Citation: 2008 TCC 583
Date: 20081222
Docket: 2004-759(IT)G
BETWEEN:
BRIAN
GALLERY,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
AMENDED REASONS FOR JUDGMENT
(Whereas
paragraph 51 of the Reasons for Judgment inadvertently stated the year 2007 instead
of 1997, these Amended Reasons for Judgment are issued in substitution for the
Reasons for Judgment signed on December 10, 2008. In all other respects, the
Reasons for Judgment remain the same.)
Jorré J.
Introduction
[1]
The Appellant owned a
numbered company, which I shall refer to as Sailings 1. In 1994
Sailings 1 sold its business and assets to another numbered company which
I will refer to as Sailings 2.
[2]
The purchase price was
$11 million divided into three tranches. The amount of $8,270,000 was payable
at closing. The balance was payable at various times.
[3]
The Appellant also entered
into a $1 million three-year employment contract with Sailings 2
beginning at the same time as the sale of Sailings 1 to Sailings 2.
Sailings agreed to pay the Appellant $200,000 per year as well as an amount of
$400,000 in March 1996.
[4]
In filing his 1996
return the Appellant failed to include the amount of $400,000 payable pursuant
to the employment contract.
[5]
The Respondent
reassessed the Appellant more than three years after the initial assessment and
imposed penalties pursuant to subsection 163(2) of the Income Tax Act
(the “ITA”).
[6]
There is no dispute
that the $400,000 is taxable but the Appellant takes the position that:
a) the assessment was
statute barred and,
b) there is no basis for
the Minister to apply penalties pursuant to subsection 163(2).
[7]
With respect to the
statute barred issue, the issue is whether the Appellant made “. . . any
misrepresentation . . . that is attributable to neglect, carelessness or wilful
default . . .”.
[8]
With respect to the
subsection 163(2) penalty, the issue is whether the Appellant “. . . knowingly,
or under circumstances amounting to gross negligence, has made or has
participated in, assented to or acquiesced in the making of, a false statement
or omission in a return . . .”.
The facts
[9]
Much of the evidence is
not in dispute, but the inferences to be drawn from that evidence are very much
in dispute.
[10]
The Appellant owned
113602 Canada Inc. (Sailings 1) and over a number of years, built up
a successful business, a trade publication called Canadian Sailings.
[11]
On March 9, 1994
Sailings 1 sold its business and assets to Sailings 2 (3011909 Canada
Inc.). At the time, the Appellant was 59 years old.
[12]
Sailings 2 was
controlled by a company in New
York, K-III Directory
Corporation (“K-III”).
[13]
Under the sales
agreement $8,270,000 was payable at closing in March 1994.
[14]
Another amount of
$230,000 referred to as the “Book Value Holdback” was subject to verification
of the Book Value at closing and was payable no later than 140 days after
the closing. The $230,000 amount was paid in 1994.
[15]
Finally, payment of a
third amount of $2,500,000 (the earn-out payments) was subject to the business
meeting certain financial targets in calendar years 2004 and 2005. The entire
$2,500,000 was paid prior to September 1995.
[16]
Sailings 1 was
amalgamated with Galbri Holdings Inc. on August 31, 1994. Galbri received
the $2,500,000 payment.
[17]
The full tax payable on
the sale of the assets and business by Sailings 1 was paid in the year of
the sale. No reserve could be taken.
[18]
On the same day as
Sailings 1 sold the business to Sailings 2, March 9, 1994,
Sailings 2 and the Appellant entered into a three-year employment
agreement whereby the Appellant would continue to manage the publication of
Canadian Sailings and sell advertising. The employment agreement provided for a
salary of $200,000 per year; it also provided that on March 9, 1996
Sailings 2 was to pay the Appellant $400,000. Apart from the
$400,000 the Appellant’s salary was paid from Sailings 2’s Canadian bank
account.
[19]
On April 3, 1996 K-III
made a wire transfer of U.S. $296,186.60. This amount converted to Canadian
dollars is $401,763.56, which was deposited into the Appellant’s account.
[20]
There are three aspects
of this transfer that must be noted. First the payment was made by K-III and
not Canadian Sailings. Second, although K-III appears to have intended to send
Canadian $400,000, it in fact sent $401,763.56. Third, the K-III cheque request
showed as instructions that the amount was to go to a specific account number
which number was that of Galbri Holdings and not the Appellant.
