Citation: 2007TCC712
Date: 20071123
Docket: 2003-4555(IT)G
and 2003-4557(IT)G
BETWEEN:
JOVO MRKALJ and MILIK MRKALJ,
Appellants,
and
HER MAJESTY THE QUEEN,
Respondent.
REASONS FOR JUDGMENT
McArthur J.
[1] These appeals are
from reassessments by the Minister of National Revenue for the Appellants’
1995, 1996, 1997 and 1998 taxation years. The Notices of Appeal and Replies are
identical for both Appellants and the evidence at the hearing on behalf of both
was given primarily by Jovo Mrkalj (“Joe”).
[2] The Minister reassessed
the Appellants to include unreported income of $8,062 in 1995, $44,484 in 1996,
$46,695 in 1997 and $16,110 in 1998 pursuant to subsection 5(1) of the Income
Tax Act, together with penalties under subsection 163(2), in the
amounts of $726, $5,070, $6,194 and $2,147 for the four years, respectively.
[3] The Appellants were
employees of 1083290 Ontario Limited (the “Corporation”) that owned the bar/restaurant
known as “The Daily Planet Tap & Eatery” (“Planet Tap”), and they operated
it. They are the sons of the former sole shareholder of the Corporation, Simo Mrkalj
(“Sam”),
who died in 2006. The Corporation pled guilty to criminal charges with respect
to unreported sales and paid arrears of taxes, interest and a fine. Criminal
charges against the Appellants were dropped, and they were reassessed as
described earlier.
[4] Prior to the
opening of Planet Tap, the Appellants had claimed bankruptcy subsequent to a
previous failed venture. During the years under review, Planet Tap was almost
their only source of income.
[5] It opened for
business in February 1995. Sam, a seasoned restauranteur, initially did much of
the paperwork and management. As time passed, Joe assumed responsibility for
much of the paperwork, and Milik (“Mike”) concentrated
his efforts on the bartending. Both sons worked long hours, often over 10 hours
a day. Within a short period of time, they assumed all day-to-day operations and
the business became very successful. The following is an extraction from an
order under the Liquor License Board of Ontario, dated May 9, 1997,
contained in Exhibit ”A”, Tab 144, which gives some background.
Testimony of Joe Mrkalj
Mr. Mrkalj stated that he is 31 years of
age, a graduate of the University
of Toronto and a manager in
the licensed premises on behalf of his father, the owner. He stated that his
father has been a licensee since 1974, currently holds two liquor licences, and
he has never had any prior adverse record with the LLBO.
He stated that he and his father order
liquor and food for the premises and monitor the day-to-day operation closely.
As the manager he is physically present in the premises 75 to 80 hours a week.
The establishment opened in February 1995
after substantial renovations which took over six months to complete at a cost
of over $150,000, and caters seven days a week to a college-type crowd of both
the United States and Canadian patrons. He stated that he
takes the responsibility of complying with the LLBO rules seriously. He
conducts full-staff meetings monthly, sub-staff meetings weekly and personally
addresses every new shift as it comes into the premises. He stated that all
staff are instructed that no one under the age of 19 is allowed into the
premises and that anyone who looks under 30 years of age is to be checked for
ID. He stated that there are 24 full and part-time employees, all of whom have
completed Smart Serve training, including the cooks.
[6] The Appellants were
careless with the accounting and recordkeeping and proper records of daily
sales were not kept, nor did they keep track of drink specials, promotions and
giveaways. There were two cash registers in Planet Tap, but summary tapes were
kept only for the main cash register during the years in question. Detailed
tapes which recorded each sale individually were discarded and no summary tapes
or detailed tapes were kept for the second register, and the Appellants claimed
that the amount from this register was totalled and then entered into the first
register.
[7] In 1997, Planet Tap
was expanded to include an adjacent building, doubling its capacity. Despite
the expansion and its apparent success, particularly with college aged students
from the Niagara
Falls area
and the US, they reported only modest
incomes during the years in question.
