Citation: 2010 TCC 419
Date: August 11, 2010
Docket: 2008-623(IT)G
BETWEEN:
KENNETH EDGAR PEARCE,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
REASONS FOR JUDGMENT
Campbell J.
A. FACTS
[1]
These appeals are from
reassessments by the Minister of National Revenue (the “Minister”) pertaining
to the Appellant’s 2001, 2002, 2003 and 2004 taxation years. In respect to the
taxation years 2001 and 2002, the Minister relied on subsection 152(4) of
the Income Tax Act (the “Act”) to reassess the Appellant beyond
the normal reassessment period.
[2]
The Appellant, a
shareholder and employee of Pearce Forest Products Ltd. (“Pearce”) during these
taxation years, reported the following T4 amounts as income:
|
Taxation Year
|
Reported Income
|
|
2001
|
$82,876
|
|
2002
|
$78,000
|
|
2003
|
$62,900
|
|
2004
|
$ 6,936
|
The Appellant also reported a T4A amount of $44,426 as
income respecting the 2004 taxation year.
[3]
In reassessing the Appellant
on February 2, 2007, the Minister added the following shareholder benefit
amounts to his income:
|
Taxation Year
|
Shareholder Benefit
|
|
2001
|
$20,297
|
|
2002
|
$39,383
|
|
2003
|
$23,337
|
|
2004
|
$ 1,800
|
In addition, the Minister disallowed employment
expenses of $14,144 in 2003 and $24,176 in 2004. Gross negligence penalties
were levied in each of the taxation years in respect to the shareholder benefit
amounts.
[4]
The corporation,
Pearce, was a wholesale lumber distributor which conducted its business
activities from the Appellant’s residence between February 1999 and
April 2004. Prior to commencing this business in 1999, the Appellant was
involved in other lumber trading operations. Because he was experiencing
financial difficulties, three of his friends invested funds in Pearce in 2000
or 2001 and became shareholders and directors. It was clear, however, from the
evidence, that the Appellant remained the operating mind of Pearce’s day-to-day
activities and retained signing authority and use of the company’s debit card
throughout these taxation years.
[5]
William Wheeler, one of
the investors, testified that it was their intention to loan the money, get a
return on the investment and then have the Appellant buy out their interests.
At the outset, the investors simply reviewed financial statements but, when the
company encountered difficulties, they implemented cost control measures.
Commencing in 2003, in addition to the Appellant’s signature, one of the
investors was required as a signatory on the corporate bank account. Mr.
Wheeler testified that the only controllable costs were those that he referred
to as “Ken‑related costs” (Transcript, page 275, line 19) such as
utilities, entertainment, automobile and so forth. Also, by 2003, Mr. Wheeler,
together with another investor, Peter Bonner, assumed the task of signing the
cheques so that a further check on costs could be implemented. He made reference
to correspondence and e‑mails between the investors and the Appellant
which outlined shareholder concerns and the Appellant’s agreement that not all
of the expenses that he was claiming could be justified. The investors also put
a limit of $9,000 monthly on expenses reimbursable to the Appellant. Despite
these controls, the expenses remained higher than they should have been,
according to Mr. Wheeler. In April of 2004, the investors discovered that
the Appellant had possession of a corporate debit card which he was freely
using to exceed the spending limits that had been placed on him. They also
discovered that the financial statements did not reflect the financial reality
of the company. For example, some of the receivables, that were clearly not
collectible, had been retained on the books. Also, incorrect balance sheet
entries were made when cash was removed and an offsetting entry would be made
and referenced as inventory. Following this, the investors made the decision to
withdraw their support and close the company.
[6]
Carol Logan, the
bookkeeper and office manager for the company during these taxation years,
testified that she was hired by the Appellant and reported directly and only to
the Appellant. She was responsible for keeping track of the Appellant’s
expenses and stated that when he presented her with receipts, he was either
reimbursed by cheque or by debit card. Early on, either the Appellant or
Ms. Logan prepared the cheque for expense reimbursement to the Appellant
and the Appellant would sign it. When the investors began to oversee the
expense cheques for which they had established a maximum limit of $9,000 monthly,
Ms. Logan was aware that such a budget had been established because the
Appellant instructed her to place the monthly debit card expenses in different
categories. According to Ms. Logan’s evidence, the Appellant was very involved
in deciding where expenses would be located in the statements and how they
would be described. She simply followed his directions but testified that she
had concerns that some of the expenses were personal to the Appellant. As a
result, she began to make notations in the journal entries.