[21]
The evidence does not
explain how it is that the payment went to the Appellant’s account rather than
that of Galbri Holdings.
[22]
The amount of the wire
transfer was debited to K-III’s account on April 3, 1996 and credited to
the Appellant’s account on April 4, the next day. On the same day the
Appellant transferred the funds from his account to Galbri Holdings’ account.
[23]
Sailings 2, when
it filed its tax return for 1996, did not claim as a deduction the expense of
the $400,000 it paid to the Appellant.
Subsequently, during the audit of Sailings 2, an audit that began in
mid-2001 and was finalized in 2002, Sailings 2 requested and obtained the
deduction of the $400,000. No T-4 was issued to the Appellant with respect to
the $400,000. T-4s were issued for the Appellant’s $200,000 yearly salary.
[24]
An internal K-III memo
dated March 11, 1994, two days after the sale of the business, describes
the purchase.
On pages 1 and 2 at paragraphs 3 and 5, the purchase price is described as
$8,900,000 plus an additional possible $2,500,000 based on earnings for a total
of $11,400,000. The $8,900,000 includes a $400,000 amount for an employment bonus
to the Appellant. On page 5 at paragraph 24, there is reference to the
employment contract with the Appellant including the $400,000.
Testimony of the Appellant
[25]
The Appellant testified
about the origin and development of the business, the publication Canadian
Sailings.
[26]
He explained that he
was editor of the publication and that his particular expertise and strength
was at selling advertising. He also stated that numbers and accounting were not
his forte.
[27]
He also explained that
while he would review financial documents and returns he very much relied on
his chartered accountants, Paul Trudel and, subsequently, John Collyer, to
correctly prepare his financial statements and tax returns. Making sure that he
did things correctly was the job of his accountants; he paid them to do that.
[28]
With respect to the
$401,763.56, he recalled that the payments somehow got into his bank account.
At the time he did not know why he was receiving the money but felt that it
must be a payment in relation to the sale of the business by Sailings 1
and accordingly deposited the amount in the account of Galbri Holdings which
had amalgamated with Sailings 1.
[29]
Subsequently, the
Appellant discussed it with Mr. Trudel, his accountant at the time.
Mr. Trudel indicated to him: we have a problem, we will find out what it
is and straighten it out. The Appellant said fine.
[30]
The Appellant testified
he heard nothing further about this from Mr. Trudel.
[31]
He also testified that
he had no intention of avoiding tax and has always been an honest person.
[32]
At the time of the
purchase the President and CEO of K-III was Allan Glass, someone he knows well
and whom he considers a friend. After the sale when he worked for
Sailings 2 he reported to Mr. Glass and was in contact regularly.
[33]
In cross-examination he
repeated that he put the $400,000 in the company’s bank account because he
thought the money was not his and did not know what to do with it.
[34]
The Appellant agreed
that he did not verify what it was and he did not ask Allan Glass but said he
had given his accountant responsibility for taking care of his financial
situation.
[35]
His accountant said he
would help but he did not subsequently check.
[36]
In November 1996
Mr. Trudel signed a retirement agreement with his accounting firm. Under the
agreement he was to retire three years later but his clients were to be
transferred gradually over the three years. In the case of the Appellant,
Mr. Trudel worked on the corporate return of Galbri Holdings for the year
ending August 31, 1996 —
which had to be filed by the end of February 1997. After that the
Appellant had Mr. Collyer as his accountant. Mr. Collyer prepared the
Appellant’s personal tax return for 1996 which would have been due at the end
of April 1997.
[37]
The Appellant testified
that when Mr. Collyer took over this accounting, Mr. Collyer said he
would check out the $400,000. The Appellant denied that Mr. Collyer had
ever asked him to check into the amount.
[38]
The Appellant agreed
that he did not inquire further from Mr. Collyer what was to be done with
the $400,000.
[39]
The $400,000 was not
included in his return.
[40]
The Appellant was quite
insistent that he expected Mr. Collyer to advise him if there was a
problem, to make inquiries, if necessary, and to tell him what was supposed to
be done.
[41]
In re-examination the
Appellant indicated that there were a lot of documents signed at the time of
the sale and that he never re-read the package after the sale was completed.
Testimony of Paul Trudel
[42]
Mr. Paul Trudel
was the Appellant’s chartered accountant for many years until early 1997 when
he transferred the Appellant to Mr. John Collyer.
