Citation: 2006TCC195
Date: 20060328
Docket: 2004-4439(IT)I
BETWEEN:
POOPATHIE COMPANY LTD.,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
REASONS FOR JUDGMENT
(delivered orally from the Bench
on March 10, 2006 at Toronto, Ontario)
Woods J.
[1] These are oral reasons in an appeal by Poopathie Company Ltd. in respect of assessments under the Income Tax Act for taxation years ending on February 28, 1999 and February 29, 2000.
[2] The appellant corporation operates a grocery store in Scarborough, Ontariounder the name Gemini Market. The store opened in 1997 and is operated by the sole shareholder, Gunabalasingam Nadarajah, and his wife. I accept that Mr. and Mrs. Nadarajah work long hours to run a viable business.
[3] There are two issues. The first is whether the appellant corporation has ownership of a vehicle for purposes of determining its entitlement to capital cost allowance. The second is whether the corporation has understated its income.
[4] I will first consider the capital cost allowance issue. The Minister takes the view that the vehicle is owned by Mr. Nadarajah and not the corporation and has denied the corporation capital cost allowance on this basis.
[5] In 1998 a Nissan Pathfinder was purchased primarily for use in the business of Gemini Market. Mr. Nadarajah negotiated the purchase and paid for it out of his personal funds. $5,000 was paid at the time of purchase and the balance, $38,000, was funded with financing from Nissan.
[6] Mr. Nadarajah is the registered owner of the vehicle but the financing documents are in the name of the corporation and the sale agreement is in the joint names of the corporation and Mr. Nadarajah.
[7] The registration of the vehicle in Mr. Nadarajah's name is not determinative of the issue. The question is who has beneficial ownership and this depends on intention. In my view the sale agreement and the financing documents show a fairly clear intent for the vehicle to be owned by the corporation and not Mr. Nadarajah. It would make no sense for Mr. Nadarajah to have the dealer put the business name on the purchase agreement if he intended to purchase the vehicle personally. The payments for the vehicle by Mr. Nadarajah are not a significant factor in this case because Mr. Nadarajah often used his personal bank account for business matters. Also, the steps to register the vehicle were likely taken by the dealer and it is not clear that Mr. Nadarajah had input into the decision to register it in his name rather than the corporation's name.
[8] Looking at the evidence as a whole, I am satisfied on a balance of probabilities that the vehicle was beneficially owned by the corporation. As the respondent accepts that the corporation is entitled to capital cost allowance if it owns the vehicle, I find that the corporate appellant succeeds on the capital cost allowance issue.
[9] I now turn to the issue of whether the corporate income has been underreported. The Canada Revenue Agency used a net worth analysis of Mr. Nadarajah and concluded that the corporation had failed to report income. A net worth analysis is used by the Agency when a taxpayer does not have sufficient books and records to verify the income reported on the tax return. The frailties of the net worth approach have been recognized in judicial decisions but it is accepted as an appropriate method if proper books and records are not kept. Presumably the reason for this is that the assessor has no other way to estimate the income earned. Based on the evidence presented, I agree with the respondent that a net worth approach is appropriate in this case because the appellant corporation's books and records are inadequate.
[10] The corporate appellant suggested in its notice of appeal, and the suggestion was repeated in closing argument, that it had provided all necessary "evidence" to the Canada Revenue Agency during the audit and that this "evidence" should be accepted. The appellant, which was represented by experienced counsel, did not present this evidence in court. It is not sufficient for the appellant to simply state that it has documentation available. In order to satisfy the burden of proof, the documentation must be introduced as proper evidence to the Court.
[11] Notwithstanding that there is insufficient documentation to support the corporate income reported in the return, the corporate appellant can still succeed in the appeal if it establishes on a balance of probabilities that the assessment is not supported by the net worth analysis undertaken by the Agency.
[12] One of the arguments that the appellant makes is that the net worth analysis is flawed because it uses the shareholder's net worth rather than the corporation's. In my view the Minister's approach is a reasonable one to take in the circumstances of this case because it is not possible to determine a net worth of the corporation.
[13] The Agency computed the corporation's income by adding to the income reported on the corporate tax return the annual increases to Mr. Nadarajah's net worth. The underlying assumption is that Mr. Nadarajah's net worth was sourced from income earned by the corporation and this is reasonable presumption to make in the absence of evidence to the contrary. I find the approach of undertaking a net worth analysis of the sole shareholder to be appropriate in the circumstances.