[7]
The auditor, Judith
Robitaille, concluded that many of the expenses were personal and they were
treated as shareholder benefits to the Appellant. As a result, those expenses
were disallowed to the corporation.
[8]
The issues to be
determined are:
(a) whether the
Minister is entitled to reassess the statute-barred years, 2001 and 2002,
pursuant to subsection 152(4) of the Act?;
(b) whether the company
conferred benefits on the Appellant in the 2001, 2002, 2003 and 2004 taxation
years in his capacity as a shareholder pursuant to section 15, or,
alternatively, in his capacity as an employee pursuant to subsection 6(1) of the Act?;
(c) whether penalties
were properly levied on the amounts of those unreported benefits pursuant to
subsection 163(2) of the Act?; and
(d) whether the
Appellant is entitled to any additional expenses in 2003 and 2004, the only
years in which he claimed employment expenses in excess of the amounts allowed
by the Minister?
[9]
The Appellant’s
position is that the audit is incorrect because the benefits which have been
assessed have already been accounted for. According to his Notice of Appeal,
“Items originally entered as business expenses and later deemed to be “personal
use” by Pearce Forest Products (PFP) were brought back into my income via my T4
for the years 2001 to 2004. This amount was $37,776. An additional amount of $44,426
covering these same years was brought back into my income via a T4A in 2004
when the company ceased business. Taxes were fully paid on these amounts, in
their respective years”. In effect, the Appellant is claiming that the Minister
has “double taxed” his income. Consequently, since there are no
misrepresentations, the Minister should not be permitted to reopen the statute‑barred
taxation years of 2001 and 2002. With respect to the employment expenses which
the Minister disallowed, the Appellant relied on the case of Coffen v.
The Queen, 97 D.T.C. 5552 to argue that the Minister must prove beyond a
reasonable doubt that each expense in each taxation year has been properly
disallowed and that each item is properly subject to be taxed.
[10]
The Respondent’s
position is that the audit was completed properly, that the Appellant has made
misrepresentations which permit the statute-barred years to be reopened and
that the shareholder benefits assessed were personal and are separate from the
amounts included in the T4 and T4A slips issued by the company. The T4A slip
was in respect to employee advances and inventory adjustments for prepaid
expenses and therefore was not in respect to benefits. The Respondent also
submitted that the Appellant was either reimbursed by the company for most of
his employment expenses claimed in 2003 and 2004 or that the expenses were not
incurred for business purposes. The auditor was very aware of the Appellant’s
position and therefore paid particular attention to the amounts included in the
T4 and T4A slips.
B. ANALYSIS
[11]
In these appeals, the
Respondent has the onus, pursuant to subparagraph 152(4)(a)(i) of
the Act, of proving that the Appellant “has made any representation that
is attributable to neglect, carelessness or wilful default or has committed any
fraud in filing the return or in supplying any information under the Act…”.
In addition, the Respondent has the onus in respect to gross negligence
penalties. On numerous occasions throughout the hearing, I explained that the
onus respecting all other issues rested with the Appellant. The Appellant
argued throughout that “…it is common law that the auditor must audit each and
every expense item submitted for each and every year.” (Transcript, page 19,
lines 15‑17). This reliance stemmed from the decision of Sheppard
J., in Coffen, where he states, at page 5554:
… In a
proceeding under the Criminal Code, the onus is upon the own [sic] to prove the guilt of the accused of the offence(s)
charged beyond a reasonable doubt. In an
income tax case that means the Crown must prove beyond a reasonable doubt that each
item of income sought to be taxed is properly subject to tax in accordance with
tax law and each expense disallowed is properly disallowed in accordance
with tax law. In cases such as this where the volume of paper is enough to fill
a small room, it is a daunting task. But it must be done, and it must be done
for each taxation year. …
(Emphasis added)
This principle was subsequently overturned on appeal
and the Ontario Court of Appeal held that a count of tax evasion does not have
to relate to a single taxation year. However, the comments of Justice Sheppard
are clearly preceded by the important phrase “in a proceeding under the Criminal
Code” and, as a result, they have no bearing in respect to the issues and
onus in the present appeals.
