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Citation: 2009 TCC 117
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Date: 20090220
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Dockets: 2006-705(IT)G
2006-841(IT)G
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BETWEEN:
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VIALINK INC.,
HUBERT WATT,
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Appellants,
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and
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HER MAJESTY THE QUEEN,
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Respondent.
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REASONS FOR JUDGMENT
Campbell J.
[1] These
appeals were heard together on common evidence and relate to the 2000, 2001 and
2002 taxation years for Hubert Watt and the taxation years ending December 31,
2001 and December 31, 2002 in respect to Vialink Inc. (“Vialink”).
Mr. Watt is the sole shareholder and director of Vialink, which operated
an internet cyber café under the name, Telnet Entertainment. Vialink was
incorporated in 1998 to carry on the business of 1-900 telemarketing chat
lines. It ceased operations in 2002.
[2] In
March 2003, an audit was commenced in respect to Hubert Watt. This audit was
triggered by an incident occurring in February 2002, in which Mr. Watt was
detained by RCMP upon his arrival from England at the airport in Toronto, for possession of cash in the amount of £39,000.
This cash was eventually returned to the Appellant after an investigation
exonerated Mr. Watt of any wrongdoing. The Minister of National Revenue (the
“Minister”) used the net worth method to determine the taxable income of Hubert
Watt and imposed penalties under subsection 163(2) of the Income Tax Act
(the “Act”). As a result, the Minister determined that the Appellant,
Hubert Watt, had failed to report total income in the amounts of $56,040.27,
$82,373.56, and $239,309.97 for the 2000, 2001 and 2002 taxation years
respectively. Mr. Watt had late-filed his income tax return for the 2000 taxation
year on June 5, 2001 and, following up on several requests from the Canada
Revenue Agency (“CRA”), late-filed his returns for the 2001 and 2002 taxation
years on May 12, 2003. The income he reported from all sources for the 2000,
2001 and 2002 taxation years was rental income of $10,273.00, $5,495.00 and
$4,729.00 respectively.
[3] The
tax returns for Vialink for the taxation years ended December 31, 2001 and
December 31, 2002 were also late-filed on May 12, 2003 and reported nil income
in each of these taxation years. Vialink filed amended T2 returns after
the audit commenced for both of these taxation years (as well as for the
taxation year ending December 31, 2000) on March 1, 2004, reporting gross
business income of $64,995.00 and $1,890.00 and a net loss of $3,795.00 and
$5,564.00 respectively for each of these years. Although a net worth assessment
was completed in respect of Hubert Watt, the auditor used a bank deposit
analysis in respect to Vialink in determining that there was unreported business
income of $187,192.00 and $7,768.00 in regard to these two taxation years.
Vialink was reassessed on June 15, 2004 to include these amounts in income and
penalties were imposed.
[4] Although
the auditor found no documentation to verify actual business expenses, she did
allow the amount of $33,309.00 in the 2001 taxation year, being the amount which
was showing on the books as a shareholder loan. During the course of the
hearing, counsel for the Appellants submitted further documentation and after
review by Respondent counsel, an additional sum of $25,302.17 was conceded as
business expenses in that same taxation year. It should be noted that, although
Respondent counsel conceded the additional amount, there were concerns
expressed that there was some duplication of expense amounts.
[5] The
issues in these appeals are:
(1) Whether the
Minister properly included amounts as unreported income in the 2000, 2001 and
2002 taxation years of Hubert Watt.
(2) Whether the
Minister properly included amounts as unreported business income in computing
Vialink’s income in the taxation years ended December 31, 2001 and December 31,
2002.
(3) Whether Vialink is
entitled to claim additional business expenses beyond the amounts of $33,309.00
and $25,302.17 allowed/conceded in respect to the taxation year ended December
31, 2001.
(4) Whether gross
negligence penalties have been properly imposed pursuant to subsection 163(2)
of the Act in respect to each Appellant.
[6] The
focus in both appeals centered around the larger sums of money flowing through
the Vialink account in the relevant taxation years. The Appellant’s short
answer was that, although large amounts of money flowed through the business
account, they represented gifts/loans to Mr. Watt personally from family and
friends, as well as amounts forwarded to Mr. Watt from Gary Williams in England for potential investment in a restaurant/bar
business in Canada. The Minister concluded that there was
either no documentation to support the Appellant’s contentions or that it was
inadequate.
[7] The
Appellants relied on the evidence of Mr. Watt; his wife,
Sita Loretta Gardner; the operators of a currency exchange centre,
Sujatha Sivanathan and Sinnathurai Sivanathan; senior manager with the
Town of Whitby, Peter LeBel; and, Jacqueline Gilling, who gave her evidence by
videoconference from England. The Respondent relied on the evidence of the
auditor, Theresa Abernathy, and the appeals officer, Colette Ouimet.
The Evidence:
Hubert Watt
[8] Mr.
Watt’s educational background is in hotel management. He has a certificate from
a college in Jamaica as well as a diploma from George Brown College and a degree from Ryerson. He has worked
in the airline industry and in various food establishments and hotels as a food
and beverage cost controller and as a night auditor. Since 2004, he has been a
licensed real estate agent.
[9] Although
he incorporated Vialink in 1998 to operate 1-900 fantasy chat lines, he did not
officially commence operations until January 2000. Each caller to the chat line
was charged on a per call basis with the amount being billed to their telephone
account. After Bell Canada deducted its fees, a monthly statement was issued to Vialink together
with a cheque for the balance. Although Vialink maintained a corporate account
at the Royal Bank, Mr. Watt testified that occasionally the Bell Canada cheques
may have been cashed elsewhere. Since it was a twenty-four hour operation,
Vialink employed a number of women on a contract basis to deal with these
calls. They were paid twice monthly in cash. One of the largest expenses, the
cost of advertising, was paid through his personal credit cards.
[10] Mr. Watt testified that during this period he continued to investigate
potential business opportunities in the hospitality field, particularly
restaurant franchises. His friend, Gary Williams, expressed an interest in
being involved with Mr. Watt in a restaurant venture in Canada. Mr. Watt had been introduced to Mr. Williams
through an acquaintance, Jackie Gilling, in 1998.
