was used to purchase used cars and spare parts that were sold to Russian
clients. According to the Appellant, because the funds received by his
father-in-law were used to acquire inventory sold in the course of the
Company’s business, they were reported as gross revenue of the business when
the goods financed with the borrowed money were sold.
[11]
The Appellant claims that
the CRA auditor ignored his explanation and treated all of the funds deposited
in his U.S. dollar personal account as undeclared revenue allegedly earned from
sales of used cars and spare parts by him and not his Company. The Appellant
claims he was asked at the objection stage to obtain documentary evidence that
the wire transfers to his U.S. dollar account were made by his father‑in‑law.
He produced documentary evidence translated into English that purports to show
that his father-in-law sold over the years sufficient shares in a joint stock
company to fund the advances received by the Appellant. Furthermore, the
Appellant alleged that the Company was audited by the CRA auditor and only
minor discrepancies were found, which were resolved to the satisfaction of both
parties.
[12]
Ms. Hkim testified
for the Respondent. She explained that the Appellant and the Company were
selected by the CRA for an audit, which was conducted by the application of
indirect audit techniques. Following an initial meeting between the Appellant, Ms. Hkim
and her direct superior, Ms. Hkim prepared an analysis of the sources of
the combined revenue and cash flow of the Appellant and his Company and an
analysis of their combined disbursements for 2001, 2002 and 2003.
[13]
According to Ms. Hkim,
this was done on the basis of the revenue reported by both the Company and the
Appellant and the costs reported by the Company in its tax returns, plus the
down payment for the townhouse and an estimate of the Appellant’s living
expenses. Her documentary analysis was introduced as Exhibit I‑1. She
claims that she questioned the Appellant on the preliminary cash flow analysis
that she prepared. She claims that it was only following this second interview
that he told her about his U.S. dollar bank account and the funds received from
his father-in-law. She did not accept the Appellant’s explanations for the
discrepancies that she found. She concluded that all of the funds deposited by
the Appellant in his personal U.S. dollar account represented undeclared gross
revenue.
[14]
On cross-examination,
Ms. Hkim admitted that the gross revenue reported by the Company for 2002
and 2003 exceeded the funds deposited in the Company’s bank account by
approximately the same amount that she treated as the Appellant’s undisclosed
income for 2002 and 2003. She further admitted that she knew that the Appellant
had tried to convince the Respondent’s counsel, in settlement discussions that
took place before the trial, that all funds deposited in his personal accounts
in 2002 and 2003 were reported as revenue of the Company. While Ms. Hkim
admitted that it was possible that the amounts attributed to the Appellant as undeclared
income were in fact reported as revenue by the Company, she was not prepared to
go any further because it was still possible that the Company had other
unreported sources of revenue. She did not offer any explanation as to why the
Company was not reassessed if indeed such was the case.
[15]
Farah De Vito, the
CRA officer from the Appeals Division who considered the Appellant’s objections
to the reassessments, testified that she did not accept the documentary
evidence produced by the Appellant regarding his father‑in‑law’s
financial means because she had no direct confirmation from an independent
financial institution that the funds received by the Appellant were transferred
to him by his father‑in‑law. According to Ms. De Vito,
while the Appellant may have established that his father‑in‑law had
the wherewithal to loan him the funds transferred to his accounts, there is
still no direct evidence to show that the wire transfers originated from him.
Analysis
[16]
The audit method
selected by the CRA to make the reassessments has a direct bearing on the
evidence that must be led by the Appellant to discharge his evidentiary burden.
The CRA itself recognizes this by outlining a hierarchy among the three
indirect methods most commonly employed to determine discrepancies between
reported and unreported income. In its audit manual dated March 2008, the CRA states
that the net worth method must be considered and used first unless it is
impossible to obtain the information required in order to complete the net
worth statement showing the evolution of the taxpayer’s assets and liabilities
and personal living expenses over the relevant period. On this subject, the
manual states the following:
13.3.1 – General Comments
The sections that follow discuss the CRA policy with respect to the
use of Indirect Verification of Income (IVI) as an assessing technique where a
taxpayer/registrant’s books and records are non-existent or inadequate, or
where audit findings indicate that revenue has not been accurately recorded in
the books and records.