[12]
Despite the Appellant’s
repeated assurances that he understood that the onus was upon him (with the
exception of the two statute-barred years and the penalty issues), as a result
of his incorrect reliance on the Coffen decision, he spent most of his
time attempting to show that the audit was flawed and that the Minister could
not prove that the expenses were personal, instead of focussing on providing
evidence to demolish the Minister’s assumptions on a balance of probabilities.
To simply allege that the audit is incorrect and that the amounts that were
recorded as expenses should be deductible falls short in meeting the
evidentiary burden which is upon him. He provided no specifics or details and,
instead, spent the majority of the time making vague and general assertions. At
times it appeared that he intended his submissions to be imprecise, ambiguous
and misleading. In a self-assessing system, it is the Appellant that is in the
best position to provide the necessary details to show why the assessments are
not correct. He has simply failed to do so.
[13]
With respect to the
reopening of the two statute-barred years, I conclude that the Respondent has
adduced sufficient evidence for me to conclude that there have been misrepresentations
by the Appellant in his tax returns for the 2001 and 2002 taxation years to
allow the reopening of these years pursuant to subparagraph 152(4)(a)(i)
of the Act. At the very least, there has been neglect and carelessness
on his part and there is also evidence for me to conclude that he had the
wilful intent to mislead.
[14]
The Appellant has a
Bachelor of Commerce degree from the University of British
Columbia. He has been
involved with other companies for many years in the lumber trading industry. He
is an experienced businessperson who had complete control of the daily
activities of this company throughout the taxation years and this was supported
by the evidence of both the bookkeeper, Carol Logan, and one of the investors,
William Wheeler. Although there were investors onboard by 2002, this was
effectively his company. He directed payments to be made to cover his personal
expenses and provided instructions to Ms. Logan in respect to the recording of
these expenses. He had sole signing authority in the beginning and, when
eventually the signature of one of the three investors was required on the
cheques, he circumvented their directives and used the corporate debit card
without the knowledge of the investors. He was very familiar with the
difference between business and personal expenses. Based on his knowledge,
education and experience, he should have been alerted to these errors. In many
instances, the errors are blatantly obvious.
[15]
In Venne v. The
Queen, 84 D.T.C. 6247, Strayer J. made the following comments at page 6251:
I am satisfied that it is sufficient for the
Minister, in order to invoke the power under sub-paragraph 152(4)(a)(i)
of the Act to show that, with respect to any one or more aspects of his income
tax return for a given year, a taxpayer has been negligent. Such negligence
is established if it is shown that the taxpayer has not exercised reasonable
care. This is surely what the word “misrepresentation that is attributable
to neglect” must mean, particularly when combined with other grounds such as
“carelessness” or “wilful default” which refer to a higher degree of negligence
or to intentional misconduct. Unless these words are superfluous in the
section, which I am not able to assume, the term “neglect” involves a lesser
standard of deficiency akin to that used in other fields of law such as the law
of tort. …
(Emphasis added)
[16]
Strayer J. again
addressed this same provision in Nesbitt v. The Queen, 96 D.T.C.
6588, where, at page 6589, he stated:
… It appears to me that one purpose of subsection
152(4) is to promote careful and accurate completion of income tax returns.
Whether or not there is misrepresentation through neglect or carelessness in
the completion of a return is determinable at the time the return is filed. A
misrepresentation has occurred if there is an incorrect statement on the return
form, at least one that is material to the purposes of the return and to any
future reassessment. It remains a misrepresentation even if the Minister
could or does, by a careful analysis of the supporting material, perceive the
error on the return form. It would undermine the self-reporting nature of the
tax system if taxpayers could be careless in the completion of returns while
providing accurate basic data in working papers, on the chance that the
Minister would not find the error but, if he did within four years, the worst
consequence would be a correct reassessment at that time.
Thus it is irrelevant that the Minister might, despite
the misrepresentation on the return form, have ascertained the true facts prior
to the expiry of the limitation period. The faulty return was when submitted,
and remained, a misrepresentation within the meaning of subparagraph 152(4)(a)(i)
of the Act.
