Citation: 2010TCC363
Date: 20100705
Docket: 2009-3235(GST)I
2010-12(IT)I
BETWEEN:
JOYCE MIDDLETON,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
REASONS FOR JUDGMENT
Miller J.
[1]
Ms. Joyce Middleton
brings two Informal Procedure appeals relating to the operation of her spa and
school in 2005 and 2006. The first appeals are an Income Tax appeals in which
she objects to the Respondent’s calculation of her income and ensuing penalties
pursuant to subsection 163(2) of the Income Tax Act (the "Act")
for the 2005 and 2006 taxation years. The second appeals are a Goods and
Services Tax ("GST") appeals in which the Respondent increased GST
owing, and also assessed penalties pursuant section 285 of the Excise Tax
Act ("ETA").
[2]
Ms. Middleton operated
a spa in Fort St. John, Bristish Columbia, in 2005 and 2006 in a
small (just under 500 square feet) space at Alexander Mackenzie Inn, under the name Reflexology and Stress
Clinic. She operated this spa which provided message therapy and reflexology,
amongst other services, through an arrangement with students who she trained –
this was the school element of the overall operation which she ran under the
name Northern School of Spa Therapies.
[3]
According to Ms.
Middleton, the students were individual contractors who would provide the spa
services at her spa, primarily for cash, at very low rates compared to other spas.
Ms. Middleton obtained a Judgment from the Tax Court of Canada in 2007 in an
Employment Insurance Appeal confirming a student worker was an independent
contractor. The Respondent did not argue otherwise in the case before me.
[4]
The student workers
would submit day sheets indicating the sessions they conducted and the charges
paid. From a $44 one-hour massage for example, the worker would retain
approximately $14 and remit the balance to Ms. Middleton. The workers also retained
their tips. The day sheets were not necessarily submitted to Ms. Middleton
daily. She would retain the cash from the student workers in what she called
her petty cash and pay expenses from the petty cash. She would deposit the
petty cash in her bank account at month’s end. With respect to any credit card
payments, those would ultimately go directly into her bank account. The student
workers would often retain cash from cash customers to cover their share of
their payment (the $14 for example) due from credit card customers. Ms. Middleton
believed that in handling finances this way, she would keep an accurate account
of her net income, though recognized it made it difficult to accurately track
gross income. This became problematic in 2005 when she registered for GST, as
she admitted it meant she ended up calculating GST on net rather than gross
revenue, as she did the calculation based on month end cash deposits.
[5]
Ms. Middleton testified
that she educated the workers primarily from her home. She also used a separate
room in her home for testing, though she did not expand as to what was entailed
in testing other than it required the use of a fridge, and that payments for
testing were primarily made by way of credit card. She also maintained a
computer at home and would use this to e-mail the workers at the spa on a
regular basis for educational and business purposes. I note that the school
aspect of her operation was not accredited as such until after the years in
question.
[6]
I was provided with no
contracts between the student workers and Ms. Middleton’s spa, though Ms.
Middleton indicated she did have written contracts with every student worker. I
did see copies of the day sheets which confirmed the student workers charged
amounts in line with what Ms. Middleton testified. It was clear that Ms.
Middleton operated on something of an honour system, relying on her student
workers to accurately complete and submit the daily sheets. Attached to these Reasons
are summaries of the auditor’s findings with respect to cash and credit card
receipts for 2005 and 2006.
[7]
In the years in
question, Ms. Middleton personally did little work at the spa location.
[8]
In filing her income
tax returns for 2005 and 2006 taxation years, Ms. Middleton reported net
income from the spa of $572 and a net loss of ($1,597), respectively.
[9]
The Minister reassessed
the Appellant’s 2005 and 2006 taxation years to include unreported business
income in the amounts of $39,539 and $14,179, respectively, and to disallow
business expenses in the 2006 taxation year of $2,682. In addition, the
Minister assessed gross negligence penalties of $2,965 and $1,085 in the 2005
and 2006 taxation years, respectively. After a Notice of Objection, the
Minister reassessed the Appellant’s 2005 and 2006 taxation years to allow additional
business expenses in the amounts of $1,709 and $1,860, respectively, and
reducing the gross negligence penalties accordingly.
[10]
Ms. Middleton filed GST
returns and reported total taxable supplies of $84,169, GST collectible of
$5,565 and Input Tax Credits ("ITC") of $3,134 in respect of the
period from February 1, 2005 to December 31, 2006. The Minister reassessed the
Appellant for a net GST adjustment in respect of that period and, accordingly,
issued a notice, so as to:
(a) assess GST
collectible of $6,550.72 and disallow ITC’s of $78.54;
(b) assess a gross
negligence penalty of $1,657.31 under section 285 of the ETA; and
(c) assess interest and
late remitting penalties under section 280 of Act with respect to the
net tax amounts.