The IVI techniques discussed are:
13.4.0 Net Worth;
13.5.0 Auditing Unidentified Bank Deposits;
13.6.0 Assessments Based on Projections.
The most frequently used IVI technique is the Net Worth Statement
and is the primary IVI technique used by the CRA. Auditors are expected to
use the net worth method whenever the information is available to allow proper
preparation of the document.
The team leader must be consulted and approve the appropriate IVI
technique for the audit as part of the Audit Plan.
[Emphasis added.]
[17]
At trial, I asked
Ms. Hkim why she did not resort to the net worth method to determine the
Appellant’s undeclared income. My question did not elicit a clear response from
Ms. Hkim. The CRA audit manual takes 25 pages to describe the
methodology to be applied by a CRA auditor to complete a net worth audit. Two
pages are devoted to describing the techniques of a deposit audit. It is
obvious that the net worth audit will produce a more reliable picture of the
taxpayer’s financial situation and discrepancies between his lifestyle and
spending habits and his reported income than will the other methods described
in the manual. Given the lack of a response to my question, I am left to
conclude that Ms. Hkim found the elaborate methodology of the net worth
method daunting in light of the Appellant’s limited English speaking abilities.
[18]
The Appellant’s
evidentiary burden is defined by the assumptions relied on by the Minister in
making the reassessments. Ms. Hkim testified that she assumed that all the
funds deposited in the Appellant’s personal bank accounts in 2001, 2002 and 2003
constituted undeclared income. She did not accept the Appellant’s explanation
that he received loans from his father‑in‑law which were used in
2001, 2002 and 2003 to fund the Company’s business operations. On cross‑examination,
however, she admitted that the gross revenue reported by the Company for 2002
and 2003 was equal to all the funds deposited in the Company’s and the
Appellant’s bank accounts for each of those years. While the Appellant’s
evidence is not perfect, I conclude that it is more likely than not that the
funds were used to finance the Company’s business operations and were
ultimately reported as gross revenue by the Company. In other words, the
Appellant received loans from his father‑in‑law in 2002 and 2003
that were used by the Company to acquire inventory and that were reported as
gross revenue when the inventory was sold by the Company. Had the CRA based its
findings on a net worth audit, it may have been able to prove that the funds
were used by the Appellant for other purposes.
[19]
Counsel for the
Respondent suggested that I should discard the Appellant’s testimony because
the evidence of Ms. Hkim and Ms. De Vito shows that his story
was inconsistent. I do not believe this to be the case. In my view, the parties
had great difficulty understanding each other because of the significant
language barrier that made the CRA’s audit more difficult in this case. The
Appellant should not be penalized for that.
[20]
I arrive at a different
finding, however, with respect to the explanation given by the Appellant regarding
the funds deposited in his U.S. dollar account in 2001. The Appellant claims
that his father‑in‑law transferred to him funds required to pay the
$105,000 down payment on the townhouse. A review of the Appellant’s bank
statements for 2001 shows that the deposits made in that year were for uneven
amounts received throughout the year. For example, amounts of US$7,997, US$1,990,
US$2,890 and US$20,597 were deposited in the Appellant’s account on
October 10, 2001, October 11, 2001, October 18, 2001 and
October 26, 2001 respectively.
[21]
Why would the
Appellant’s father‑in‑law make unequal deposits on numerous dates
if the purpose of the wire transfers was to finance the sum of $105,000 due on
the townhouse? The more likely conclusion is that these funds were also tied to
the operation or financing of the Company’s business. As the Appellant failed
to lead evidence to show that the funding was in fact used, and reported as
gross revenue, by the Company, the reassessment for 2001 must stand.
Conclusion
[22]
For the reasons noted
above, the appeal for the 2002 and 2003 taxation years is allowed and the
reassessments for both years are vacated. The appeal for the 2001 taxation year
is dismissed. There is no award of costs for either party in light of this
split result.
Signed at Ottawa, Canada, this 6th day of December 2010.
"Robert J. Hogan"
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