(Emphasis added)
[17]
The Appellant submitted
that he has been transparent in his actions and that he did not attempt to hide
pertinent information from the Minister. However, the standard for determining
that a misrepresentation has been made is low and requires only that there be a
material incorrect statement. He was involved in the maintenance of the
corporate books and records and directed the bookkeeper respecting the
treatment of journal entries. He prepared his own return manually for the 2002
taxation year. The evidence supports that he knew that in directing the company
to pay these personal expenses, such as rent and utilities, he was conferring
taxable benefits upon himself. In any event, with his background, if he did not
know the results of his actions, he should have known them. The unreported
gross benefits in 2001 and 2002 were $22,172 and $42,571 respectively.
These amounts were not insignificant. His only explanation was that these
expenses were all business-related or that they had been included in the T4A
amounts. However, he produced no evidence to support this alleged duplication
of amounts, nor did he adduce any evidence to show that, although these amounts
were expensed by the company, they were incurred to earn income from the
business or from employment. In fact, he admitted on cross-examination that
most of the benefits had not been duplicated on the T4A slip. In these
circumstances, the Minister was justified in reopening the statute-barred
years.
[18]
With respect to the
benefits that the corporation paid, which amounts included rent, utilities,
automobile expenses, entertainment, office expenses, travel and legal payments,
I conclude that these were personal expenses and, as such, should have been
included in the Appellant’s income as shareholder benefits pursuant to
subsection 15(1) of the Act. Essentially, the Appellant’s argument is
that these benefits have already been included in the T4A slip issued in 2004
by the company and to include these amounts again in his income amounts to
double taxation. During his testimony, Mr. Wheeler stated that the T4A
consisted of an advance to the Appellant and an inventory adjustment, which was
actually another advance taken by the Appellant. The T4A was issued when these
advances came to the knowledge of the investors subsequent to the controls they
attempted to implement to curb the Appellant’s expenditures. Mr. Wheeler
concluded that many of the expenses were not related to the corporate
activities. According to Mr. Wheeler, the company was either paying
expenses directly or reimbursing the Appellant for the reasonable
business-related expenses he incurred. This is supported by the terms of the
employment contract (Exhibit R-2). Many of the types of expenses claimed by the
Appellant are the same as those that the company was also paying. He did not
offer any explanation for this, reasonable or otherwise. The auditor testified
that she recognized the Appellant’s concerns of duplication and in completing
the audit, she tried to track the source of the advances to ensure that they
did not include any other benefits that had been assessed. For example, the
auditor traced approximately $20,000 paid to the Appellant through a series of
cheques for which the Appellant conceded that they were, in fact, personal
expenses which had been characterized as “prepaid expenses” in the corporate
records.
[19]
Although the Appellant
alleged duplication, he never supported this allegation with evidence that
would suggest duplication between the amounts assessed by the Minister and the
amounts included in the T4A slip. The Appellant was in the best position to
provide such evidence as he was clearly directing the corporate activities,
involved in the corporate record-keeping and freely expensing amounts, even
after the investors attempted to implement controls. The Appellant has failed
to demonstrate that the auditor erred in reassessing and has also failed to
show that any duplication existed.
[20]
With respect to the
employment expenses, the Minister disallowed expenses because they were either
not incurred for the purpose of earning income or they had been reimbursed by
the company. The Appellant argued that he chose to incur many of these expenses
personally due to the tenuous relationship between himself and the investors.
He claimed other expenses because he felt the company had not reimbursed him.
[21]
The employment contract
(Exhibit R-2) clearly establishes that the company would be paying for any
expenses which were incurred for business purposes. The onus is on the
Appellant to convince this Court that any expenses beyond those contemplated in
this contract were required for business purposes and that he had not been
reimbursed for any of those expenses. However, the Appellant’s evidence in this
regard was again vague and ambiguous. Many of the expenses, on their face, have
an apparent personal element. The Appellant failed to establish any business
purpose related to expenses such as birthday parties, hunting and fishing
trips, dog food, kitchen items and a trip to Blackcombe Mountain on New Year’s Day. It is also telling that the
shareholders/investors did not dispute the corporate reassessments which
disallowed these expenses to the corporation. In fact, the investors had
suspicions respecting the expensing activities by the Appellant and attempted
to place controls on him, which for a period he successfully and covertly
circumvented.