[8] Mr. Doug Bronson of
the investigations division of Canada Revenue Agency, testified that the
original target of the assessments was Sam Mrkalj. After the investigation was
completed, the Appellants were assessed for appropriation of unreported income
as employees of the Corporation and not as de facto shareholders or
officers of Planet Tap, although they were in complete control of every aspect
of the business during the years in issue.
[9] I will now deal
with the first issue raised by the Appellants. I believe it was their
contention that their now deceased father should have been assessed rather than
them. I conclude that the Appellants were the correct persons to be assessed
for the years 1996, 1997 and 1998 only. Mike and in particular Joe had control
in those years. During the start-up year, 1995, Sam at least shared control of
the operation with his sons.
[10] It is undisputed
that the father, Sam, was the legal owner of the bar as sole shareholder of the
Corporation. The Minister claims that Joe and Mike, acting as employees, took
unreported cash from Planet Tap and loaned some back to the Corporation
tax-free. Further, they stored some cash in the two safes above the business.
[11] As mentioned above,
the Appellants were responsible for the day-to-day operations of Planet Tap
more so after 1995, which was confirmed by the testimony of several witnesses.
For instance, after examination of the records of Planet Tap, Mr. Bronson
concluded that Sam was a shareholder in name only and that the Appellants were
in fact responsible for the financial and day-to-day operations. I agree with
his conclusion particularly after 1995. The testimony of Sherry Ann Shortland,
a bookkeeper for Padgett Business Services, also confirms that the sons were in
charge. She took her instructions from them, and mostly from Joe. In addition,
it was Joe and not Sam who signed the T2 Corporation income tax returns for the
years in question. In addition, evidence given by waitresses from Planet Tap
indicated that primarily, they took orders from the Appellants, and not Sam.
Finally, the auditors from CRA dealt exclusively with the Appellants and not with
Sam when conducting the audit of the Corporation because they held themselves
out as being in complete control, if not de facto owners.
[12] The Minister
speculated that Sam agreed to be the only shareholder because the Appellants
were unable to obtain a liquor license due to a previous bankruptcy and
criminal charges. Whether this is factual or not has no bearing on my
conclusion.
The Appellants were responsible for opening the bar and closing out the cash
register each day and they were responsible for all the banking. They were
originally charged criminally but the charges were dropped after the
Corporation pled guilty. They were then personally reassessed for unreported
income. They did not challenge the assertion that they had divided the proceeds
of unreported income equally between them.
[13] Mr. Bronson calculated
the projected sales of Planet Tap which represents the Minister’s estimation of
sales during the years in question. His evidence was impressive and it is reproduced
in part as follows:
Reconciliation with Reported Income
The auditor’s found two cash registers
present and were told no tapes were kept for the second register. Rather the
amount of sales were summed and then entered into the first register. We found
no evidence to confirm this sequence. Only daily and monthly summary tapes were
kept for the main register, as the detail tapes for this register are also
discarded.
The Taxpayer’s Reported Income is based
upon the total of monthly summary tapes which the two brothers provided to the
bookkeeper at Padgett Business Services. She took the Gross Total from the
summary cash register tapes, and then removed all taxes – PST and GST. The
balance was allocated to Food or Liquor Sales for each month. The monthly
amounts were totalled to produce the Total Sales for the year. Miscellaneous
Income was derived from Sales Tax Commission and Rental Income. The combination
of these amounts equal the amounts reported on the Financial Statements.
The average selling prices used in the
projections were derived from the average of the total of the Monthly Summary
tapes. The Total Value of Sales were divided by the Quantity Sold for Liquor,
and Bottled Beer. For Draft Beer, pitchers of beer were considered as the sale
item rather than glasses, since pitchers would give a lower projection figure
and keep with our conservative approach to the projections. Normal Sales prices
for draft were obtained from the managers and confirmed by review o the summary
tapes. The figures for ending inventory and promotion items (free drinks) were
supplied to the accountant by the manager. Taxes were removed from the sales
prices. We compared our costs of the purchase costs claimed in financial
statements to verify that costs were not understated, that is, that the excess
funds were not used to purchase inventory that was not claimed in the financial
statements.