[11] Mr. Watt’s evidence was that he made a number of trips to England to meet with Mr. Williams and that, beginning in
the fall of 2001, Mr. Williams wired him significant sums of money through
Sindi Financial, a currency exchange centre. These transfers occurred on different
occasions to satisfy franchise commitments and application fees. Mr. Watt
testified that Vialink was used as a “facilitator” in having these monies flow
through the Vialink corporate account. However, on one occasion the sum of £39,000
was given to Mr. Watt personally while he was in England to carry back with him
to Canada, instead of being wired.
[12] Mr. Watt was detained by Customs and the RCMP upon his arrival to Canada at the airport in Toronto in February, 2002. The money was retained for a number of months before
eventually being returned to him. When this occurred, Mr. Williams got “cold
feet” and requested the return of all of his money. Mr. Watt testified that he
returned a total of $120,000.00 to Mr. Williams over a period of time. This
was all of the money, which Mr. Williams provided to him, except for the £39,000
held by the RCMP. On cross‑examination, he clarified that it was actually
$161,389.00 that had been returned to Mr. Williams (November 26, 2007
Transcript, page 152). Mr. Williams died in July 2002. It appears that Mr.
Watt never returned the £39,000 to Mr. Williams.
[13] According to Mr. Watt’s evidence, there was a trust relationship
between them because Mr. Watt had given advice to Mr. Williams in the past
with respect to his restaurant in England. There were no
official records kept by Mr. Watt respecting these loans and no written
agreements respecting this money or Mr. Williams’s role in a potential
business venture in Canada. However, Exhibit A-2 contained
copies of cheques from Sindi Financial payable to Telnet Communications,
received in the period October 2001 to early 2002. Exhibit A‑1, Tab
1 contained bank account statements for Vialink, showing deposits to the
corporate account of $15,000.00 on October 23, 2001, $18,280.00 on October 23,
2001, $15,000.00 on October 29, 2001, $17,569.00 on November 5, 2001,
$15,000.00 on November 6, 2001, $30,000.00 on November 13, 2001, $35,000.00 on
December 13, 2001, and $15,540.00 on December 17, 2001.
[14] Mr. Watt testified that he pursued three possible business ventures
during this time period: Tim Hortons, Licks Restaurant and the Pump House in Whitby, Ontario. Exhibit A-1, Tab 2, contained a license
application to Tim Hortons which was completed but not signed. Exhibit
A-1, Tab 4, contains a letter from the Tim Hortons group dated June 29, 2001
acknowledging receipt of a completed franchise questionnaire (Exhibit A-1, Tab
5). Since locations that he proposed for a Tim Hortons’ site were already
saturated, he then looked into a Licks franchise. The only documentation
supplied in this respect was a one page letter (Exhibit A-1, Tab 9), dated
November 5, 2001, from Licks referencing introductory franchise information.
While pursuing a Licks franchise, Mr. Watt also investigated a potential site
for a restaurant and bar known as the Pump House in Whitby. Mr. Watt testified that he obtained information
from the Planning Department of Whitby and, subsequently, he and his wife met
with Peter LeBel concerning development of this site.
[15] In addition to the significant amounts received from Mr. Williams,
Mr. Watt testified that he received gifts and loans from family and
friends in Jamaica. According to Mr. Watt’s evidence, he
and his wife were to hold 51% share of any business venture entered into
with Mr. Williams. To raise the 51% share required by the franchisors, he
intended to use their family assets, as well as a bar in Jamaica, gifted to him by his father. Through an agreement
with his stepmother, he sold this bar to her and received the sum of $75,000.00
(instead of the initial agreed upon amount of $150,000.00), which was paid to
him over a period of time. Since he did not receive the original price of
$150,000.00, he listed the value of the bar at $90,000.00 in the Tim Horton’s
licensing application which, by his own admission, was $15,000.00 more than he
testified that he had received. He stated that he used these funds to pay down
his mortgage. A Bank of Montreal statement (Exhibit R-3, Tab 1) showed mortgage
payments of $20,000.00 in 2001 and $20,000.00 in 2002. In addition,
correspondence from an attorney in Jamaica was introduced to confirm that Mr. Watt’s
stepmother purchased the bar from him to keep it in the family and that lump
sum payments were made to Mr. Watt in the period 2000 to 2002 (Exhibit A-3).
When Mr. Watt agreed to accept less money for the sale of the bar to his
stepmother, he asked Mr. Williams for a further advance of money. He travelled
to England to obtain money from Mr. Williams and,
on February 24, 2002, he was detained with the £39,000. When this occurred, he told
authorities that £19,000 belonged to him personally and that only £20,000
belonged to Mr. Williams. However, in the pleadings, he admitted that he
was responsible to repay the entire amount of £39,000 to Mr. Williams.
[16] In cross-examination, Mr. Watt confirmed that, in the 2000, 2001 and
2002 taxation years, he reported only rental income and reported no income from
Vialink. After he claimed deductions for rental expenses and support payments,
he reported net income of $6,373.80 in 2000, $1,595.79 in 2001 and $827.09 in
2002. In 2001 and 2002 Vialink reported income of nil. All of these returns
were late-filed. Mr. Watt testified that he filed those returns quickly, without
giving them much thought, subsequent to a request by CRA after the airport
incident. The personal and corporate returns for 2001 and 2002 were filed on
May 12, 2003. After the audit commenced, he filed amended T2 returns for
Vialink showing a loss of $20,291.00 in 2000, a loss of $3,795.00 in 2001 and a
loss of $5,564.00 in 2002. The balance sheets in the amended returns for the
taxation years ended December 31, 2000 and December 31, 2001 list a
liability of over $38,000.00 due to shareholder. The amount due to shareholder
in the amended return for the taxation year ended December 31, 2002 was in
excess of $40,000.00.
