Citation: 2010 TCC 296
Date: 20100602
Docket: 2007-739(IT)I
BETWEEN:
DENNIS BEREZUIK,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
Docket: 2007-740(IT)I
AND BETWEEN:
BONNIE BEREZUIK,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
Docket: 2007-2075(GST)I
AND BETWEEN:
BONNIE AND DENNIS BEREZUIK,
Appellants,
and
HER MAJESTY THE QUEEN,
Respondent.
REASONS FOR JUDGMENT
D'Arcy J.
[1]
The Appellants have filed three separate
appeals. In the first appeal, Bonnie Berezuik has appealed income tax reassessments
in respect of her 1998, 1999, and 2000 taxation years. In the second appeal,
Dennis Berezuik has appealed income tax reassessments in respect of his 1998,
1999, and 2000 taxation years. In the third appeal, a partnership that
carried on business as Berezuik Farms
(I will refer to this partnership as the “Farming Partnership”) has appealed a
GST reassessment in respect of its GST reporting periods that began on January
1, 1998 and ended on December 31, 2000.
[2]
The three appeals were heard together on common
evidence.
[3]
The income tax issue before the Court is whether
the Minister of National Revenue (the “Minister”) has properly assessed the Appellants
under the Income Tax Act for unreported income and subsection
163(2) penalties in respect of statute-barred years. The GST issue is whether
the Minister has properly assessed the Appellant for over claiming input tax
credits in respect of mostly statute-barred periods and the gross negligence
penalty imposed by section 285 of Part IX of the Excise Tax Act (the “GST Legislation”).
[4]
I will first address the income tax appeals.
Background
[5]
Mr. and Mrs. Berezuik are farmers. Mrs. Berezuik
also works as a nurse. During the relevant years, they carried on the farm
business through the Farming Partnership. There were three equal partners
in the partnership: Mr. Berezuik, Mrs. Berezuik and their son, Shaun
Berezuik.
[6]
Mr. Berezuik and his son also carried on a
trucking business through a partnership. Mr. Berezuik held a 10% interest
in this partnership (I will refer to this as the “Trucking Partnership”).
[7]
The Appellants filed income tax returns for the
relevant years and reported income and losses from the following sources: the
Farming Partnership (Mr. and Mrs. Berezuik), the Trucking Partnership (Mr.
Berezuik), employment income (Mrs. Berezuik), Workers’ Compensation Benefits
(Mr. Berezuik), and a small amount of investment income (Mr. Berezuik). In
assessing the Appellants, the Minister assumed that the noted sources were
the Appellants’ only sources of income.
[8]
The Canada Revenue Agency (the "CRA")
performed an audit of the Appellants for each of the relevant taxation years. At
some point during the audit, the CRA auditor determined that the Appellants’
standard of living and accumulation of assets were inconsistent with the income
reported by the Appellants and that the Farming Partnership and the Trucking
Partnership did not maintain adequate records.
Because of these determinations, the CRA auditor elected to conduct a net worth
analysis.
[9]
After completing his net worth analysis, the CRA
auditor reached the following conclusions:
-
The income of Mrs.
Berezuik for the 1998, 1999 and 2000 taxation years was understated by no less
than $123,889, $78,432, and $66,307 respectively.
-
The income of Mr. Berezuik for the 1998, 1999
and 2000 taxation years was understated by no less than $122,257.54, $68,881.71
and $99,976.31 respectively.
[10]
When assessing the Appellants, the CRA allowed
the Appellants to reduce the amount of their revised income by increasing the
capital cost allowance claimed by the Farming Partnership. This resulted in the
Minister issuing reassessments, on February 25, 2005, to adjust the Appellants’
total income as follows:
-
The income of Mrs.
Berezuik for the 1998, 1999 and 2000 taxation years was increased (decreased)
by $815.71, $4,775.24, and ($16,835.62) respectively.
-
The income of Mr.
Berezuik for the 1998, 1999 and 2000 taxation years was increased (decreased)
by ($815), ($4,775) and $16,835 respectively.