[43]
Mr. Trudel
described the Appellant as a good client who was organized, open and easy to
work with. He stated that the Appellant relied on him to do the right thing for
him.
[44]
The Appellant had a
bookkeeper who did all the accounting entries during the year. At the end of
the year Mr. Trudel would prepare the financial statements, the corporate
tax return and the Appellant’s personal tax return.
[45]
He described the
Appellant’s approach to tax as conservative, as very scrupulous and as unhesitating
in doing the right thing. Mr. Trudel gave two examples.
[46]
He described the
Appellant as unsophisticated in accounting and tax matters.
[47]
When Mr. Trudel
finished preparing statements or tax returns he would sit down with the
Appellant and they would review the statements or returns before they were
finalized.
[48]
Mr. Trudel
prepared the tax return of Galbri Holdings for the fiscal year ending
August 31, 1996 which had to be filed by the end of February 1997.
[49]
When he worked on the
tax return he found the $400,000 payment in the cash book of Galbri. It was not
identified and the Appellant could not explain what it was for.
[50]
Because time was
running out and he had to complete the corporate tax return, Mr. Trudel
made the decision to credit the $400,000 to the Appellant’s shareholder account
with Galbri.
[51]
He also, some time
after February 1997, wrote up notes of items to be followed up. In the
follow-up notes was an item regarding the $400,000.
[52]
In these notes
Mr. Trudel wrote by hand on the left centre of the sheet: “What is status
of 296,176 U.S. from K-III? (401,763 Canadian)”. To the
right of that he wrote: “Personal fulfillment of performance 400,000 U.S. less DAS”. Below this he wrote on the left centre:
“Taxable in Brian’s hands?” To the right and below that, and linked by an arrow
he wrote: “Yes”.
[53]
This was written after
the corporate return was filed in early 1997 and prior to the due date for the
personal return.
[54]
DAS stood for
deductions at source and Mr. Trudel expected that a T-4 slip would come in
for this.
[55]
These notes were placed
in the file for Galbri Holdings.
[56]
The purpose of writing
these notes on file was to insure that the item would be followed up.
Mr. Trudel expected to deal with it in the personal return. However,
Mr. Collyer took over the Appellant as a client before the personal return
was filed and so Mr. Trudel did not deal with it.
[57]
Mr. Trudel does
not think he mentioned these notes to Mr. Collyer and he did not mention them
to the Appellant. He did not place a copy of the notes in the Appellant’s
personal file.
[58]
When Mr. Trudel
decided to put the $400,000 in the shareholder account he told the Appellant
that he was putting it there because he was not sure what to do with it and that
they would check into it later.
[59]
Mr. Trudel is not
aware of the Appellant subsequently making inquiries into what the amount was
for.
[60]
After Mr. Trudel
closed the financial statements of Galbri, the Appellant never brought up the
$400,000 again with Mr. Trudel.
Testimony of John Collyer
[61]
Mr. Collyer is a
chartered accountant and took over the Appellant as a client in early 1997 from
Mr. Trudel.
[62]
He described the
Appellant as a good client, one who was loyal, prudent and who listens to the
advice given. He also described the Appellant as unsophisticated in tax or
accounting matters, one who relies on the advice given.
[63]
He also said the
Appellant was very conservative in tax matters.
[64]
The Appellant reviewed
his tax returns and financial statements with Mr. Collyer and he would
discuss the returns and statements.
[65]
When Mr. Collyer
prepared the Appellant’s 1996 personal tax return he examined the Appellant’s
personal file but did not examine the corporate file at that time.
[66]
When he reviewed the
1996 personal tax file with the Appellant he asked if there was anything
missing. The Appellant said that there was not. He did not mention the
$400,000.
[67]
Before transferring the
Appellant to Mr. Collyer, Mr. Trudel did not bring the notes to his
attention.
[68]
Mr. Collyer subsequently
became aware of the $400,000 when preparing the corporate tax return of Galbri
Holdings for the year ending August 31, 1997.
[69]
He asked the Appellant
about the amount and the Appellant could not explain why he had received the
amount. The Appellant also said to him that as far as he was concerned it was
an amount that belonged to the company. The Appellant also said to him that he
had spoken to Mr. Trudel but Mr. Trudel had not resolved the item.
[70]
Mr. Collyer asked
Mr. Trudel about the amount but Mr. Trudel could not give him further
information. He also testified that Mr. Trudel did not give him the
assurance that it should have been included in the Appellant’s income.
