Citation: 2007TCC680
Date: 200711
Docket: 2006-3099(GST)I
2006-3100(IT)I
BETWEEN:
JACEK MILKOWSKI,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
REASONS FOR JUDGMENT
Miller J.
[1] This is a net worth
assessment case. The use of the net worth assessment has been described as the
use of a blunt instrument, yet that bluntness can be sharpened by reasonable,
respectful dialogue between the parties outside the trial setting. That did not
happen in this case. That is regrettable.
[2] Mr. Milkowski
appeals by way of the informal procedure assessments under both the Income
Tax Act and the Excise Tax Act for the three-year period of 2001, 2002 and
2003. The Minister of National Revenue has also assessed penalties and
interest.
[3] Mr. Milkowski is a
painter by trade. During the relevant period, he carried on his painting business
in partnership with his wife on a 75-25% split. Most of Mr. Milkowski’s
work was in commercial premises (about 90%) with the balance on residential. He
testified that he always received payment by cheque from the general
contractors for whom he worked. Seventy to 80% of his work was for one general
contractor: the balance of his work came from two or three other general
contractors. Occasionally, Mr. Milkowski had to hire subcontractors to get a
job finished. Most jobs were remunerated on the basis of so much per square
foot: 22¢ was an amount Mr. Milkowski suggested was common.
[4] Mr. Milkowski filed
his income tax returns for the 2001, 2002 and 2003 taxation years, reporting
gross income from the business of $59,260, $45,930 and $48,735, respectively,
and net income of $18,871, $10,754 and $7,781, respectively. He reported his
personal total income as $10,626, $6,278 and a loss of ($3,175) in 2001, 2002
and 2003, respectively.
[5] In 2005, Canada
Revenue Agency (“CRA”) conducted an audit. They received from Mr. Milkowski
business bank statements, invoices and certain other records. Due to a belief
that the income reported could not support the lifestyle of a family of five,
CRA proceeded to conduct a net worth assessment. When the Appellant, and more
particularly his accountant, were made aware of the net worth approach, they
provided no further information to CRA. The auditor suggested there were two
financial tests that supported the notion of underreported income: the bank
deposit analysis and the source and application of funds analysis. The bank
deposit analysis consisted of totalling all the bank deposits for 2001 and
noting that the total of $64,470 was $7,280 greater than Mr. Milkowski’s gross
income reported. The source and application of funds analysis for 2003 noted
that there were funds applied of $346,302 with a source of only $294,861. This
was in large measure due to purchasing a home, for which Mr. Milkowski relied
on savings, a line of credit and a mortgage. He was first refused a mortgage by
TD Canada Trust, as his down payment was too small, so he had to go through a
broker to get a mortgage.
[6] The auditor proceeded
to conduct the net worth assessment based on information already provided by
the Appellant including income tax returns filed, and also based on Statscan’s statistics.
CRA concluded that the Appellant had underreported income by $14,205, $18,298
and $35,337 in 2001, 2002 and 2003, respectively, and assessed accordingly
under both the Income Tax Act and the Excise Tax Act. In a
proposal letter dated April 25, 2005, CRA stated:
After conducting a factual audit of your
business, we have determined that your revenues and expenses matched the
documentation provided. However, we believe that your net income is too low to
support your lifestyle. In order to determine your correct income we have
employed an indirect audit technique for the three-year period. The additional
income was calculated using the net worth method of assessment. Calculating the
change in net worth from year to year and then making adjustments for personal
expenditures and non-taxable income sources, have determined your minimum
income requirements.
So, following that approach, the
auditor calculated assets and liabilities, both personal and business,
acknowledging that he only had personal banking information for one year and no
information with respect to mortgage principal reduction, which he assumed was
$6,300 in 2001, $4,200 in 2002 and $4,200 in 2003. He also calculated a summary
of personal expenditures under the following 14 headings:
1)
Food
2)
Shelter
3)
Household
operations
4)
Clothing
5)
Transportation
6)
Health
care
7)
Personal
care
8)
Recreation
9)
Reading
material and other printed matter
10)
Education
11)
Tobacco
and alcohol
12)
Security
13)
Gifts
and contributions
14)
Miscellaneous
For the purposes of determining the
shelter, transportation and health care expenses, the auditor relied on
information received from the Appellant. For everything else he relied on
Statscan’s statistics. Notices of Reassessment for the 2001, 2002 and 2003
taxation years were received on July 21, 2005 and confirmed on July 25, 2006.
[7] Mrs. Milkowski
testified as to the household expenditures. Her evidence was that the family
lived at a very low standard as they had little money. She discussed their food
requirements and needs including household maintenance needs, and estimated
about $150 a week in 2003. She outlined the clothing requirements and suggested
approximately $2,400 a year was accurate. She similarly went through their social,
recreational and educational needs setting costs significantly less than CRA’s
estimates based on Statscan. It also came to light that one of the Milkowski’s
children had income of $4,800 in 2003.