[11]
However, the Minister assessed penalties under
subsection 163(2) based upon the unreported income before the adjustment for
the additional capital cost allowance. In particular, the Appellants were
assessed penalties of $72,058.15 as follows:
|
|
Mr. Berezuik
|
Mrs. Berezuik
|
|
1998
|
$15,840.00
|
$17,203.00
|
|
1999
|
8,341.80
|
9,891.40
|
|
2000
|
12,767.15
|
8,014.80
|
|
Total
|
$36,948.95
|
$35,109.20
|
[12]
The Appellants have appealed the reassessments. Since
the reassessments were issued after the expiry of the three-year assessment
period provided for in subsections 152(3.1) and (4), the onus is on the Respondent
for each of these years to prove, on a balance of probabilities, that the Appellants
made misrepresentations that were attributable to neglect, carelessness or
wilful default.
[13]
The burden of establishing the facts justifying
the imposition of the gross negligence penalties is also on the Minister.
[14]
Before considering whether the Respondent has
satisfied the onus placed on it, I will address the issue of whether the Appellants
maintained proper books and records.
[15]
The Appellants testified that they maintained
detailed books and records and provided five boxes containing these records to
the CRA auditor. Mrs. Berezuik testified that she spent a significant amount of
time maintaining and organizing the books and records. She prepared a manila
folder for each category of expenses and placed invoices for each of the
expenses into the relevant manila folder. She also retained copies of all
cheques relating to the business. During the hearing, I reviewed a manila
folder containing the invoices for capital expenditures for one of the
relevant years.
[16]
I accept the testimony of Mrs. Berezuik that the
books and records were prepared and were available to the CRA auditor. As a
result, it is not clear to me why the auditor conducted a net worth analysis. The
net worth analysis is a method of last resort. The method should only be used
where, due to a lack of reliable records, approaches that are more conventional
cannot be used. However, as this Court has noted on numerous occasions, it is
open to the Minister under subsection 152(7) to use the net worth method
whenever he considers it appropriate.
It is not the role of this Court to question the use of the net worth method by
the Minister to assess the Appellants; rather I must, based upon the
evidence before me, determine the correctness of the assessments at issue.
The evidence of the Respondent with respect to
unreported income
[17]
The foundation of the Respondent’s case is the 26
pages of schedules attached to its Reply to the Notice of Appeal (the “Net
Worth Schedules”), which purport to be the details of the net worth analysis
performed by the CRA auditor. The schedules are barely comprehensible. This is
due largely to the fact that a number of the schedules prepared by the
auditor are missing.
[18]
The CRA auditor who prepared the net worth
assessment did not testify. The main witness for the Respondent was Ms. Angela
Taylor. Ms. Taylor is the CRA appeals officer who dealt with the Appellants’ Notices
of Objection. Ms. Taylor attempted to explain the calculations contained
in the Net Worth Schedules.
[19]
It was clear from Ms. Taylor’s testimony that
she did not completely understand the calculations and, in certain instances,
did not have knowledge of the assumptions made by the auditor when he performed
the net worth assessment. This is not a reflection of Ms. Taylor's skills. As I
noted previously, the schedules were incomplete and barely comprehensible.
[20]
It is also clear that the CRA auditor did not
explain the calculations to the Appellants. This left them in the difficult (if
not impossible) position of attempting to refute calculations that they did not
understand. Mr. Berezuik was, however, able to explain to the Court the nature
of certain items included in the schedules.
[21]
Based upon the testimony of Ms. Taylor, Mr.
Berezuik, and Mrs. Berezuik, and after a detailed review of the schedules,
I have determined the following:
1.
The net worth
calculation had a number of components.
2.
The Court was not
provided with the complete net worth calculation.
3.
The CRA made material
errors when estimating the change in net worth of the Appellants.
The Components of the Net Worth Calculation
[22]
The first page of the Net Worth Schedule
contains a summary of the CRA's calculation of the purported unreported income
of the Appellants. This summary page shows that the CRA auditor first combined
the following three items:
1.