Projections
Beer
To ensure accuracy, figures were gathered
from several different resources. The actual Purchase Invoices held by the
taxpayers were obtained by search warrant and these were totalled. This covered
the period from February 1995 to January 31, 1998. Secondly, a list of total
purchases by month, was obtained directly from the Head Office of Brewer’s
Retail. It showed purchases beginning in January 1995. The results were then
compared and reconciled to each other.
LCBO Purchases
The calculations are based upon seized
records. The LCBOI does not keep records by clients, nor are they computerized
to allow such printouts. The purchases are difficult to calculate because of
the variety of purchases, i.e. coolers, and other special drinks. Variations in
sizes and packages also confuse calculations. Consequently, only 26, 40 and 60
ounce bottles of liquor were calculated. That is, Wine sales and the sales of
coolers and other special drinks (Mike’s Hard Lemonade) are not included in our
projections because of variations in the selling prices. Thus our projections
are deliberately understated, by excluding wine and other types of Liquors.
For beer and liquor, wastage has been
deliberately over estimated. Lines for draft beer were maintained on a regular
basis and after the first year were not a problem (clogging, foaming).
[14] Mr. Bronson affirmed
that the primary source in the determination of beer and alcohol purchased by
Planet Tap was seized invoices from the premises. In addition to the seized
invoices, he used LCBO and Brewer’s Warehouse records to determine the amount
of beer and liquor purchased. These purchases were multiplied by the average
selling price to calculate projected sales, which were then compared to
reported sales. Where invoices were missing, there was often a cancelled cheque
from Planet Tap to confirm the purchase. He affirms that his projections were
supported not only by the information from Brewer’s Retail, but also by data
from Planet Tap itself, in the form of seized invoices, cancelled cheques and
accounting records. He calculated of the average selling price for a drink (liquor)
to be from $2.38 to $2.52 and beer to be from $2.12 to $2.27. Wastage, ending
inventory and taxes were taken into account. His methodology was conservative.
He did not include wine and coolers, slanting the projections in favour of the
Appellants. In addition, the assessment was decreased by 20% subsequent to an
agreement reached in the criminal case against the Corporation.
[15] Counsel for the
Appellants put forth several explanations for the discrepancy between projected
and reported sales, including: free drinks were often given to customers, happy
hour specials were not taken into account, the cash registers improperly input
a bucket of beer as one beer and the liquor license number at the LCBO may have
been used for purchases by third parties unrelated to the business. These items
may have had some effect on Mr. Bronson’s projections but they were advanced in
generality with no specific amounts and no corroborating evidence. I cannot
guess what effect these explanations would have but find that Mr. Bronson’s
calculations were fair and conservative. The Appellants were the authors of
their own misfortune and they did not come close to meeting the burden of proof
incumbent on them. In addition, although the Appellants stated that the calculation
of the average price by Mr. Bronson was flawed, they did not give evidence as
to what the average price should have been.
[16] I find that the
discrepancy between the projected and reported sales of the Corporation was misappropriated
by the Appellants. These funds were reinvested in Planet Tap in the form of
shareholder loans, or stored in a floor safes in the office above Planet Tap, or
used to purchase the adjacent building in 1997.
[17] In 1997, the
Appellants purchased the building adjacent to Planet Tap for $88,000. The
details of the purchase are confusing. A document registered as number 749730
is a land transfer from 1083278 Ontario Limited, by its president, Simo Mrkalj
(Sam), to the Appellants, registered on July 7, 1998. The consideration is
shown as $80,000 and the land transfer tax affidavit reflects that the
purchasers (the Appellants) assumed a $57,000 mortgage and transferred
securities to the value of $31,000. Monies paid in cash was entered as nil.