[17] In addressing the source of payments made on several credit cards,
Mr. Watt stated that he was able to make those credit card payments
because be either transferred advances from one credit card to another, used funds
he obtained from family or used funds from the repayment of loans he had made
to friends. He acknowledged transferring amounts totalling $44,572.75 in 2001
and $18,059.00 in 2002 to his MBNA card; $11,527.50 in 2000, $7,273.58 in 2001
and $7,000.00 in 2002 to his Canada Trust card; and $9,258.22 in 2000,
$29,735.65 in 2001 and $10,079.19 in 2002 to his Royal Visa card. All
payments substantially exceeded his net reported income in each year.
[18] By consent of both parties, an MBNA application form received by the
Bank in January 2001 was entered as an exhibit, which, although unsigned,
contained Mr. Watt’s name, address and referenced his annual income at
$100,000.00. In addition, two forms completed for the Tim Horton’s franchise
listed his salary as $45,000.00 annually, which he admitted as being
inaccurate.
[19] In correspondence to Theresa Abernathy (Exhibit R-1, Tab 22) dated
March 17, 2004, to clarify matters Mr. Watt supplied information regarding the
funds which were purportedly from investors and loan providers as well as gifts
from his family. Mr. Watt admitted that the content of the letter was, in his
words, “an embellishment” but that the history of his family and the
inheritance in Jamaica were so complicated that it was simply
easier to explain the origin of funds in the manner he did. He also admitted
that the amount of $20,000.00 which he claimed to have received from his mother,
Vera Jones, was another “embellishment” and that the amount of the funds was
$5,000.00 or $10,000.00. The letter (Exhibit A‑1, Tab 15) from Vera
Jones was also an “embellishment” of the stated amount.
[20] In respect to the money which he testified he returned to Mr.
Williams, he stated that he used an exchange agency recommended by Mr. Williams
and that individuals not known to Mr. Watt came to his house and picked those
funds up in cash. He produced handwritten receipts (Exhibit R-6) to support
this claim. All of the receipts were signed by an R. Thompson or an R. Smith
but did not contain an agency name. They were never provided to the auditor or
appeals’ officer and were introduced only at the examination for discovery. In
reviewing the Vialink bank statements, he identified withdrawals for the
amounts returned to Mr. Williams by picking out amounts he thought might relate
to those withdrawals. However, he admitted that there was no apparent
correlation between the receipts and the withdrawals.
Sita Gardner
[21] Sita Gardner, the Appellant’s wife, testified that she was never
involved in Vialink’s business operations but that she did intend to act in a
management position if they were successful in obtaining a restaurant
franchise.
[22] Ms. Gardner testified that because franchises required application
fees to be paid upfront, her husband went to relatives and friends, including
Mr. Williams, to obtain funds. However, she never actually saw money
transferred from Mr. Williams; she never saw bank accounts or statements
connected to her husband’s business; and she was never privy to any information
or documentation concerning his rental property, other than what her husband
told her. She completed franchise applications for Tim Hortons and Licks, based
on financial information supplied by her husband. She testified that she
attended a meeting with Peter LeBel concerning a potential restaurant in the
Town of Whitby.
Sujatha Sivanathan and Sinnathurai Sivanathan
[23] These individuals are co-owners of Sindi Financial, a currency exchange
centre located in Scarborough. Because their records are kept for a
period of five years only, they were unable to provide any documentation
respecting these money transfers from England for the period
under appeal.
[24] Sujatha Sivanathan identified the cheques payable to Telnet Communications,
at Exhibit A-2, as those cheques representing the funds that came from England with instructions from a dealer there to contact
Mr. Watt to obtain identification and to then issue cheques. She stated that the
instructions were to issue the cheques to the company.
[25] Sinnathurai Sivanathan confirmed that it was Mr. Watt who attended at
their office to pick-up the cheques. He confirmed that he recalled receipt of
instructions from his dealer in the United Kingdom
respecting those orders.
Peter LeBel
[26] Mr. LeBel is a senior management employee with the Town of Whitby. He testified that the Town had authorized him to
assist in having a heritage building, known as the Pump House, converted
to a restaurant and that proposals could be entertained from potential
investors. Over the last eight or nine years, there have been about fifteen
inquiries. He had documentation in his possession confirming applications and
other information concerning the Pump House property between 1995 and
2005. He explained that an individual interested in completing such an
application would follow a procedure, beginning with consultations with
Mr. LeBel. He confirmed that the documentation submitted by the Appellant
to the Court, concerning the Pump House application, at Exhibit A‑1,
Tab 10, would be accessible by the general public without beginning the process
of an application. He had no recollection that Mr. Watt or his wife had ever
made an application to locate a restaurant at the Pump House site and he had no
documentation in his records between the years 1995 to 2005 that evidenced any
dealings of any kind with Mr. Watt, including a possible meeting.
Jackie Gilling
[27] Ms. Gilling stated that Mr. Watt had been an acquaintance since 1998
when they both resided in Jamaica. She testified that Mr. Williams and Mr.
Watt were business associates and that Mr. Williams had expressed an interest
in investing in a restaurant in Canada. She testified
that he told her that he sent funds to Mr. Watt in Canada. She had no knowledge of the amounts. She also stated that Mr. Watt had
visited them in England on a couple of occasions. She had no
knowledge of whether Mr. Watt had returned any of those funds to Mr. Williams
but stated that Mr. Williams had requested that they be returned.
[28] On cross-examination, Respondent counsel referred Ms. Gilling to an
affidavit (Exhibit R-5) that she had signed and sworn on July 21, 2006. In that
affidavit she stated that when Mr. Watt visited England, Mr. Williams would
give him cash to carry back to Canada. Contrary to
her oral testimony, Ms. Gilling in the affidavit stated that she had no
specific knowledge of the type of business venture for which Mr. Williams was
advancing funds to Mr. Watt. The affidavit also contradicted her oral evidence
respecting the return of the funds to Mr. Williams. At paragraph 10 of that
affidavit, she stated that some of the money had been returned.