An estimate of the
combined change in personal net worth of Mr. and Mrs. Berezuik.
2.
An estimate of the
change in net worth of the Farming Partnership (two‑thirds of the change
was allocated to Mr. and Mrs. Berezuik).
3.
An estimate of the
combined personal consumption of Mr. and Mrs. Berezuik, adjusted for
miscellaneous items such as a personal income tax payment by Mr. Berezuik, source
deductions of Mrs. Berezuik, and an item referred to as “Driveway personal
expenditure.”
[23]
The auditor then deducted from the amount,
determined by combining the three items, the income reported by Mr. and Mrs.
Berezuik on their filed income tax returns. One-half of the amount determined
was allocated to Mrs. Berezuik and one-half to Mr. Berezuik. The amount
allocated to Mr. Berezuik was adjusted for his share of the change in net worth
of the Trucking Partnership (10% of the change was allocated to Mr. Berezuik).
The Missing Evidence
[24]
The remaining 25 pages of the Net Worth
Schedules are supposed to evidence how the auditor arrived at the numbers that
appear on the summary page. The Respondent relied upon these 25 pages to
satisfy the onus placed on it with respect to its ability to assess statute-barred
years and levy the section 163 penalties. The problem for the Respondent
is that a number of the schedules that evidence how the CRA auditor arrived at
the numbers that appear on the summary page are not included in the Net Worth
Schedules and were not otherwise provided to the Court.
[25]
The first set of missing schedules is the set of
schedules that explain the net worth calculation for the Trucking Partnership. Further,
Ms. Taylor did not provide any evidence relating to the partnership. The only
evidence before the Court relating to the Trucking Partnership is a one-line
reference to the partnership that appears on the summary page. I raised this
lack of evidence relating to the Trucking Partnership with counsel for the Respondent.
She was not able to provide the Court with the missing schedules.
[26]
The second set of missing schedules is the set
of schedules containing the auditor’s calculation of the change in net worth of
the Farming Partnership before any adjustments for capital cost
allowance. The auditor used these calculations to determine the amount of the section 163
penalties. The set of schedules filed with the Court contains the auditor's
calculation of the change in net worth of the Farming Partnership after
the adjustment for additional capital cost allowance. During the hearing, Ms.
Taylor tried to reconcile the set of schedules filed with the Court with the
purported unreported income of the Appellants noted in the summary page of the
Net Worth Schedules (i.e. the amounts used to determine the penalties). She was
somewhat successful. Although she was not able to identify all of the items
considered by the auditor, she was able to identify the majority of items used
by the auditor when estimating the unreported income of the Appellants.
Material Errors in Net Worth Calculation
[27]
During the hearing, it became apparent that the
net worth calculations contained a number of serious errors.
[28]
The first error is contained in the calculation
of the change in personal net worth of the Appellants. This calculation is
detailed in Schedule 4 of the Net Worth Schedules. The Schedule shows the Appellants'
investments increasing from a negligible amount between 1997 and 1999 to
$83,240 in 2000. The $83,240 is identified in Schedule 9 of the Net Worth
Schedules as amounts held in a registered retirement savings plan.
[29]
In short, the CRA concluded that, in a single
year, the Appellants contributed over $83,000 to their RRSPs. It is not clear
to me how such a conclusion could be made, in light of the annual
statutory limit for RRSP contributions. Ms. Taylor was not aware of the
assumptions made by the CRA auditor when he included the amount in the net
worth calculation.
[30]
Mr. Berezuik testified that the $83,000 existed
prior to 2000; it represented transfers from employer controlled RSPs to the
RRSPs of the Appellants. By only including the amount in 2000 and subsequent
years, the CRA over-stated the increase in the Appellants' personal net worth
in 2000 by $83,000. Counsel for the Respondent accepted that this error
overstated the calculated net worth of the Appellants.