[71]
Mr. Collyer was
satisfied that it should not be taxed in the hands of the company because the
company had no contracts with K-III and therefore it had no reason to receive
income from K-III.
[72]
The accounting firm did
not amend the Appellant’s personal tax return because the Appellant did not say
to them that the $400,000 was his income for a certain transaction.
[73]
He agreed that the
Appellant would have been aware of the fact the $400,000 amount had not been
declared after the preparation of the 1997 financial statements.
Testimony of Lucie Fortin
[74]
Ms. Lucie Fortin
is a CRA auditor. She was originally assigned to work on the audit of
Sailings 2. That audit led to the assessment of the Appellant.
[75]
She explained the
assessment in issue. The key facts in her testimony are set out elsewhere in
this decision.
Other facts
[76]
The total income
declared by the Appellant in his 1996 personal tax return was $211,054.09. The financial
statements for Galbri Holdings for the year ending August 31, 1996 show
(approximately) gross revenues of $438,000, net earnings of $99,000, assets of
$6,350,000 and shareholders’ equity of $4,500,000.
[77]
Apart from the penalty
in issue CRA’s information system does not show any penalty as having been
levied against the Appellant or Sailings 1. With respect to Galbri
Holdings, CRA’s information system shows two penalties as having been levied — one relating to a late instalment and one
relating to the late filing of a return. These do not appear to be significant.
The system showed no other penalties regarding Galbri.
The law
Statute barred years
[78]
With respect to the
question whether the Minister can reassess the test is set out in subparagraph
152(4)(a)(i) of the ITA. The issue is whether the Appellant made
“. . . any misrepresentation . . . that is attributable to neglect,
carelessness or wilful default . . .”.
[79]
There is no doubt that
there was a misrepresentation insofar as the $400,000 was left out. The question
is whether there is neglect, carelessness or wilful default.
[80]
In Venne v. Canada Strayer J. sets
out how the test in subparagraph 152(4)(a)(i) of the ITA is to be
applied:
I am satisfied that it is sufficient for the Minister, in order to
invoke the power under sub-paragraph 152(4)(a)(i) of the Act to show
that, with respect to any one or more aspects of his income tax return for a
given year, a taxpayer has been negligent. Such negligence is established if it
is shown that the taxpayer has not exercised reasonable care. This is surely
what the word “misrepresentation that is attributable to neglect” must mean,
particularly when combined with other grounds such as “carelessness” or “wilful
default” which refer to a higher degree of negligence or to intentional
misconduct. Unless these words are superfluous in the section, which I am not
able to assume, the term “neglect” involves a lesser standard of deficiency
akin to that used in other fields of law such as the law of tort. See Jet
Metal Products Limited v. The Minister of National Revenue (1979), 79 DTC
624 at 636-37 (T.R.B.).
Gross negligence penalty
[81]
With respect to the
subsection 163(2) penalty of the ITA, the issue is whether the Appellant
“. . . knowingly, or under circumstances amounting to gross negligence, has
made or has participated in, assented to or acquiesced in the making of, a
false statement or omission in a return . . .”.
[82]
In Farm Business
Consultants Inc. v. The Queen,
Bowman A.C.J. (as he then was) made the following comments:
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.
[83]
In examining this issue
I must also consider whether the conduct of the Appellant amounted to wilful
blindness. As stated by Nadon J.A. speaking for the court in Panini v.
Canada:
. . . Consequently, the law will impute knowledge to a taxpayer who,
in circumstances that dictate or strongly suggest that an inquiry should be
made with respect to his or her tax situation, refuses or fails to commence
such an inquiry without proper justification.
[84]
Compared to
subparagraph 152(4)(a)(i) of the ITA, much more is required
before subsection 163(2) can be involved. In the Venne case, Strayer J.
states:
. . . “Gross negligence” must be taken to involve greater neglect
than simply a failure to use reasonable care. It must involve a high degree of
negligence tantamount to intentional acting, an indifference as to whether the
law is complied with or not. . . .
This is very understandable when one considers that
subsection 163(2) imposes a penalty equal to 50% of the tax on the additional
income added to the Appellant’s income tax that was understated as a result of
the false statement or omission. It is interesting to note that the minimum
fine under subsection 239(1), the provision for criminal tax evasion, is also
50%.
