Citation: 2010 TCC 531
Date: 20101020
Docket: 2010-814(IT)I
BETWEEN:
SIGMA PNEUMATIC RESOURCES INC.,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
REASONS FOR JUDGMENT
Hogan J.
Introduction
[1]
The Minister of
National Revenue (the “Minister”), by notice of reassessment dated
March 11, 2008 with respect to the Appellant’s 2003 taxation year
(the “2003 reassessment”) and by notice of reassessment dated February 3, 2010
with respect to the Appellant’s 2004 taxation year (the “2004 reassessment”),
increased the income tax liability of the Appellant through the addition of
undeclared gross revenue and the disallowance of expenses. The Minister used,
for the most part, the deposit method to achieve this result.
[2]
The issue to be
determined in this appeal is whether or not the Minister overstated the
Appellant’s income. The Appellant argues that the Minister overstated its revenue
by $26,000 and $21,808.50 for the 2003 and the 2004 taxation years,
respectively.
[3]
With respect to the
2003 taxation year, it appears that, after much confusion at trial, the
Appellant’s position is that the Minister treated $16,000 in shareholders’
advances deposited in the Appellant’s account as undeclared gross revenue. Secondly,
the Appellant argues that it should be allowed a deduction for salary of
$10,000 paid to its principal shareholder. The Appellant claims that this amount
was not claimed by it as an expense in the tax return filed for its 2003 taxation
year.
[4]
With respect to the
2004 taxation year, the Appellant argues that the Minister was wrong to treat the
amount of $16,000 shown on an invoice for an order that was not filled by the
Appellant as undeclared gross revenue. Not surprisingly, counsel for the
Respondent argues that the Minister’s reassessments are accurate and were made
in conformity with the provisions of the Income Tax Act (Canada).
[5]
The evidence shows that
the Appellant operated a procurement business. It was hired by foreign
manufacturers and shipbuilding businesses located around the world to procure
goods used in their operations. The Appellant worked with a corporation
situated in Dubai, Qais Equipment & Systems Trading (L.L.C.),
(“Qais”), owned by one of its other shareholders. Qais would seek out
procurement contracts for the Appellant in the Middle East and Asia, which
would be filled by the Appellant from manufacturing sources located in Canada,
the United States and Europe.
[6]
In the years under
review, the Appellant had one employee, Imamuddin Mohammed, the principal shareholder
of the Appellant. Mr. Mohammed was an engineer who had undergone his
training in India. According to this witness, the business
was started in 2003 and the Appellant began filling procurement orders only in
June of that year.
[7]
Mr. Mohammed
identified documentary evidence entered as Exhibits A‑1 to A‑5. The
witness claims that the document numbered page 33 of Exhibit A‑3
is evidence of a shareholder’s advance in the amount of US$9,975 received personally
by him from one of the Appellant’s other shareholders located in Dubai, with instructions to deposit the amount in the
Appellant’s bank account. Mr. Mohammed testified that initially he deposited
the funds received from his co‑shareholder in his personal US dollar
account with the TD Bank. He then transferred the funds to the Appellant’s
account. The parties agreed that the applicable exchange rate in 2003 was 1.4
meaning that this deposit represents a shareholder’s advance of $13,966, if I
accept the Appellant’s evidence on this matter. The witness claims that the
balance of the shareholders’ advances at issue ($2,034) was made up of a number
of small cash deposits.
[8]
With respect to the
second point at issue for the 2003 taxation year, Mr. Mohammed claims he
received a salary of $10,000 paid to him by the Appellant for services rendered
in the Appellant’s 2003 taxation year. According to Mr. Mohammed, he
reported this salary as employment income in his tax return for that year.
[9]
On cross‑examination,
the witness admitted that he worked on a part‑time basis at a gas station
on weekends. After much hesitation, he claimed that he earned approximately $150
to $200 a week from that activity, for a total of approximately $5,000 annually.
[10]
The last matter covered
by Mr. Mohammed’s testimony was three invoices concerning the same
purchase order that were treated, by the auditor assigned to complete the audit
of the Appellant, as unreported gross revenue of US$16,750 earned by the Appellant
in its 2004 taxation year. The parties agree that the Canadian dollar
equivalent of this amount is $21,808.50. According to the witness, these three
invoices (the “Shipbuilding Invoices”) related to a procurement order received
from a shipbuilding company located in Sri Lanka called Columbo Dockyard.
[11]
According to
Mr. Mohammed, Columbo Dockyard required electrical cables for use in ships
that it was under contract to complete. Mr. Mohammed explained that all of
the Appellant’s company’s invoices are prepared in advance in the name of Qais
because that company is responsible for sourcing business for the Appellant in
the Middle East and Asia. If the business did not originate with
Qais, then, Mr. Mohammed claims, he would change the name on the invoice
to the name of the client. According to the witness, the Appellant did not have
the funds available to finance the goods required by the client, which pays for
the order only 30 days after the shipping of the goods occurs. In the
meantime, the Appellant is required to finance the purchase order out of its
working capital. The manufacturer would not ship the goods unless they were
fully paid for. Mr. Mohammed testified that Columbo Dockyard was an
important client of the Appellant and that he was anxious to be helpful. Because
the Appellant was unable to finance the purchase, Mr. Mohammed was obliged
to find another, unrelated company, to fill the order. According to the
witness, the Appellant received no revenue for its efforts in this regard. The
Appellant relinquished the order to another procurement company to protect its
goodwill with Columbo Dockyard.