[11]
These assessments arose
from a thorough income tax audit of Ms. Middleton’s affairs for the 2005
and 2006 taxation years, which led also to a review of her GST filings. The
auditor, Ms. Roberts, who testified at trial, calculated revenues based on all
the daily sheets for the two-year period as well as all credit card deposits to
Ms. Middleton’s bank account. Ms. Middleton did not question this determination
of revenue which resulted in the additional revenue of $39,539 in 2005 and
$14,179 in 2006. The auditor determined:
(a) in 2005 and 2006,
credit card revenues recorded on the daily sheets totalled only $16,649 and
$11,395, respectively;
(b) in 2005 and 2006,
Ms. Middleton received credit card revenues totalling $39,717 and $30,185,
respectively; and
(c) in 2005 and 2006,
Ms. Middleton received cash and cheque revenues totalling $82,944 and $36,456,
respectively.
[12]
From Ms. Middleton’s
testimony, it appears that the difference in credit card deposits relates to
the testing work that she conducted at home.
[13]
Ms. Middleton
strenuously maintained that her spa was not set up to earn the type of profit
determined by the auditor, and that fees were set low to recognize the work was
conducted by student workers, who were still learning their trade.
Ms. Middleton clearly felt she was providing a valuable service for the
well-being of her community at an affordable cost. She never intended this
service to be a profit‑making venture. She pointed out that she attempted
to sell the business through eBay with a starting bid of $70,000 USD and in
January 2009, tried to get at least $40,000 through a realtor, ultimately
reducing the price to $25,000. She was unable to sell the business. She
believed common sense alone dictated she could not have made the kind of profit
suggested by the auditor. Yet, she only took objection to a limited number of
denied expenses. The Respondent allowed expenses of $76,235 in 2005 and $50,629
in 2006. The only disallowed expenses which Ms. Middleton disputed were with
respect to rent, attendance at a conference, legal expenses and vehicle
expenses.
Rent
[14]
Ms. Middleton seeks two
claims in connection with her home. First, an additional $200 a month for using
what was formerly a bedroom in her home for purposes of conducting the hair and
saliva testing. Second, an additional $200 a month plus 10% taxes and utilities
for office space, as she stored some supplies at home and she also worked from
home on her computer, for example, e-mailing her students. She maintained that
she ordered supplies from home and also marked papers. She also testified that
she conducted education sessions at home, though gave no indication as to the
regularity or frequency of such sessions.
[15]
With respect to rent
for the spa itself, the Respondent did not allow December’s rent at $550, as no
invoice or other proof was provided.
Conferences
[16]
Ms. Middleton seeks an
additional $791 of travel costs for her husband accompanying her to a
conference in Colombia/Ecuador. She maintained this was primarily for security
reasons.
Legal
[17]
The Respondent has
conceded that legal fees of $4,825 allowed in 2006 could be moved to 2005. The
materials submitted by Ms. Middleton (a letter from a law firm) indicates an
amount of $5,698 was paid. She also provided evidence of a $4,626 money order
to Employment Standards Board, though it was dated in 2007.
Vehicle expenses
[18]
Ms. Middleton
determined the amounts of $3,064 in 2005 and $2,614 in 2006 were the travel
costs for her twice a week trips to the spa plus miscellaneous trips for shopping,
mail, etc., and four trips a week to the spa for her husband delivering
supplies, taking keys, etc. No logs were provided. The estimated costs were
based on a 47.5 cent per kilometre charge for a 38 kilometre round trip.
Ms. Middleton then estimated half of this mileage was reasonably allocated
to business for her husband and 75% of this mileage to business for her.
Miscellaneous
[19]
Ms. Middleton sought an
additional deduction for a new lock of $121, for which she provided the
receipt.
[20]
The issues are:
i. Did the Minister
correctly determine Ms. Middleton’s business income for 2005 and 2006?
ii.
Is Ms. Middleton liable
for gross negligence penalties in respect of unreported income pursuant to
subsection 163(2) of the Act?
iii.
Did the Minister
correctly determine Ms. Middleton’s underreported net tax pursuant to the ETA
of $6,629?
iv.
Is Ms. Middleton liable
for gross penalties pursuant to section 285 of the ETA?
Analysis
[21]
Ms. Middleton presented
an emotional case. She seemed sincerely bewildered by CRA’s determination of
significant net income. She simply could not understand it, yet did not doubt
the revenue figures. Her response that it did not make sense when you consider
the low fees charged by the student workers in what she believed were costs
equivalent to what full-fledged spas charging full rates would incur, was,
regrettably, inadequate. The only way to reduce the net income to something she
believed would make sense, was to satisfy me that CRA underestimated expenses,
yet CRA, with the exception of the few items in dispute, relied on the numbers
provided by Ms. Middleton. To accept Ms. Middleton’s approach is to ignore the
facts and rely on a somewhat vague notion that common sense combined with her attitude
that she never intended to make profit should override the clear numbers.