Theresa Abernathy
[29] Ms. Abernathy, an auditor during this period with the special
investigation department of CRA, received the file in 2002 to complete a
jeopardy assessment after Mr. Watt had been detained at the Toronto airport. Upon completion of the jeopardy assessment,
the £39,000 was returned to Mr. Watt through the RCMP. She then commenced an
audit, in March 2003, using a net worth analysis with 1999 as the base
year. She used a net worth approach because insufficient information was
supplied to enable her to correctly determine what amounts should have been
reported on the returns.
[30] Ms. Abernathy completed her analysis of the family unit using year-end
bank statements, tax returns, a review of properties owned and property tax
statements. As she was unsuccessful in getting responses for information from
Mr. Watt or his then solicitor, Bruce Olmsted, a “requirement for information”
was issued to his bank. The information, obtained from this, was used to
complete the net worth analysis. Statistics Canada data was used throughout the analysis with the auditor making any
adjustments based on the tax returns because Mr. Watt did not respond to
correspondence concerning adjustments to these proposed figures. The result was
that substantial discrepancies existed between the reported income ($10,273.00
in 2000, $5,495.00 in 2001 and $4,729.00 in 2002) and the additional amounts to
be included in his income $56,040.27 in 2000, $82,373.56 in 2001 and $239,309.97
in 2002). Vialink’s bank account was reviewed to ascertain if some of these
discrepancies could be accounted for. She was able to readily identify the Bell
Canada revenue. The unidentified deposits were attributed to income of
Vialink. In 2001, she allowed $33,309.00, the value of the shareholder loan, as
a deduction for business expenses, although there was actually no documentation
to support this amount. She stated that she simply used the expenses from the
prior year to offset the shareholder loan. No deductions were permitted for
business expenses in 2002 as she had no information respecting these.
[31] The auditor also completed an analysis of the credit card statements
and reviewed the information and documentation that was submitted concerning
the investments and franchises during the last meeting with Mr. Watt. She
concluded that the documentation, respecting Tim Hortons, Licks and Pump House
property in Whitby, simply consisted of general information
available to the public and were not the actual applications. Therefore, she
rejected Mr. Watt’s explanation that the unidentified amounts, flowing through
the Vialink account, related to the franchise fees. She could not verify the
loans from family/friends nor could she verify amounts. Mr. Watt claimed some
funds came from gambling because he had gambled in Europe and the Caribbean but this could not be substantiated either. She did
not reassess Vialink using the amended T2 returns of Vialink because “Mr. Watt
had actually filed T2 returns that were signed by Mr. Watt showing zero income
in all years” (April 22, 2008 Transcript, pages 86-87) and Vialink was not under
audit. The withdrawals from the Vialink account could not be supported by
documentation.
[32] The auditor also completed an analysis of reported income and expenses
from Mr. Watt’s T1 returns beginning in 1992 when he came to Canada to see whether some of the unreported amounts could
have accrued from prior years as investments. Although this analysis (Exhibit R-1,
Tab 25) assisted in providing an overall financial picture, it did not provide
any additional information respecting the origin of the amounts. She also
completed an analysis (Exhibit R‑1, Tab 26) of Mr. Watt’s expenditures
and income, summarized and itemized monthly, between 1999 and 2002.
Discrepancies in each year were not supported by any reported income.
[33] Her conclusion in respect to the volume of withdrawals in each of the
taxation years 2000, 2001 and 2002 was that they were for personal use and that
they were actually appropriations because Mr. Watt was using the corporate bank
account for his personal use.
[34] On cross-examination, the auditor stated that Vialink’s books were
reviewed to determine the amounts Mr. Watt should have reported. Where there
were supporting documents, amounts were identified as Bell Canada amounts in
her report, otherwise amounts were identified as “other” and included in income
for Vialink. She confirmed that since the audit was being completed for
Mr. Watt, the figures for Vialink were prepared subsequent to the audit in
conjunction with the determination of unreported income by Mr. Watt.
[35] The auditor confirmed that she did not use Vialink’s amended T2
returns because she considered Vialink’s reassessment to be secondary to Mr.
Watt’s audit. She testified that she did not pursue a detailed investigation
into the origin of Vialink’s income because Vialink was only reassessed and
that the net worth analysis was in respect to Mr. Watt.
[36] The auditor confirmed that in her analysis of the personal credit
cards, she recognized that Mr. Watt personally paid some of the expenses
belonging to Vialink. Since Mr. Watt did not provide sufficient documentation,
she allowed expenses for Vialink in 2001 up to the amount of the shareholder
advance of $33,309.00 or up to the extent of the benefit conferred on Mr. Watt.
She did not know why she used subsection 15(1) instead of subsection 15(2) in
categorizing the unknown amounts in Vialink’s account nor did she recall why in
2002 she attributed $7,768.00 as an appropriation from Vialink to Mr. Watt.
[37] On redirect, she clarified that the amount of $7,768.00 consisted of
the deposits to the Vialink account that could not be identified and that were therefore
attributed as income to Mr. Watt.
Collette Ouimet
[38] Ms. Ouimet, the appeals officer, reviewed the objections filed by both
Appellants. All of the numbers, with the exception of the appropriation figures
for Vialink, came from the auditor’s working papers. She revised those
appropriation figures for the 2001 and 2002 amounts because the auditor had
used the deposit amounts to the Vialink account rather than the withdrawal
amounts in determining the appropriations. However, she conceded that she had
omitted to adjust the penalties on the adjusted appropriation figures, and that
the penalties should be adjusted to reflect the proper revised amounts in 2001.
[39] Ms. Ouimet stated that the basis for assessing unreported income in
respect to Vialink was that there was no actual supporting documentation to
verify the flow of funds in and out of the Vialink account. Although
explanations were provided, there was no evidence to substantiate the
explanations respecting the origin of the funds. On cross-examination, she
testified that not all of the documentation respecting the Licks, Tim Hortons
and the Pump House pre-dated the Vialink deposits, during the period of October
to December 2001. She also stated that the documentation she received from Mr.