[18] The oral evidence
was that the property was purchased in 1997, perhaps by the Corporation,
1083278, but no registry office or other documents were submitted. In his
submission, the Appellants’ lawyer does not challenge the Minister’s statement
that “they bought a building in 1997, but states that the purchase price was
$88,000, not $90,000 and there was a mortgage of $57,000 and $31,000 came from
loans”. There was no corroborating evidence of loans. Some of the confusion
could have been easily cleared by a subsearch of the title by either side. I am
left to speculate. It is the Appellants who have the burden of establishing
that they did not fail to report substantial income. They appeared more
inclined to leave it to the Minister to prove his assumptions as one might
proceed in a criminal case. I am left with the following with respect to the
adjacent building:
a) The Appellants
purchased the property in 1997.
b) The deed or
transfer is from their father in July of 1998.
c) The
transfer reflects that they assumed a mortgage (charge) of $57,000 paid “nil”
money in cash and transferred securities to the value of $31,000.
d) The
Appellants’ counsel quotes counsel for the Minister as saying “the Appellants
bought the land in 1997 for cash.
e) The
Appellant’s counsel continues to say that there was a mortgage of $57,000 and
that the Appellants explained in discovery that $31,000 came from loans. No
corroborating evidence was produced to substantiate any of this. The Appellants
blame their father for not keeping proper books and records.
[19] Several times, in
submissions, the Appellants’ counsel made reference to the inaccuracy and
ineptness of Mr. Bronson’s evidence. At page 75 of the transcript, counsel stated:
He has looked only at those
items which would support his theory which has no basis. Had we had the whole
picture, I suspect you may have been entitled to draw an inference of who the
real owner is. But without Sam’s investigation being part of this, I
respectfully submit that they are asking you to close one eye and make an
improper judgment. Again, that’s part of what we said.
I said that Mr. Bronson’s
entire examination here is flawed, and we are trying to make the best of it,
but those flaws can’t be cured. There’s the selective calling of witnesses.
Mr. Bronson’s examination may have
flaws and obviously he drew inferences but, he did so as a last resort. The
Appellants provided no evidence which could have cured potential flaws. The
Appellants’ records were inadequate and they withheld critical information from
their accountants.
[20] I find, for the most
part, that Mr. Bronson did the best he could with the information available to
him. Where there are inconsistencies, and there are many, I accept the evidence
of the Minister’s witnesses over that of the Appellants. The Appellants have
not proven that the following assumptions were incorrect:
…
d) During the
years under review Milic Mrkalj and the Appellant had no other source of
income, other than working at the Business;
…
f) The unreported
sales of the Business for the years in question was properly calculated by
comparing reported sales to document any purchases;
g) The Appellant
and his brother Milic Mrkalj operated the Business at all times. They were
responsible for operating the bar and closing off the cash register each day.
They were also responsible for all banking including preparing bank deposits
and paying expenses either in cash or by cheque;
…
i) For the years
1995-1997 the following contributions were made to the Shareholder Account by
Milic Mrkalj and Joe Mrkalj:
|
1995
|
$62,367.00
|
|
1996
|
$18,490.00
|
|
1997
|
$338.00
|
j) The unreported
income from the Business was the source of contributions to the Shareholder
Loan account by the Appellant and Milic Mrkalj;
k) For many days,
points of sales tapes were missing from the Business’ records. No sales were
recorded by the Business for those days;
l)
A search of the
business premises as well as the attached living quarters of Milic Mrkalj and
the Appellant on April 8, 1999 found approximately $80,000.00 in a safe. Milic
Mrkalj and the Appellant were the only people who had knowledge of and access
to this safe;
m)
The $80,000.00 found
in the safe was obtained by Milic Mrkalj and the Appellant from unreported cash
taken from the Business;
n)
Milic Mrkalj and the
Appellant split the proceeds of unreported income between themselves.
[21] Although neither of
the Appellants were shareholders, a liability account named “Shareholder Loan”
was created to their benefit and included in the financial statements of Planet
Tap. The name “Shareholder Loan” account was changed to “Accounts Payable” in
1999. Despite the fact that Sam was legally the sole shareholder, the
Appellants were often referred to as shareholders, demonstrated by the fact
that their loans were deposited in the “Shareholder Loan” account until the
name of this account was changed in 1999.