Although I am a strong advocate of common sense on a regular basis, it must be
grounded in some facts. Unfortunately for Ms. Middleton, she has been
unable to produce facts to support her common-sense approach. I conclude
she in fact made more than she thought.
[22]
With respect to those
few expenses that were identified as possible deductions, I find as follows:
i. rent – with
respect to claiming any expense for the use of her principal residence, Ms.
Middleton has the hurdle of subsection 18(12) of the Act to overcome. It
reads:
18(12) Notwithstanding
any other provision of this Act, in computing an individual's income
from a business for a taxation year,
(a) no
amount shall be
deducted in respect of an otherwise deductible amount for any part
(in this subsection referred to as the "work space") of a self-contained domestic
establishment in which the individual resides,
except to the extent that the work space is either
(i) the
individual's principal
place of business, or
(ii) used exclusively for the purpose of earning income from business and used on a
regular and continuous basis for meeting clients, customers or patients of the individual in respect
of the business;
(b) where
the conditions set out in subparagraph (a)(i) or (ii) are met, the amount for the work
space that is deductible in computing the individual's income
for the year from the business shall not
exceed the individual's income
for the year from the business, computed
without reference to the amount and sections 34.1
and 34.2;
and
(c) any
amount not deductible
by reason only of paragraph (b) in computing the individual's income
from the business for the
immediately preceding taxation year shall be
deemed to be an amount otherwise
deductible that, subject to paragraphs (a) and (b), may be deducted
for the year for the work space in respect of the business.
[23]
I have not been
satisfied that Ms. Middleton’s principal residence served as her principal
place of business for the spa or school. In that respect, I see little
distinction between the spa and the school as far as identifying two separate
businesses. They were inexplicably linked.
[24]
With respect to the
second qualification: was any workspace in the house used exclusively for the
purpose of earning income and used on a regular and continuing basis for
meeting customers, there was one area of Ms. Middleton’s business, the testing
of hair and saliva, that she conducted exclusively from home. Although there
was not a great deal of evidence on this point, I find that the exclusive use
of a bedroom meets the requirements for deduction of some amount for the home
work space. I allow $200.00 a month in this regard. Further, I find Ms.
Middleton incurred a rent expense of $550.00 in December 2005, notwithstanding
the lack of receipt.
Conferences
[25]
Ms. Middleton’s
husband’s attendance at a conference with his wife is entirely personal and no
part of such expenditure is deductible as business expense.
Legal
[26]
The Government has
conceded an amount can be moved from the 2006 to 2005 taxation year. I am
satisfied the amount in question is $5,698. The ESB amount of $4,628 was not
incurred in either of the years in issue.
Vehicle expenses
[27]
The Respondent argues
that the vehicle expenses claimed by Ms. Middleton are the personal expenses of
travelling to and from work and home, and as such are not deductible business
expenses. There was also an element of travelling to obtain supplies and run
other miscellaneous business related errands. Without any work logs it is
difficult to determine what percent pertained to such business travel and not just
getting to and from work. I am prepared, however, to recognize such business
travel and, therefore, allot 20% of Ms. Middleton’s calculated vehicle expenses
to business, resulting in $613 in 2005 and $523 in 2006.
[28]
I also allow the $121
expense for a lock at the spa.
[29]
Ms. Middleton has been
unable to satisfy me there are any other further deductions from income other than
$3,684 in 2005 and $2,923 in 2006, with the move of $5,698 from 2006 to 2005
for legal fees.
GST
[30]
With respect to the GST
assessment, Ms. Middleton has acknowledged that she mistakenly calculated her
GST on the net month end cash deposits, recognizing now that this was
considerably less than the revenue figure that should have been used for
calculating GST. The only objection remaining to CRA’s assessment of the GST is
that they considered the full amount charged by the workers in determining her
revenue, rather than basing the calculation on the net revenue, after deducting
the workers’ payment. In effect, Ms. Middleton is maintaining that her revenue
was the net amount; for 2005 for example, this would reduce the revenue figure
by $31,282, being the amounts retained by or paid to the workers.