Watt was not sufficient to verify the amounts and the explanations he was
providing. For example, she rejected a letter from Jacqueline Gilling,
respecting dealings between Mr. Watt and the deceased Mr. Williams, as being
too vague and general in regard to specific dates and amounts. As she received
no verification of expenses, she determined that the unidentified withdrawals
from the Vialink account were not in respect to the business operations and
therefore were appropriately identified as shareholder appropriations pursuant
to subsection 15(1).
Analysis
[40] The net worth method was described in Ramey v. The Queen, 93
DTC 791 (T.C.C.), at page 793, as follows:
…A net worth assessment involves a
comparison of a taxpayer's net worth, i.e. the cost of his assets less his
liabilities, at the beginning of a year, with his net worth at the end of the
year. To the difference so determined there are added his expenditures in the
year. The resulting figure is assumed to be his income unless the taxpayer
establishes the contrary.
The Ramey decision identified this method as a last resort to be used when
all else fails. The Minister must show only that the taxpayer’s net worth has
increased between two points in time. In Bigayan v. Canada, [1999] T.C.J. No. 778,
Justice Bowman, as he then was, at paragraph 2 stated:
…Frequently it is used when a taxpayer has
failed to file income tax returns or has kept no records. It is a blunt
instrument, accurate within a range of indeterminate magnitude. It is based on
an assumption that if one subtracts a taxpayer's net worth at the beginning of
a year from that at the end, adds the taxpayer's expenditures in the year,
deletes non-taxable receipts and accretions to value of existing assets, the
net result, less any amount declared by the taxpayer, must be attributable to
unreported income earned in the year, unless the taxpayer can demonstrate
otherwise. It is at best an unsatisfactory method, arbitrary and inaccurate but
sometimes it is the only means of approximating the income of a taxpayer.
[41] In Hsu v. Canada, [2001]
F.C.J. No. 1174, Justice Desjardins at paragraphs 29 and 30 described net worth
assessments as follows:
29 …
Its purpose is to relieve the Minister of his
ordinary burden of proving a taxable source of income. The Minister is only
required to show that the taxpayer's net worth has increased between two points
in time. In other words, a net worth assessment is not concerned with
identifying the source or nature of the taxpayer's appreciation in wealth. Once
an increase is demonstrated, the onus lay entirely with the taxpayer to
separate his or her taxable income from gains resulting from non-taxable
sources (Gentile v. The Queen, [1988] 1 C.T.C. 253 at 256 (F.C.T.D.)).
30 By its very nature, a net worth
assessment is an arbitrary and imprecise approximation of a taxpayer's income.
Any perceived unfairness relating to this type of assessment is resolved by
recognizing that the taxpayer is in the best position to know his or her own
taxable income. Where the factual basis of the Minister's estimation is
inaccurate, it should be a simple matter for the taxpayer to correct the
Minister's error to the satisfaction of the Court.
[42] The burden is on the taxpayer to show, to
the satisfaction of the Court, that the net worth assessment is wrong, provided
the Minister has properly conducted the audit work. Justice Hamlyn in Saikely
v. M.N.R., 93 DTC 397, stated the following, at page 401, as to how a
taxpayer may attack such an assessment:
A taxpayer may prove that some of his
increase arose from non-taxable receipts, such as inheritances or gambling;
that his net worth at the beginning of the period was undervalued or that his
assets at the end were overvalued; that liabilities existing at the end were
omitted or undervalued; that the money had been borrowed or that income losses
were greater than assessed. Whatever is alleged by the taxpayer must be proved
by him; a mere statement is not enough. Moreover, cogent evidence is required
to disprove a net worth assessment.
[43] Almost all of the evidence focused on the alleged advances totalling
$160,000.00 from Gary Williams. In fact it was the incident at the airport in Toronto, in February 2002, that led to the examination of
Mr. Watt’s affairs. The Appellant argued that these monies were forwarded to
him personally to pursue franchise investments and that the funds simply flowed
through the Vialink account for convenience until he was able to incorporate
another company with a separate account. As such, these monies would generally
not be taxable. However, the problem is that there was little, if any, direct
documentation to support the flow of funds from Mr. Williams. I must be
satisfied that the Appellant has produced enough evidence to substantiate the
source of these funds.
[44] In respect to the documentary and oral evidence produced, I have
cheques totalling $143,109.00 (Exhibit A‑2) issued to the
corporation by Sindi Financial between October and December 2001. These funds
originated in England and were forwarded to Sindi Financial by their
dealer in the United Kingdom. On the flip side, I was provided with copies
of the receipts (Exhibit R‑6) which, according to the Appellant, support
his position that he returned these monies to Mr. Williams. These receipts
total $143,080.00, a slight discrepancy from the documents at Exhibit A-2. The
owners of Sindi Financial did not retain the records and with the passage of
time could provide little evidence except that they recalled that the money
came from their currency dealer in the United Kingdom. They were uninterested third parties but they
could do little else except confirm the origin of these cheques at Exhibit A-2
as coming from England. Their agency was not involved with the
alleged return of the funds to Mr. Williams.
[45] The evidence of Sita Gardner in respect to the transfer of these funds
added very little because she never saw money going from Gary Williams to
Mr. Watt and never saw Vialink’s bank statements or accounts.
[46] Ms. Gilling had no first-hand knowledge as to whether Mr. Williams
actually wired money to Mr. Watt. She stated that money had been given to Mr. Watt
when he was in England but she had no knowledge of the amount.
She stated that Mr. Williams told her that some of the money had been returned
but she did not know the amount. The problem with much of the evidence is that
it was hearsay and based on information that Mr. Williams supposedly told her.
In addition, there were discrepancies between her oral testimony and her
affidavit.
[47] The receipts dated between March and June 2002, Exhibit R-6, were
handwritten and of a generic type, with no identifying earmarks, as to the name
of the financial institution that wired the funds or the address. They were
signed by an R. Williams and R. Smith, who picked up the cash from Mr.