[22] The following
contributions were made to the “Shareholder Loan” account during the years
under review: $62,367 in 1995, $18,490 in 1996 and $338 in 1997. These
Shareholder Loans made by the Appellants to Planet Tap was unreported income
from the business. I agree with Respondent’s counsel’s submissions that
included:
(a) The
Appellants had almost no assets after emerging from bankruptcy in 1994, but
they were making large Shareholder loans to Planet Tap in the next few years;
and
(b) Shareholder
loans are normally made by cheque, but these Shareholder loans were made in
cash – in similar denominations as would be seen in the normal cash deposit
from the bar.
[23] The Appellants
provided little in the way of explanation as to the source of the Shareholder
Loans. They asserted that their tips were reinvested in Planet Tap (tips which
are subject to tax); however, this does not explain the sizeable contributions
from the Appellants to Planet Tap. They also claimed that the source of these
loans may have been their father yet, they provided no proof to substantiate
this claim. They argued further that the cash was from guests at Joe’s wedding in
November 1998. Again, no witnesses were called to support this.
[24] The office above
Planet Tap contained two safes, one under the desk and the other under the
floor boards. The Appellants were the only two people with access to the safes.
Sam may have had access but the evidence is conflicting in this regard. The
floor safe contained upwards of $80,000 in cash and the desk safe $21,270 in
cash. For the reasons that follow, I find these amounts were unreported income.
[25] The Appellants’
evidence as to the source of this cash was inconsistent. Initially, in
examination for discovery, Joe stated that the cash in the safe was sales
income from Planet Tap. The Appellants could not show where this amount was
included on the financial statements of Planet Tap. However, during trial, he
stated that the cash was from both the sales of Planet Tap as well as cash
received from friends and family in celebration of his wedding. The Appellants
called no witnesses and produced no evidence to support this claim, other than
a list of purported cash gifts received. He could not explain why he would mingle
cash given to him and his wife with sales income from the business which was
divided equally with his brother. This defies common sense and reasonableness.
[26] The Appellants’
counsel argued that there was no net worth assessment by the Minister,
therefore, one can infer that the position of the Minister is weak. I disagree.
A net worth assessment is a method of last resort. In this case, documentation
such as seized invoices and LCBO rewards were available, which provided a more
accurate calculation of unreported sales rather than would a net worth
assessment. The Minister has demonstrated that the Appellants were responsible
for operating the bar. The Minister has also relied upon data available to
calculate the projected sales of Planet Tap during the years under review,
which were superior to reported sales. In addition, the Minister provided a
plausible explanation for the discrepancy between projected and reported sales,
namely, that this unreported income was the source of the “Shareholder Loans”
as well as the cash found in the safes. The onus to refute these assumptions
rests upon the Appellants. Apart from viva voce evidence provided by
Joe, no evidence was advanced by the Appellants. Mike’s testimony was of little
assistance. He is a self-admitted, recovering drug addict and remembered very
little from the time in question.
[27] That the burden is
upon the Appellants to refute the Minister’s assumptions is well established as
stated in Voitures Orly Inc./Orly Automobiles Inc. v. R.:
To sum up, we see no merit in the submissions of the
appellant that it no longer had the burden of disproving the assumptions made
by the Minister. We want to firmly and strongly reassert the principle that the
burden of proof put on the taxpayer is not to be lightly, capriciously or
casually shifted. There is a very simple and pragmatic reason going back to
over 80 years ago as to why the burden is on the taxpayer: see Anderson
Logging Co. v. British Columbia, [1925]
S.C.R. 45, Pollock v. Canada (Minister of National Revenue) (1993),
161 N.R. 232 (F.C.A.), Vacation Villas of Collingwood Inc. v.
Canada (1996) 133
D.L.R. (4th) 374 (F.C.A.), Anchor Pointe Energy Ltd. v. Canada,
[2003]
F.C.J. No. 1045, 2003 FCA
294. It is the taxpayer's business. He knows how and why it is run
in a particular fashion rather than in some other
ways. He knows and possesses information that the Minister does not. He has
information within his reach and under his control. The taxation system is a
self-reporting system. Any shifting of the taxpayer's burden to provide and to
report information that he knows or controls can compromise the integrity,
enforceability and, therefore, the credibility of the system. That being said,
we recognize that there are instances where the shifting of the burden may be
warranted. This is simply not one of those cases.