[31]
A second error occurred when the CRA attempted
to determine the change in net worth of the Farming Partnership. The auditor's
schedule containing the calculations shows no inventory in 1997, grain
inventory of $1,000 in 1998, grain inventory of $307,500 in 1999 and grain
inventory of $400,000 in 2000. Ms. Taylor could not explain to me either
the nature of the grain inventory, or why it was included in the net worth
calculation.
[32]
Mr. Berezuik testified that the inventory
numbers represented grain grown on his farm. The amounts were large in 1999 and
2000 because of "bumper" crops.
[33]
The important point for purposes of the net
worth calculation is the fact that the amounts shown as inventory did not
represent assets acquired by the partnership from third parties or proceeds
from the sale of assets. The amounts represented the value of an asset grown on
the farm. The increase in value of the inventory did not arise from a cash
outlay. The Respondent's counsel agreed that in such a situation the inventory
should not have been included in the net worth calculation. By including
the inventory in the net worth calculation, the CRA overstated the increase in
the net worth of the Farm Partnership allocated to the Appellants by $204,333
in 1999 (two-thirds of the error) and $61,666 in 2000 (two-thirds of the error)
in 2000.
[34]
A third error relates to the methodology used by
the CRA auditor: he conducted a single net worth calculation for the two Appellants.
As Bowie J. stated at paragraph 17 in Francisco vs. Canada, above:
17 … it can never be valid to combine the assets and the liabilities
of two different taxpayers for the purpose of computing an estimate of their
combined incomes because the effect is to assume, quite incorrectly, that any
changes in the assets and any changes in the liabilities of either one of them
during the period being assessed are shared between them …
[35]
Without the missing schedules, it is not
possible to determine the total effect the error had on the calculations. However,
based upon the evidence before me, it is clear that the error materially affected
the calculations. For example, each of Mrs. Berezuik and Mr. Berezuik was given
credit for 50% of the income reported by the other on his or her income tax
return. This resulted in the auditor allocating over $93,000 of Mr. Berezuik's
income to Mrs. Berezuik and over $18,600 of Mrs. Berezuik’s to Mr. Berezuik. Such
an error clearly distorts the net worth calculations for each of the taxpayers.
[36]
Another error was brought to the Court’s
attention during closing argument. Counsel for the Respondent noted that the
CRA auditor had made an $87,800 error prior to 1999 by failing to include the
mortgage on the Appellants' home.
[37]
In light of the magnitude and nature of these
errors, the Respondent’s failure to provide any evidence with respect to the
net worth calculation for the Trucking Partnership and the missing schedules
relating to the Farming Partnership, it is not possible for the Court to give
any weight to the Net Worth Schedules.
[38]
The CRA auditor determined that, for the 1999
taxation year, the Appellants had unreported income of $156,864.38. However, as
counsel for the Respondent acknowledged, the amount allocated to the Appellants
for 1999 in respect of the Farm Partnership is overstated by $204,333. If one
only adjusts the CRA's calculation for this overstatement, the income reported
by the Appellants on their tax returns exceeds their income, as calculated
by the auditor, by $47,469.
[39]
Errors of a similar magnitude are contained in
the calculations for the 2000 taxation year. Page one of the Net Worth
Schedules states that the Appellants had unreported income in 2000 of
$132,614.15.
However, this includes the errors of approximately $83,000 relating to the
RRSPs and $61,666 relating to the grain inventory. These errors, which total
$144,666, exceed the unreported income calculated by the auditor.
[40]
If the Net Worth Schedules retain any
credibility after the magnitude of the errors is considered, the remaining
credibility is lost once one considers the nature of the errors. The error
relating to the grain, equal to 130% of the calculated unreported income, did
not involve the acquisition of an asset. It is difficult for the Court to
understand the basis for including the value of grain grown on the Appellants'
farm in the net worth calculation. The error relating to the RRSP involved the
auditor assuming that the Appellant could, in a single year, contribute $83,000
to an RRSP. It was not reasonable for the auditor to make such an assumption. These
two errors, together with the auditor’s error arising from his decision to
conduct a single net worth calculation for two Appellants, led to the
conclusion that the net worth calculation is based upon a number of faulty
assumptions.