Watt, according to his evidence. These individuals were not called as witnesses
and because of the Appellant’s admissions, that he had falsified other
documentation, I can give no weight to these receipts. In addition, I am unable
to locate or to match up Vialink withdrawals or other documentation to the
amounts indicated in these receipts. Mr. Watt in reviewing the bank statements
did pick out amounts that he thought would be related to the amounts in the
receipts. However, there was never one amount that specifically corresponded to
the amount in a receipt because it was his evidence that he would keep
withdrawing smaller amounts at various times until he had a larger amount to
return to Mr. Williams. Another problem, which I have with these receipts, is
that they were never provided to the appeals officer or the auditor either
voluntarily or in response to numerous requests to provide supporting
documentation. They were finally submitted during the examination for
discovery.
[48] However, the main problem with respect to these wire transfers is the lack
of existence of a link or connection between the transfers through Sindi
Financial or family/friends and the Vialink bank deposits. The precise
correlation is missing and because of the credibility issues, that are
problematic in these appeals, I consider it essential that such a satisfactory
correlation exist or be provided. After all, the onus is upon the Appellant to
rebut the assumptions contained in the Reply to the Notice of Appeal and I do
not believe it is unreasonable in these circumstances to expect that the
Appellant could provide sufficient evidence linking the deposit to the source.
[49] With respect to the franchise documentation, all of the exhibits
relating to the Pump House investment were clearly documents that were
available to the general public. In addition, Peter LeBel had no record of any
meeting with Mr. Watt and no record of any application by Mr. Watt
concerning this property. There was one exhibit concerning Licks restaurant and
it confirmed only that information on a Licks franchise had been forwarded to
Mr. Watt. There was no evidence of further follow-up. There was more
information submitted respecting the Tim Hortons’ franchise, with the most
important document being the license application dated November 19, 2001.
Although it supports the Appellant’s contention that he was actively pursuing
franchise investments in late 2001, it listed a salary of $45,000.00 which was
shown to be inaccurate when the figure was compared to income stated in his
returns. I am left with a great deal of doubt in terms of giving too much
weight to such documents. I do not believe the salary information was mere
inadvertence on the part of Mr. Watt because he also completed MBNA application
forms which inaccurately listed his yearly salary as $100,000.00. Yet none of
his returns reflected these figures. When asked about this information he
advised CRA officials that it was none of their business to make such an
inquiry. It seems that Mr. Watt is engaged in a pattern of supplying false
information to achieve his own ends and in a larger context this casts a shadow
not only on his documentary evidence but on his oral evidence as well.
[50] Some of Mr. Watt’s evidence related to gifts and loans received from
family and friends, including money received from his stepmother in respect to
a bar in Jamaica that had been gifted to him by his father.
However, Mr. Watt admitted that the correspondence (Exhibit R-1, Tab 22) in
which Mr. Watt provided names of franchise investors and the amounts loaned to
him, together with the amounts of gifts he had received from family, was
falsified in its entirety.
[51] The bar in Jamaica was to be used as one of the assets to
show that he had the ability to finance his share of the potential franchise
investments. However, he listed the value of the bar at $90,000.00, although he
actually received only $75,000.00. He admitted that he previously submitted
false information on this. In addition he admitted in the following exchange,
during cross-examination, that the letter, at Exhibit A-1, Tab 15, from his
stepmother, verifying the sale of the bar and some of the payments she
forwarded to him, had been falsified:
Respondent counsel: …
Are you saying that she was
not being completely truthful in writing this letter, as well?
Mr. Watt: As I said, it was an
embellishment on the amount.
(Transcript November 26, 2007, page 149)
He admitted that none of these amounts in this exhibit were correct and
that they were “embellishments”, to use his terminology, but that his
stepmother did give him some money and “It could be $5,000, or $7,000, or it
could be $10,000” (Transcript November 26, 2007, page 147). It is not clear
from the evidence whether Vera Jones, the stepmother, drafted this document and
signed it at the request of Mr. Watt or whether Mr. Watt drafted it and signed
her name to it.
[52] Whichever scenario applies, it creates another problem in my
acceptance of another piece of correspondence (Exhibit A-3) from a lawyer in Jamaica which supposedly confirmed payments to Mr. Watt
between 2000 and 2002 respecting this bar. There were no particulars supplied
in respect to amounts paid or dates of payment in that correspondence but, more
importantly, there was no independent evidence produced to authenticate this
document nor was Respondent counsel able to cross-examine on its authenticity.
In different circumstances where I had no evidence before me of falsification
of other documentation, I would be inclined to give it some weight but the
problems associated with some of the related documentation casts a pall of
suspicion on all of it.
[53] During the hearing, Mr. Watt produced a summary schedule (Exhibit A-5)
of the expenses in 2000, 2001 and 2002 that he was able to locate for Vialink.
Bell Canada receipts were produced, as well as those
respecting advertising, but there was no documentation respecting other expense
categories such as salaries or rental payments. Beyond the sufficiency of
supporting documentation, there appear to be errors in the numbers that were
provided. For example, Mr. Watt claimed that the advertising expenses, as per
the actual receipts, totalled $24,667.15 when in fact the total should have
been $21,013.00. In addition, it appears that this figure relates to Bell Canada expenses and not the advertising
expenses.
[54] In another set of facts, I might have overlooked such a variance but taken
in conjunction with the other problematic documentation, it is at best yet
another example of careless record keeping. It supports my lack of confidence
in any of the documents produced by the Appellant. Net worth assessments turn
largely on their facts and credibility issues. The Appellant has admitted to
submitting inaccurate, false and misleading information not only to CRA
officials but on other documentation, including MBNA credit card application
forms and on Tim Hortons’ franchise applications. Mr. Watt’s willingness
to misinform and, as he put it, “embellish”, taints the entirety of his
evidence. Whatever language one wishes to use, it boils down to multiple
fabrications, pure and simple.