[8] Issues
(i) Is
CRA statute-barred from reassessing 2001 under the Income Tax Act?
(ii) If
not, are the net worth assessments correct for purposes of both the Income
Tax Act and GST liability for 2001, and also for 2002 and 2003?
Analysis
[9] Mr. Abinajem, the
Appellant’s agent, made two major submissions regarding the net worth
assessment:
1. First, it is
unwarranted;
2. Second, it is
incorrect.
[10] With respect to his
position that it is unwarranted, Mr. Abinajem argued that as a method of last
resort, an arbitrary net worth assessment should not be relied upon when there
are books and records in place. In this case he maintained the Appellant had
proper accounts and records and that the auditor even acknowledged by letter
that “after conducting a factual audit of your business, we have determined that
your revenue and expenses match the documentation provided”. CRA’s letter
identifies the reason for the audit was a belief that income was too low to
support the Milkowski’s lifestyle. Mr. Abinajem argues this approach would open
the floodgate to abusive and unnecessary audits.
[11] The authority for
the net worth assessment is found in subsection 152(7) which reads:
The Minister
is not bound by a return or information supplied by or on behalf of a taxpayer
and, in making an assessment, may, notwithstanding a return or information so
supplied or if no return has been filed, assess the tax payable under this
Part.
[12] This section has
been relied upon by CRA to assess on whatever basis it determines is
appropriate, including an arbitrary or net worth assessment. These assessments
are used in many cases where the taxpayer refuses to file a return, files a
return that is grossly inaccurate or does not furnish any evidentiary support
or documentation to allow CRA to verify the return. Mr. Abinajem maintains none
of these circumstances exist in this case. Mr. Siegal, for the Respondent,
argues that Mr. Milkowski’s declared net income was grossly inaccurate
justifying the net worth assessment.
[13] Can the Court find the
subsection 152(7) assessment is invalid due to the circumstances surrounding
its instigation, and proceed to vacate the assessment on that basis? No.
[14] There are no
limitations written into subsection 152(7) that serve as preconditions subject
to review by this Court. This is not a two step process of first determining
whether CRA can make an assessment, and only then determining the correctness
of that assessment. If a taxpayer believes CRA is acting abusively in invoking subsection
152(7), then the remedy may be found in an action for abuse of process. But
once the assessment is issued, subsection 152(8) deems that assessment to be
correct and it is the correctness of the assessment at issue before this Court.
[15] I will turn
therefore to the assessment itself. The parties spent all day on the evidence
of the Milkowskis and the CRA auditor, to the point that there was no time at
the end of the day for oral argument. The parties provided me with over 60
pages of written argument. The Respondent conceded certain points in the net
worth assessment. The Appellant emphasized the auditor’s errors and
inappropriate motivation for conducting a net worth in the first place, which I
have addressed. I have seen no better example than this case for insisting that
parties involved in a net worth assessment meet long before trial with each
other and their respective financial advisors to work through the numbers. They
have not done so.
[16] I find that parts of
the net worth assessment are inaccurate. The following is my summary of the
adjustments to be made to the net worth assessment, based on the testimony I
have heard from the Milkowskis and a review of the Government’s Statscan’s
statistics. I have related my adjustments to the CRA’s audit schedules:
Schedule I – Assets
Schedule II – Liabilities
Schedule III –
Adjustments
Schedule IV – Personal
Expenditures
Deductions from Underreported
Income
|
|
2001
|
2002
|
2003
|
|
From Schedule I
|
|
|
|
|
Value of vehicle
|
-$1,200
|
-$900
|
-$8,459
|
|
From Schedule II
Difference in net worth arising
from accurate mortgage balances
(see Appendix A)
|
-$3,281
|
$308
|
$19
|
|
From Schedule III
|
|
|
|
|
Ontario supplement
|
-$1,100
|
-$1,100
|
-$308
|
|
Additional family income
|
|
|
-$4,800
|
|
From Schedule IV
|
|
|
|
|
Food
|
-$2,000
|
-$2,000
|
-$2,000
|
|
Shelter (agreed)
|
|
-$1,800
|
-$11,544
|
|
Household
|
-$1,000
|
-$1,000
|
-$1,000
|
|
Clothing
|
-$1,250
|
-$1,250
|
-$1,250
|
|
Personal care
|
-$500
|
-$500
|
-$500
|
|
Recreation
|
-$1,500
|
-$1,500
|
-$1,500
|
|
Education
|
-$500
|
-$500
|
-$500
|
|
Tobacco and alcohol
Security (agreed)
|
-$500
-$2,745
|
-$500
-$3,293
|
-$500
-$3,660
|
|
Gifts
Transportation (agreed)
Other (agreed)
|
-$500
-$1,654
-$266
|
-$500
-$167
-$272
|
-$500
$355
-$280
|
|
Total
|
-$17,996
|
-$14,974
|
-36,427
|
|
Government underreported income
|
$18,940
|
$24,398
|
$47,117
|
|
|
|
|
|
|
Actual underreported income
|
$944
|
$9,424
|
$10,690
|
|
|
|
|
|
[17] The Appellant argued
that adjustments should also have been made in the following areas:
1. RRSPs
– I find the auditor correctly listed the contributions to RRSPs as assets, and
not as security, which is where the Appellant showed the contribution. This has
the effect of reducing the security amount in Schedule IV, otherwise there
would be a doubling-up.