[41]
As stated previously, the onus is on the Respondent
for each of the statute‑barred years to establish that the Appellants
made misrepresentations that were attributable to neglect, carelessness or
wilful default and to establish that the penalties under subsection 163(2) were
properly applied.
[42]
Clearly, the Respondent has not satisfied this
onus. It based its case entirely on the Net Worth Schedules, evidence that is
fatally flawed and can be given no weight by the Court. Therefore, the
appeals must succeed since there is no evidence before the Court that the Appellants
failed to report any income on their tax returns for the 1998, 1999 and 2000
taxation years.
[43]
Normally when the Court finds that the Minister
was not entitled to assess statute-barred years, the relevant assessments or
reassessments are vacated. Unfortunately, my judgment, as it relates to Mr.
Berezuik's 1998 and 2000 taxation years and Mrs. Berezuik's 1998 taxation year,
is subject to section 18.1 of the Tax Court of Canada Act. This
section provides that every judgment under the Court's informal procedure be
deemed to include a statement that the aggregate of all amounts in issue not be
reduced by more than $12,000 or that the amount of the loss in issue not be
increased by more than $24,000, as the case may be. The Appellants were
made aware of this limitation prior to, and at the commencement of, the
hearing. They elected to proceed under the Court's informal procedure since
they could not afford counsel and wished to bring closure to the matter.
[44]
As a result, while the reassessments in respect
of Mr. Berezuik’s 1999 taxation year and Mrs. Berezuik’s 1999 and 2000
taxation years will be vacated, it is not possible to vacate the reassessments
in respect of Mr. Berezuik’s 1998 and 2000 taxation years and Mrs. Berezuik’s
1998 taxation year, due to the $12,000 limitation contained in section 18.1 of
the Tax Court of Canada Act.
[45]
I would strongly suggest that the CRA's Fairness
Committee review this matter and consider removing any remaining penalties or
taxes.
Summary
[46]
The appeals are allowed. The reassessments
dated February 25, 2005 in respect of Mr. Berezuik's 1999 taxation year and
Mrs. Berezuik's 1999 and 2000 taxation years are vacated. All penalties will
be removed. The reassessments in respect of Mr. Berezuik's 1998 and 2000
taxation years and Mrs. Berezuik's 1998 taxation year are referred back to
the Minister for reconsideration and reassessment on the basis the reassessments
were statute-barred and thus are invalid. As a result, the penalties will be
removed subject to the $12,000 limitation contained in section 18.1 of the Tax
Court of Canada Act.
[47]
In light of the significant time and effort
spent by the Appellants fighting an assessment that, in my view, the Minister
should have been able to see was based upon calculations that were fatally
flawed, I award each Appellant costs of $1,000.
GST Appeal
[48]
On January 2, 2005, the Minister assessed the
Farming Partnership for its quarterly reporting periods ending between January
1, 1998 and December 31, 2000 (the "Reporting Period"). The
amounts assessed were subsequently adjusted pursuant to a reassessment issued
by the Minister on November 30, 2006. It is my understanding that all of the
Reporting Periods assessed were statute-barred, except for the last two
periods.
[49]
When filing its GST tax returns for the
Reporting Periods, the Farming Partnership reported net tax of
$(102,420.65) comprised of tax collected/collectable of $56,565.50 less
input tax credits of $158,986.24.
The reassessment issued by the Minister increased the Farming
Partnership's net tax for the Reporting Periods to $(88,437.48) comprised of
tax collected/collectable of $26,310.64
less input tax credits allowed of $114,782.12.
[50]
The CRA determined that the Farming Partnership
had over-stated its tax collectable and over-claimed its input tax
credits. The Farming Partnership was assessed additional net tax of $13,983.13,
the amount by which the over-claimed input tax credits exceeded the over-stated
tax collectable. Based upon paragraphs 3 to 6 of the Reply to the
Notice of Appeal, I have determined that the Farming Partnership was also
assessed interest of $3,808.09, a penalty under section 280 of $6,630.17, and
a gross negligence penalty under section 285 of $4,361.28.