[55] Mr. Watt’s educational background includes degrees in marketing and
hospitality management from several colleges. He is an experienced businessman
who has held management level positions in various businesses. This is unlike
the case of an inexperienced and uneducated taxpayer. Based on Mr. Watt’s
background, it is not unreasonable to expect that at minimum a general ledger
would be kept tracking revenues and expenses. The closest thing to a ledger
produced at the hearing was the summary schedule of expenses (Exhibit A-5) and
the uncorroborated financial statements appended to the amended T2 returns. It
is clear from the evidence that CRA officials made numerous requests to Mr.
Watt to supply supporting documentation. Although some documentation was
provided, it was inadequate and as discovered, after the documents were
submitted, some of them had been falsified. In completing the net worth, the
entire family unit was considered. Although Sita Gardner gave evidence,
she was not questioned in direct examination in respect to her assets and
liabilities and how those figures might materially impact upon the net worth.
The Statistics Canada figures used in the assessment were not questioned
either. I believe the reasonable conclusion to draw from this is that the net
worth analysis was correct in this respect because a further review in either
of these areas would either have adversely affected the Appellant by raising
the net worth assessment or simply may not have altered it at all.
[56] In conducting a net worth assessment, the Minister is relieved of the
usual obligation of identifying a source of income (Hsu v. Canada,
previously quoted). The Minister is responsible to demonstrate only that an
increase in the taxpayer’s net worth has increased between two points in time
and this is premised on the fact that the taxpayer has provided insufficient or
inaccurate information or no information at all. Taxpayers are always in the
best position to know their own affairs. It is logical that they should be able
to furnish adequate information to counter a net worth assessment and to
satisfy a Court, on a balance of probabilities, as to the source of unreported
income.
[57] The Minister relied on subsection 15(1) to identify some of the larger
amounts coming out of the Vialink account as shareholder appropriations. Mr. Watt
is the sole shareholder and director of Vialink so the control resides with
him. He admitted to co-mingling the personal and business accounts. The appeals
officer altered the net worth assessment to focus solely on the withdrawals
from Vialink, as opposed to the deposits as the auditor had done. Due to a lack
of documentation suggesting anything to the contrary, the Minister assumed that
these amounts were appropriated from Vialink for Mr. Watt’s personal use.
I believe the wording in subsection 15(1) is broad enough in its scope to
encompass withdrawals such as these and that, if the evidence suggests that a
shareholder has appropriated “in any manner”, then, it is reasonable that the
Minister in a net worth assessment should make such an assumption, particularly
where the taxpayer supplies no evidence to the contrary. In the case of Penny
v. Canada, [1994] F.C.J. No. 1847, Justice Simpson made the following
comment concerning subsection 15(1) at paragraphs 18 and 19:
18 …However, it seems to me that, in
the case of an appropriation of corporate property by a shareholder, the tax
consequences to the shareholder are unambiguous. They are clearly set forth in
section 15 of the Act. In these circumstances, I am satisfied that Parliament
must have intended the tax consequences which flow from the operation of the
section.
19 …The section applies if the shareholder appropriates "in any
manner". To me, this language encompasses a de facto taking. As long as
the shareholder derives a benefit, the legality of the appropriation matters
not.
If such an assumption is made, it seems to me that it should be a simple
matter for a taxpayer to produce documentation, such as a general ledger or
actual receipts, that could easily refute the Minister’s assumptions.
[58] I have been given a lot of documentation, some of which has been
falsified and contains incorrect or inaccurate information. Where an Appellant
demonstrates a history of misrepresenting information, it is only clear,
concise, specific and uncontroverted evidence that will demolish the Minister’s
assumptions. Despite the otherwise misleading information, I have been given no
such evidence here. I have evidence of wire transfers but only conjecture
respecting their link to the Vialink withdrawals; handwritten generic receipts;
documents purporting to relate to Licks and Pump House applications which were
simply requests to obtain information or information available to the general
public; allegations of a meeting with Mr. LeBel in support of the Pump House application,
which Mr. LeBel cannot recall and had no supporting records to
substantiate either the meeting or the application; credit card and Tim
Horton’s franchise applications where Mr. Watt supplied incorrect information; and
letters written by Mr. Watt and/or his stepmother, respecting investors and
monies loaned or gifted, that Mr. Watt admits contained false and
misleading information. All of this was general and vague and nowhere nearly
sufficient in satisfying the onus which is upon the Appellant.
[59] Mr. Watt’s explanation for filing late returns with zero income for
Vialink was that since he had been caught with £39,000 at the airport he quickly
completed the returns and filed them. However, this is yet another
inconsistency in his evidence because the Vialink returns were filed more than
one year after the airport incident. The fact that the Appellant subsequently
filed amended T2 returns has no direct bearing other than as an attempt to
rectify the situation he found himself in. It appears from the evidence that
the auditor ignored these amended T2 returns but I do not think that this had
much bearing because the audit was underway. In relying on the initial returns
as filed, the requests for adequate documentation, if complied with, might have
otherwise settled the net worth analysis that was being conducted. Instead, he
submitted false documents and incorrect information. As a result, the method of
last resort employed by the Minister was the net worth assessment, with a bank
deposit analysis used in respect to Vialink to determine its revenue. In giving
her evidence, the auditor stated that she did not perform an audit of Vialink.
On re‑direct, she clarified that her evidence meant that she had not done
an extensive review of all of the documentation of Vialink. Although a bank
deposit analysis may not have been as thorough a vehicle to determine Vialink’s
unreported income as that of an audit, a reassessment was completed with
assumptions pled in support of that reassessment. That does not change the
rules that follow concerning burden of proof.