[28] The unreported
income of Planet Tap was loaned back to Planet Tap by the Appellants, stored in
the safes above Planet Tap and used to purchase the adjacent building, all to
the benefit of the Appellants. Obviously it should have been included in their
taxable incomes pursuant to subsection 6(1) of the Act, but for
the 1995 taxation year when it is plausible that their father exercised some
control over the business.
Penalties
[29] Both Appellants have been assessed penalties pursuant
to subsection 163(2) of the Act. I find for the reasons stated
previously, that they knowingly, or under circumstances amounting to gross
negligence, made or participated in the making of a false statement or omission
in their 1996, 1997 and 1998 income tax returns.
[30] With respect to the burden of proof for penalties
assessed under subsection 163(2) of the Act, it is incumbent upon
the Minister to demonstrate that the Appellants knowingly, or under
circumstances amounting to gross negligence, made or participated in the making
of false statements or omissions in their 1996, 1997 and 1998 income tax
returns.
[31] In Farm Business Consultants Inc. v. R.,
Bowman J. discussed the principles which should be applied in penalty cases:
A Court
must be extremely cautious in sanctioning the imposition of penalties under
subsection 163(2). Conduct that warrants reopening a statute-barred year does
not automatically justify a penalty and the routine imposition of penalties by
the Minister is to be discouraged. Conduct of the type contemplated in
paragraph 152(4)(a)(i) may in some circumstances also be used as the basis of a
penalty under subsection 163(2), which involves the penalizing of conduct that
requires a higher degree of reprehensibility. In such a case a court must, even
in applying a civil standard of proof, scrutinize the evidence with great care
and look for a higher degree of probability than would be expected where
allegations of a less serious nature are sought to be established. Moreover,
where a penalty is imposed under subsection 163(2) although a civil standard of
proof is required, if a taxpayer’s conduct is consistent with two viable and
reasonable hypotheses, one justifying the penalty and one not, the benefit of
the doubt must be given to the taxpayer and the penalty must be deleted. I
think that in this case the required degree of probability has been established
by the respondent, and that no hypothesis that is inconsistent with that
advanced by the respondent is sustainable on the basis of the evidence adduced.
Had I been able to construe the statute, or to view
the evidence, in a manner that permitted me to give the appellant the benefit
of the doubt I would have done so. That course of action is not open to me. The
appellant’s depiction of the legal relationship between it and Agricultural as
that of a consulting arrangement went beyond simple negligence.
[32] In addition, in DeCosta v. R.,
Bowman J. went on to summarize the factors as follows:
In drawing the line between “ordinary” negligence or
neglect and “gross” negligence a number of factors have to be considered. One
of course is the magnitude of the omission in relation to the income declared.
Another is the opportunity the taxpayer had to detect the error. Another is the
taxpayer’s education and apparent intelligence. No single factor predominates.
Each must be assigned its proper weight in the context of the overall picture
that emerges from the evidence.
[33] The overall picture that emerges in these appeals is
clear. The conduct of the Appellants went beyond simple negligence. The
Appellants deliberately and repeatedly failed to properly account for sales in
order to make false statements in their 1996, 1997 and 1998 income tax returns.
Such actions are far more egregious than simple negligence.
[34] The appeals are allowed for the 1995 taxation year
only. The appeals for the 1996, 1997 and 1998 taxation years are dismissed,
with costs to the Respondent.
Signed at Ottawa, Canada, this 23rd day of November, 2007.
“C.H. McArthur”
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