[12]
Mr. Mohammed claims
that in his discussion with the appeals officer assigned to the file he was led
to believe that he should prepare a credit note to cancel out the gross revenue
included by the auditor in the Appellant’s income with respect to the aborted Columbo
Dockyard transaction. After he did so, he claims, the appeals officer changed
her mind, suggesting instead that the amount should have been claimed as a bad
debt.
[13]
Indra Kukabalan
conducted the audit of the Appellant for the Canada Revenue Agency. It was
unclear from her testimony why she adopted the deposit method to reconstruct
the Appellant’s income for the years under review. She did not claim that the
Appellant’s records were unreliable or, for that matter, that it received large
unreported cash receipts.
[14]
The witness did explain
that the Appellant forgot to convert US dollar revenue, which comprised the
bulk of the revenue received in the years under review, into Canadian dollars
when reporting its income in its tax return. The Appellant recognizes this
important omission and does not contest Ms. Kukabalan’s calculation of
additional revenue with respect to this particular amount.
[15]
Under the deposit
method used by Ms. Kukabalan, all deposits in the Appellant’s bank account
were treated as gross revenue unless she received a reasonable explanation justifying
their not being treated as such. The Court noted from Ms. Kukabalan’s
testimony that she did not use the deposit method to calculate the Appellant’s
undeclared gross revenue for the 2004 taxation year. In fact,
Ms. Kukabalan admitted during her testimony that she did not examine
whether the Appellant actually received funds in connection with the Columbo
Dockyard matter. She included the amount relating thereto in gross revenue
because the Shipbuilding Invoices had not been formally cancelled in the
Appellant’s records, and she did not believe Mr. Mohammed’s explanation
that the order had not been filled.
Analysis
[16]
It is a well‑established
principle of Canadian tax law that the Minister may use alternative methods to
determine if a taxpayer has failed to report all of its income. In the instant
case, the Appellant has produced evidence which, although not perfect,
establishes on a balance of probabilities that the Minister overestimated its
gross revenue by $16,000 with respect to the 2003 taxation year by treating
shareholders’ advances as undeclared revenue. The documentary evidence offered
by Mr. Mohammed corroborates his testimony that $13,966, being the
Canadian dollar equivalent of US$9,975, was deposited in the Appellant’s
account from funds withdrawn from Mr. Mohammed’s account. The Appellant’s evidence,
considered as a whole, including Mr. Mohammed’s testimony with respect to
the small cash deposits, was more compelling than Ms. Kukabalan’s
testimony on this matter.
[17]
The Court does not
reach a similar conclusion with respect to Mr. Mohammed’s claim that he
received $10,000 in employment income from the Appellant. He offered no
explanation why the Appellant would have failed to claim the expense in its tax
return as originally filed. In light of the evidence, it is obvious that the
Appellant believed it was in a significant loss position in the 2003 taxation
year. From the vantage point of Mr. Mohammed, it would have been
preferable if he had received the payment in consideration of a reduction of
his shareholder’s advance. Finally, Mr. Mohammed did admit on cross‑examination
that he worked for another employer during the year. The Court has no way of
knowing whether the $10,000 of employment income reported by him on his 2003
tax return pertains to amounts received from his other employment. The Court
also takes note of the fact that he did not raise this issue at an earlier
stage. Finally, the fact that Mr. Mohammed admitted only on cross‑examination
that he had another source of employment income causes the Court to question
the accuracy of his testimony on this matter.
[18]
Mr. Mohammed
testified that the procurement order covered by the Shipbuilding Invoices was
not filled because the Appellant did not have financing available to complete
the purchase. Here again, while the evidence is not perfect on this point, the
Court finds Mr. Mohammed’s testimony to be more compelling on this issue
than that of Ms. Kukabalan. She admitted that she used the deposit method
for the most part to determine the amount of the Appellant’s undeclared revenue.
However, with respect to the Shipbuilding Invoices, she changed methodologies.
She did not attempt to determine, under the other method, whether any funds
were received by the Appellant. She did not examine the Appellant’s bank
records for that period. Therefore, the Court is left with credible evidence on
the one hand that the order was not filled and no probative evidence on the
other hand that it was.
[19]
Counsel for the
Respondent pointed out that a credit note was apparently prepared much later by
Mr. Mohammed to cancel this order hand hinted that this may be tantamount
to backdating. The Court accepts Mr. Mohammed’s evidence that the appeals officer
led him astray by suggesting that this issue could be made to go away if he
proceeded in that fashion. The appeals officer did not testify on this particular
point and there is no direct rebuttal evidence that contradicts Mr. Mohammed’s
testimony in that regard. Therefore, the Court concludes that the Appellant’s
income was overstated in the 2004 reassessment by the amount shown on the relevant
Shipbuilding Invoice.
[20]
The evidence does not
allow me to conclude that any changes other than those which are consequential
to the above should be made to the 2003 and 2004 reassessments.
Conclusion
[21]
For all of these
reasons, the 2003 and 2004 reassessments should be referred back to the
Minister to be varied in accordance with the findings set out above. There will
be no award of costs.
Signed at Ottawa, Canada, this 20th day of October 2010.
"Robert J. Hogan"
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