[60] In respect to 2001, the auditor allowed the amount of $33,309.00 as
business expenses because she discovered a shareholder loan account in the same
amount in the year 2000. She allowed this amount because there was no question
that Vialink was conducting a business that would incur some expenses, even
though no documentation had been provided. Her explanation was that the 2000
shareholder loan advance was not there in 2001 so she assumed that it was
expenses and “docked it out”. This was an arbitrary figure that she chose, although
I am not convinced of its accounting efficacy. In addition, to this amount, a
further sum of $25,302.17, based on limited documents produced during the
hearing in respect to expenses in 2001, was conceded for total allowable
expenses in 2001 of $58,611.17. No amount was allowed for expenses in 2002
because Vialink ceased operating early in the year; it had minimal revenues
compared to prior years; and, unlike 2001 there was no shareholder loan account
and no receipts. I do not believe any additional amounts should be allowed in
respect to business expenses. The $33,309.00 was permitted as an expense
deduction without supporting documentation. The documentation supporting the
second amount of $25,302.17 was limited and there were legitimate concerns
raised that there could be some duplication in these amounts. The Appellant’s
contention that the auditor had not done enough to ascertain the expenses, when
it is his responsibility to provide properly itemized documents and he fact
that he initially filed returns showing zero income for Vialink and personal returns
showing insignificant amounts of revenue in comparison to his lifestyle, must
also be factored in.
[61] Finally there is the matter of penalties imposed by the Minister
pursuant to subsection 163(2) of the Act. The Minister bears the onus
with respect to penalties and must show on a balance of probabilities that
there is gross negligence. It is necessary under this provision that the
taxpayer has “knowingly, or under circumstances amounting to gross negligence …
participated in assented to or acquiesced in the making of” a false statement
or omission in a return. This wording also implies knowledge or the requisite
mental state on the part of the taxpayer of such mis-statements in those
returns.
[62] Based on all of the facts before me, I conclude that the Respondent
has met the onus and has sufficiently proved that the Appellant knowingly made misleading
and false statements that justify the imposition of gross negligence penalties.
There were both intentional and indifferent actions taken by the Appellant
which involve a greater neglect than simply a failure to use reasonable care.
[63] Mr. Watt is an educated individual with several college degrees and
work experience with a number of different companies. He came across as a
bright and competent individual. He was the sole shareholder and director of
Vialink and had total control of the corporate activities. He co-mingled his
corporate account with his personal business. He stated that he made deposits
to the Vialink account, which were from family and friends, that had nothing to
do with Vialink’s business. However, some of his supporting documentation for
this included, by his own admission, falsified, inaccurate and incorrect
information. I am asked to overlook these documents and accept the Appellant’s
explanations which are supported only by general, vague and non-specific
documents and information. These deposits are significant and remain largely
unsubstantiated by the evidence. Although he had a tax preparer complete his
returns, he was responsible for supplying the figures and he signed the
returns. Other than receipts contained in a box supplied to the auditor, he
maintained no records, including ledgers or payroll accounts.
[64] As the sole individual in charge of the corporate activities, I
believe Mr. Watt should have known that the withdrawals, in excess of his
outstanding shareholder loan, could become part of his corporate income, and
that if it originated otherwise from a non-taxable source, that proper records
should be kept to support this claim. In addition, any information that has
been supplied appears to have been provided sporadically, in dribs and drabs,
and haphazardly in respect to sequence and order. The evidence also suggests
that he was uncooperative in supplying information during the audit. Initially
he refused to supply the requested information concerning these alleged loans.
When he finally did provide the names of those individuals, with their
telephone numbers, that had gifted/loaned him money, he did not go the step
further and supply exact dates of receipts of these funds or the connection to
the deposits to the Vialink account. This had the potential of supporting some
of his contentions concerning the Vialink account and how he maintained his
lifestyle based on the insignificant amounts of reported income. CRA officials
were unable to substantiate the telephone numbers of the individuals that
loaned him money or other information he provided. Eventually Mr. Watt admitted
to having falsified this document in its entirety.
[65] In respect to Mr. Watt’s personal reported income and lifestyle, he
reported total income of $10,273.00, $5,495.00 and $4,729.00 from rental income
in 2000, 2001 and 2002 respectively. During this period and based on reported
rental income, he incorporated Vialink, loaned it $33,309.00 in 2000 and paid
significant amounts against the mortgage on the rental property in each year.
According to his evidence, he made numerous trips to England and Jamaica. Even if one considered his spouse’s income, the
lifestyle is not supported by the figures provided. The amount of the
shareholder benefit, being in excess of $377,000.00, is significant over the
three year period. The auditor’s reasons for imposing penalties in respect to
both Appellants are clearly supported by the evidence.
[66] On a final note, I want to commend Appellant counsel who did a superb
job of cross-examination of the auditor and the appeals officer. While I
believe there were some problematic areas in their approach, overall, on a
balance of probabilities, given the facts before me, it was not sufficient, in
the end, to discredit the audit procedure employed or the net worth assessment as
being straightforward and credible. After all, by its very nature, a net worth
analysis is an inherently unreliable attempt at reconstructing a taxpayer’s
business and personal activities but sometimes, as in these appeals, it remains
the only means of approximating a taxpayer’s income. The auditor acted on the
best evidence she could find.
[67] In summary, it is my conclusion that the documentation and
explanations submitted are insufficient to meet the onus which is upon a
taxpayer in a net worth assessment. In addition to the problem of verifying the
accuracy of these, the Appellant’s credibility issues cast a long dark shadow
over much of the evidence.
[68] Since the additional amount of $25,302.17 for expenses was allowed
during the hearing and because adjustments respecting penalties were also
conceded, I am allowing the appeals to permit the additional amount of $25,302.17
for total deductible business expenses of $58,611.17 in 2001. Ms. Ouimet
admitted that when she adjusted the figures for the shareholder appropriations
under subsection 15(1) and reassessed the total tax payable in 2001, she
omitted to readjust penalties. Therefore the penalties in 2001 should be
adjusted to reflect the proper amount of tax payable. The penalty amount for
2002 shall remain unchanged because if an adjustment were to be made to this
amount it would increase the assessment for that year. In addition, there will
be an interest adjustment for the period of time in which the processing of
these matters was delayed by the CRA (April 23, 2008 Transcript, page 87).
[69] The appeals are allowed and the assessment is referred
back to the Minister of National Revenue for reconsideration and reassessment
to incorporate the preceding concessions and adjustments.
[70] If the parties are unable to agree as to the issue of costs, they may
provide written submissions within 60 days from the date of the within Reasons.
Signed at Ottawa, Canada, this 20th
day of February 2009.
Campbell J.
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