[51]
Similar to the income tax appeals, the Respondent
bears the onus of establishing that the Farming Partnership made
misrepresentations that allowed the Minister to assess the statute-barred periods
under subsection 298(4) and that the conditions of section 285 were
satisfied.
[52]
The CRA auditor, after concluding that the
Farming Partnership did not maintain proper books and records, determined
the net tax of the Farming Partnership using the amounts reported on the
T1 income tax returns of the partners (Mr. Berezuik, Mrs. Berezuik and their
son). The auditor's calculations were attached as Schedules I, II and III to
the Respondent's Reply to the Notice of Appeal.
[53]
The Respondent has relied upon these schedules
to satisfy the onus placed on it with respect to the statute-barred years and
the gross negligence penalty.
[54]
Schedule II contains the auditor's calculations
of tax collected/collectable by the Farming Partnership. The auditor began by
determining the total sales of the Farming Partnership as reported on the
partners' T1 returns. He then reduced the amount by revenue not subject to GST
at 7%, namely zero-rated supplies (grain, oilseeds), crop insurance
receipts, supplies made outside of Canada, and other miscellaneous amounts. While, theoretically, I
accept the methodology used, the fact that the amount determined by the
CRA to be the tax collectable for the Reporting periods was only 53% of the
amount reported by the Farming Partnership on its GST tax returns, brings
into question the reasonableness of the amount calculated by the auditor. A
taxpayer does not normally overstate the amount of tax that it has collected
and is required to remit.
[55]
Schedule III to the Respondent's Reply to the Notice of Appeal contains
the auditor's calculation of the allowable input tax credits of the Farming Partnership.
The calculation begins with the total Farming Partnership expenses as
reported on the partners' T1 income tax returns. This amount is then reduced by
the following expenses that did not generate input tax credits: depreciation,
inputs that constituted exempt or zero-rated supplies, salaries and wages,
insurance, interest expense, property taxes, inputs that were supplied outside
of Canada and “other non‑registrant
expenses”.
[56]
The amount is then increased by the capital
additions of the Farming Partnership. Schedule III evidences that the
additions were taken from the T1 income tax returns. However, the amounts
shown for capital additions ($86,150) is substantially less that the capital
additions determined by the auditor in the Net Worth Schedules. Schedules
7(a), (b) and (c) of the Net Worth Schedules show total capital additions of
$1,187,778, and provide a brief description of each capital addition. Based
upon a review of the schedules and the evidence provided during the hearing, it
is clear to me that the purchase of each capital item was subject to either
Division II or Division III tax, and that the input tax credit documentary
requirements were satisfied.
[57]
As a result, I find that the input tax credits
shown on Schedule III to the Respondent's Reply to the Notice of Appeal
understate the input tax credits of the Farming Partnership for the
Reporting Periods by $77,114.
Adjusting the auditor’s calculations as shown in Schedules I, II and III for
the input tax credit error, one is left with the Farming Partnership having
over-remitted tax of $63,131, not under-remitted tax of $13,983.
Summary
[58]
The Minister has not satisfied the onus placed
on him with respect to the statute-barred periods and the section 285
penalties. With respect to any periods that are not statute-barred, there is no
evidence before me to support a finding that the Appellant under-remitted tax. In
fact, once the calculation prepared by the CRA is adjusted for the input tax
credit error, the evidence indicates that the Farming Partnership
over-remitted tax.
[59]
The appeal is allowed in full. The reassessment
is referred back to the Minister for reconsideration and reassessment on the
basis that the Appellant’s net tax for each of the assessed reporting periods
is the amount reported on its GST tax return as filed. All penalties will
be removed. There will be no order with respect to costs.
Signed at Ottawa, Canada, this 2nd day of June 2010.
“S. D’Arcy”
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