2. Credit
card liability – There was insufficient evidence to indicate changes from one
year to the next to make any adjustments in this category.
3. Capital
cost allowance – The Appellant argued that the non-cash CCA on fixed assets
should be deducted from the increase in net worth. This would be acceptable had
the fixed assets remained constant from year to year. However, CRA reduced the
asset value of the fixed assets by taking into account the CCA; therefore no
further deduction is in order.
[18] I conclude from this
review that Mr. Milkowski’s 2001 tax return was accurate: he made no
misrepresentation justifying the application of subsection 152(4) which would
allow the Respondent to assess Mr. Milkowski’s 2001 taxation year beyond the
normal reassessment. The appeal from the 2001 taxation year is therefore
allowed and the assessment is vacated.
[19] With respect to the
2002 and 2003 taxation years, the underreported income is to be adjusted
downwards to $9,424 and $10,690 respectively, Mr. Milkowski’s portion
being 75% of those amounts.
[20] There remains the
issue of penalties for the 2002 and 2003 taxation years.
Subsection 163(2) of the Act
stipulates that a taxpayer is liable for penalties where he has knowingly or
under circumstances amounting to gross negligence made or participated in the
making of the false statement or omission in a return. The parallel provision
is found in section 285 of the Excise Tax Act. When a gross negligence
penalty is imposed, the onus is on the Minister on a balance of probabilities
to prove the gross negligence. It does not follow that just because there is an
underreported income there has been gross negligence on the part of the
taxpayer. The Respondent acknowledges there must be other factors and suggests
the following in this case: magnitude of the unreported income, percent of
unreported income to the amount which should have been reported and the lack of
credibility of the Appellant with respect to mortgage and other borrowings.
[21] With respect to the
magnitude of the underreported income, while there is no hard and fast measure,
I find that underreported income of approximately $10,000 given the numerous
areas of possible dispute and the range of alternative estimates is not so
significant as to render it a certainty that Mr. Milkowski knew or ought to
have known he was underreporting. The shortfall of $10,000 does, however,
represent a significant proportion of what should have been reported in 2002
and 2003. With respect to the mortgage, the Respondent argues that the size of
the mortgage and the rate obtained do not suggest a high-risk loan and
therefore Mr. Milkowski must have shown the lender more assets and income than
he reported. The Respondent also referred to Mr. Milkowski’s line of credit to
suggest this position. This is only conjecture on the Minister’s part, and
certainly not sufficient proof to meet the onus of proving gross negligence.
[22] Finally, I am swayed
by the fact that Mr. Milkowski did provide books and records of which CRA wrote
“we have determined that your revenue and expenses match the documentation
provided”. While the Appellant has been unable to satisfy me, on balance, that
the income he reported is accurate, the Minister has likewise not satisfied me
that the inaccuracy of the Appellant’s underreporting arises from gross
negligence.
[23] The income tax
appeal for 2001 is allowed and the assessment is vacated on the basis that the
Minister simply assessed too late. The income tax appeals for the 2002 and 2003
taxation years are allowed and the matter is referred back to the Minister on
the basis that that Mr. Milkowski’s underreported income in 2002 was $7,068 and
in 2003 was $8,017 and that there are no subsection 163(2) gross negligence
penalties. The GST appeal is allowed and referred back to the Minister on the
basis that there is no underreported income in 2001, but $9,424 and $10,690 of
unreported income in 2002 and 2003, respectively. Again, there are no section
285 gross negligence penalties.
[24] I make no award of
costs.
Signed at Ottawa, Canada, this 7th day of November, 2007.
“Campbell J. Miller”
Appendix “A”
|
|
2000
|
2001
|
2002
|
2003
|
|
CRA Net Worth
|
$45,276
|
$53,988
|
$53,934
|
$50,268
|
|
Increase in mortgage*
|
$12,728
|
$16,009
|
$15,513
|
$15,493
|
|
Revised Net Worth
|
$32,548
|
$37,979
|
$38,421
|
$34,725
|
|
Less Prior Year
|
|
$32,548
|
$37,979
|
$38,421
|
|
Increase (decrease) in Net
Worth
|
|
$5,431
|
$442
|
($3,646)
|
|
CRA’s Increase in Net Worth
|
|
$8,712
|
($54)
|
($3,665)
|
|
Deduction from Net Worth
|
|
$3,281
|
($388)
|
($19)
|
* As agreed by
parties.
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