Analysis
[85]
I found the evidence of
all four witnesses to be credible. In particular, I would note that I accept
the Appellant’s evidence that he had no intention of avoiding tax and that he
relied on his advisors to deal with any issues.
[86]
Bearing these
considerations in mind could the Minister reassess beyond the normal
reassessment period? There is no question that there was a misrepresentation,
the omission of the $400,000. Was such omission the result of neglect,
carelessness or wilful default? Did the taxpayer exercise reasonable care?
[87]
The contractual terms
of the contract of employment was quite clear; it was a three-year
$1 million contract payable at the sale of $200,000 with a further amount
of $400,000 payable on the second anniversary. The seven-page contract of
employment is not particularly complicated.
[88]
Although the amount was
received from K-III instead of Sailings 2, was paid late, was of an odd amount,
$1,763.56 greater than the $400,000, and was not subsequently the subject of a
T-4, it would have been quite straightforward for the Appellant to determine
why he received it by asking the President of K-III, Allan Glass, a friend, to
look into the origin of the payment.
[89]
Mr. Trudel did
find the $400,000 in the cash book. The Appellant and Mr. Trudel did speak
about the $400,000 and the Appellant did expect Mr. Trudel to take care of
it. However, the Appellant never followed up with Mr. Trudel after the
time when Mr. Trudel told him he would put it in the shareholder account,
complete the corporate return and deal with the $400,000 later. There is no
evidence that the Appellant asked Mr. Collyer about the $400,000 prior to
or at the time of the filing of his personal tax return for 1996; the $400,000
came up with Mr. Collyer later when preparing the corporate tax return for
the year ending August 31, 1997.
[90]
While there is no
question that the Appellant received a large sum, $11 million, for the
company, that amount was received prior to 1996; in 1996 he received a salary
of approximately $211,000. A single payment of $400,000 received in his account
was a large sum and one would expect a person to seek to determine the nature
of the payment not just by leaving it with his advisor but by following up
until satisfied that there was a satisfactory explanation.
[91]
Here, he did put the
issue in the hands of an advisor but he never followed up either with his
advisor or with someone else such as Mr. Glass to determine definitely
what the amount was even though his advisor, Mr. Trudel, was clearly not
satisfied that it belonged to the company and told him that he was putting it
in the shareholder account pending resolution.
[92]
While I am satisfied
that the omission was not wilful, I do find that the facts here lead to the
conclusion that there was neglect or carelessness on the part of the Appellant;
it has been established “that the taxpayer has not exercised reasonable care”.
[93]
As I indicated earlier
I accept the Appellant’s testimony and have concluded that the omission was not
done knowingly. What remains is whether we have circumstances amounting to
gross negligence (or circumstances of wilful blindness).
[94]
While the Appellant
could easily have made further inquiries, I am satisfied that he was a person
who relied on his advisors and paid them to deal with issues and that he did in
fact believe, wrongly, that the money must somehow relate to the sale.
[95]
His behaviour is
consistent with this in his having immediately transferred the money to the
company’s account on the same day he received it. It is also significant that
the decision to put the amount in the shareholder account was made by
Mr. Trudel, not the Appellant.
[96]
Following his practice
of relying on his advisors, he was satisfied to leave it in the hands of
Mr. Trudel. Given his belief that it belonged to the company
Sailings 1, and given that tax on the sale of the business had already
been paid at the time of the sale in 1994, I can accept that in his mind there
was not an outstanding issue.
[97]
Indeed, had
Mr. Trudel not, as part of his transition to retirement, transferred the
Appellant’s file in early 1997 to Mr. Collyer, this case might well not
have arisen.
[98]
There was not an
indifference as to whether the law was complied with. The conduct of the
Appellant did not amount to wilful blindness; it did not amount to gross
negligence.
Conclusion
[99]
To summarize, the
Respondent was entitled to reassess beyond the normal reassessment period but
the circumstances do not justify the application of penalties pursuant to
subsection 163(2).
[100]
Accordingly, the appeal
will be allowed and the matter referred back to the Minister for
reconsideration and reassessment on the basis that the penalty under subsection
163(2) should be deleted.
[101]
I wish to thank counsel
for the parties.
[102]
Before signing the
judgment, I will ask Registry to contact the parties to make arrangements
regarding submissions on the matter of costs.
Signed at Ottawa, Canada, this 22nd day of December 2008.
"Gaston Jorré"
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