[31]
This case is very
similar to the recent case of Manship Holdings Ltd. v. R.,
a case also involving massage services being provided by independent
contractors. Justice Angers determined at trial, and was approved at the
Federal Court of Appeal, that notwithstanding the workers were independent
contractors, the operator of the massage parlour was providing a single supply
of services and as such was responsible for collection and remittance of HST on
the entire amount received from the customer. Implicit in this approach is that
the workers were providing their services to the operator, who offered the
whole package on a single supply if you will, (premises, supplies and massage
services) to the customer. The fact the workers did not charge GST leaves the
question somewhat up in the air as to whom they would have charged the GST –
Ms. Middleton or the customer? Taking the view that Ms. Middleton offered the
whole service it would follow that had the workers charged anyone it would have
been Ms. Middleton. However, whichever way you slice it, the amount determined
by the CRA as gross revenue includes the portion allocable to the workers. I
did note, however, that CRA’s calculation of gross revenue included tips to the
workers, which I find should not be included in Ms. Middleton’s revenue for GST
purposes. I therefore reduce revenue by $3,222 in 2005 and $1,704 in 2006 to
reflect the tips, with a corresponding deduction in GST.
Penalties
[32]
I turn now to the area
of most concern to Ms. Middleton, the application of gross negligence
penalties. It was clear that she was distraught that anyone would suggest she
had acted criminally or fraudulently. I attempted to assure her this was not a criminal
matter but a question of penalties from acting indifferently as to whether the
law was complied with, citing the test laid out in Venne v. R..
…
37. With respect to the possibility of gross
negligence, I have with some difficulty come to the conclusion that this has
not been established either. "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. …
[33]
The Respondent’s
position was that Ms. Middleton’s actions did show an indifference to
compliance with the law. The Respondent based this view on the materiality of
the differences in revenue reported, the lack of a reasonable explanation and
the fact that Ms. Middleton personally prepared all the returns.
[34]
What the Courts have
made clear, following Venne, is that gross negligence is a bar
considerably higher than negligence. I have little difficulty in attaching the
negligence label to Ms. Middleton in regards to how she managed her business in
the context of attempting to comply with the Act and the ETA. Her
actions indicate she did not take reasonable care. However, with respect to the
higher bar of gross negligence, I draw a distinction, albeit a fine one,
between her actions in attempting to comply with the Act versus her
actions in attempting to comply with the ETA.
[35]
First, with respect to
gross negligence penalties pursuant to the Act, I believe Ms. Middleton
most likely did pay more expenses from her cash receipts than she has been able
prove. This is regrettable, but it does go to the issue of the extent of her
negligence. As indicated, I have concluded she was negligent in handling her
business affairs in the manner she did, but, I also conclude that for income
tax purposes, her actions do not constitute gross negligence. She believed that
her approach would still result in an accurate determination of net income;
that is, the deposit and recording of her monthly net cash earnings combined
with her credit card deposits should have yielded the correct numbers for
income tax purposes. The material discrepancy may not have been as the
Respondent suggests, but, as I have said, unfortunately for Ms. Middleton,
she has presented very little evidence other than speculation to support that
position. However, her belief that her accounting for income should have been
accurate for income tax purposes, plus the fact the material discrepancy was
likely not as significant as suggested by the Respondent, plus my view of Ms.
Middleton as a decent, straightforward individual more interested in healing
physical ills than attending to accurate bookkeeping, leads me to conclude that
the Respondent has not proven Ms. Middleton was grossly negligent in accordance
with subsection 163(2) of the Act. This has been a very close call.
[36]
The gross negligence
penalties found in section 285 of the ETA is similarly worded to the
sister provision in the Act. The GST is determinable on Ms. Middleton’s
gross revenue; her system of accounting for revenue was set up to focus on net
income. Even a cursory review of the ETA legislation or limited advice
from a professional or CRA itself would have caused any reasonable person to
realize that reporting for GST as Ms. Middleton did would grossly understate
the GST required to be collected and remitted. So, it is not so much the
materiality of the difference, as the Respondent contends, but the total
disregard for what the GST is all about. I find this is quite distinct from an
understanding that an income tax is based on net income. With respect to the ETA
legislation, Ms. Middleton ignored completely on what basis GST was collected.
In this regard, I must conclude she did indeed act indifferently as to whether the
law was complied with, and is liable for gross negligence penalties pursuant to
section 285.
[37]
The Appeals from the
reassessments made under the Income Tax Act are allowed and the
reassessments are referred back to the Minister of National Revenue for
reconsideration and reassessment on the following basis:
i. for income tax
purposes, Ms. Middleton’s income in 2005 and 2006 is reduced by additional
deductions of $3,684 and $2,923, respectively.
ii. for income tax
purposes, a deduction of $5,698 is moved from Ms. Middleton’s 2006
taxation year to her 2005 taxation year.
iii.
there shall be no gross
penalties pursuant to subsection 163(2) of the Act in 2005 and 2006.
iv.
for ETA
purposes, Ms. Middleton’s revenue is reduced by $3,222 in 2005 and $1,704 in
2006 with a corresponding adjustment to net tax and to penalties pursuant to
section 285 of the ETA.
Signed at Hamilton, Ontario, this 5th day of
July 2010.
"Campbell J. Miller"
Email this Content