[22]
Finally, I conclude
that gross negligence penalties pursuant to subsection 163(2) of the Act
are justified in these circumstances. Much of the Respondent’s evidence
with respect to the penalty issue was the same evidence adduced to support
reopening the statute-barred years. However, as I noted in Dao v. The Queen,
2010 D.T.C. 1086, the type of conduct of a taxpayer that would support
reopening statute-barred years under subparagraph 152(4) may not necessarily or
automatically support the imposition of penalties under subparagraph 163(2).
While subparagraph 163(2) is a penal provision, 152(4) is not. As noted by
Strayer J. in Venne, at page 6256:
… “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. …
Again at page 6249, Strayer J. noted the following:
… By virtue of sub-section 163(3) “the burden of
establishing the facts justifying the assessment of the penalty is on the
Minister”. It will be noted that for the penalty to be applicable there appears
to be a higher degree of culpability required, involving either actual
knowledge or gross negligence, than is the case under sub-section 152(4) for
reopening assessments more than four years old where mere negligence seems to
be sufficient. …
[23]
The evidence
established that the Appellant was the directing mind of the company. He
prepared and signed his own tax returns for the 2002, 2003 and 2004 taxation
years. He directed the bookkeeper respecting the entry of items in the
financial statements. He instructed the bookkeeper on the reimbursement of his
expenses and her testimony was that she simply followed his directives and
recorded the amounts as the Appellant instructed. E-mails between the Appellant
and shareholders/investors support their growing concerns over the Appellant’s
expense spending. In an attempt to avoid the controls imposed on the
Appellant’s spending, he used the corporate debit card. His explanation
concerning the debit card use was that it was humiliating for him to have a
cheque signed by Mr. Wheeler for every expense. However, I agree with the
Respondent’s submissions, that these events are more reasonably explained by
the fact that the Appellant’s ability to freely expense personal items, as he
had done in the past, was now being hampered by the investors. In addition, the
Appellant instructed the bookkeeper to post items in pre‑paid and
inventory accounts for the purpose of minimizing both creditor issues and the
existing problems which the investors had with his spending. The evidence
supports that he intentionally engaged in these accounting irregularities,
together with the use of the company debit card, to enable his expense
spending. This resulted in corporate records that were not fully transparent.
Finally, the amounts, upon which penalties have been imposed, are significant.
As the auditor noted in her penalty recommendation report, the unreported
income, in each of the taxation years, was greater than 25 per cent of the reported
income.
[24]
Despite the Appellant’s
business background and experience, he failed to report benefits which were
clearly personal and also claimed expenses which were personal or improper. He
was unable to explain why he had deducted many of these expenses. He engaged in
intentional accounting irregularities to wilfully misrepresent the true state
of the corporate activities. All of these facts warrant the imposition of
penalties pursuant to subsection 163(2).
[25]
In summary, throughout
the hearing, the Appellant consistently submitted that the audit was flawed and
that the Minister was unable to show that the expenses were personal. Despite
my warnings, he failed to recognize that it was his responsibility to submit
evidence to show that he did not receive the shareholder benefits or that some
benefits had already been included in the T4 and T4A slips. He also failed to
show why any of the employment expenses should be allowed. His position was
basically that if he could submit a receipt, he could automatically claim it as
an expense without making any attempt to show how the expense was related to
his employment duties. This was all the more important for the Appellant to
address where an employment contract existed which directed the company to pay
directly or to reimburse the Appellant for the business-related expenses. Since
the Appellant failed to submit any evidence on these issues, I must infer that
such evidence, if adduced, would have been unfavourable to his position. The
evidence supports Mr. Wheeler’s testimony that the Appellant was simply helping
himself to the company’s cash in spite of the efforts implemented by the
shareholders/investors to control his free-spending activities.
[26]
The appeals will be
allowed in respect to two concessions for the 2002 taxation years which the
Respondent made at the commencement of the hearing in respect to automobile and
office expenses. The amounts were detailed in an Amended Schedule “A” to the
Reply to the Notice of Appeal submitted by the Respondent and they result in
the reduction of the total shareholder benefit amount of $39,383 by an amount
of $3,890 for a revised total shareholder benefit of $35,493 in 2002. In all
other respects, the appeals are dismissed with costs to the Respondent.
Signed at Charlottetown, P.E.I., this 11th day of August 2010.
“Diane Campbell”
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