[14] Before looking at particular items in the net worth analysis, I would comment first about a matter of timing. The corporation's taxation year did not coincide with the calendar year and therefore the corporation's income had to be computed for 12 month periods commencing March 1.
[15] This meant that the shareholder's net worth similarly had to be computed for 12 month periods commencing March 1. However, the auditor did not do this. Instead the auditor did a net worth determination of the shareholder for calendar years and then pro-rated the results to determine a net worth for periods coinciding with the corporation's taxation year.
[16] It is not clear to me why the Agency did the calculation in this manner. I do not think that anything turns on this, however, because the appellant did not establish that the income was overstated as a result.
[17] I now turn to specific items that the appellant suggests should be taken into account in the net worth analysis. The items are described in Exhibit A6 in the following manner: investments, RRSP loan, automobile, money from father, private loan, and food expenses.
[18] Exhibit A6 is a series of charts that is intended to show that the corporation's income as reported in the tax returns is fairly consistent with the shareholder's net worth if the net worth calculations are adjusted to take into account the items suggested by the appellant. I will consider each of the items in turn.
[19] The first item is the RRSP loan. The question to be determined is whether Mr. Nadarajah's net assets should be reduced to take into account loans totalling $4,000. The appellant suggests that these loans were incurred by Mr. Nadarajah in order to finance contributions to RRSPs. The auditor did not take the liability into account as no documentation was provided. The documentation was provided at the hearing, however.
[20] In my view the appellant has made a prima facie case for taking these loans into account. The respondent suggests that there may be a timing problem because the loans were obtained after the year end. However, the respondent has not provided sufficient evidence to show that the timing of the loans is a problem. I find that the appellant has satisfied the onus with respect to the RRSP loans.
[21] The second item is the automobile. The net worth calculation by the auditor assumed that the Nissan Pathfinder was owned by Mr. Nadarajah. For the reasons above I have concluded otherwise. The respondent concedes that the automobile and the related principal amount of the financing should be removed from the net worth calculations if I find that the automobile is owned by the corporation. Because of this concession, it is not necessary for me to consider this issue further. The net worth calculations should be adjusted to remove the Nissan Pathfinder as an asset of Mr. Nadarajah and the principal amount of the Nissan financing should similarly be deleted. The net worth calculations also take into account the payments of interest on the Nissan financing. To be consistent, I find that the interest payments on the Nissan financing should similarly be deleted from the net worth calculations.
[22] I turn now to food expenses. Under the net worth computation, Mr. Nadarajah's net worth is increased by estimates for personal expenditures. The question is what amount should be taken into account for food. The appellant first proposed to the Agency that Mr. Nadarajah's annual expenditures on food were $3,600 and the auditor accepted this figure. The appellant later suggested to the Agency that the figure should be reduced to $2,400 per year. The question is whether this reduction should be made.
[23] I have concluded that the appellant has not established a prima facie case for reducing the amount assumed for food expenditures, which is $3,600 per year. I accept the appellant's position that Mr. Nadarajah's food expenditures would be less than for other families because he operates a grocery store but the appellant has not provided a reasonable basis for me to choose one figure over the other. In the circumstances, there is no basis for me to conclude that there is an error with the net worth calculations in regard to food expenditures.
[24] I now turn to an issue dealing with amounts withdrawn from Mr. Nadarajah's personal bank account. The question is whether these withdrawals should be included in computing Mr. Nadarajah's net worth. The item at issue is identified at Tab 1 of Exhibit R2 as "investments/unidentified withdrawals." The amounts at issue are $3,400 for 1998, $42,100 for 1999 and $32,000 for 2000.
[25] The basis for including these amounts in the net worth analysis is stated in a footnote in the relevant schedule. I am going to quote the footnote because it sets out the Minister's rationale for adding the amounts to Mr. Nadarajah's net worth.
[26] The footnote reads:
Some items have been allowed. For settlement purposes, we have deleted those cheques which can be identified as being issued to a supplier. We do not find the documents provided sufficient to show a business connection on some of the withdrawals discussed. No evidence has been provided to link the rest of the withdrawals to the business.
[27] The appellant submits that it is inappropriate to include these withdrawals in the net worth analysis because they all have some connection to the business except for one cheque that cannot be identified. The specific use of the withdrawals, according to the appellant, is:
1. Three of the withdrawals are cash withdrawals made for the purpose of depositing them into the business bank account.
2. Of the withdrawals by cheque, all but two of these are payments for supplies.
3. Of the two remaining cheques, one is a repayment of a loan obtained for business purposes and the other cannot be identified.
[28] The appellant submitted into evidence as support for this explanation copies of the bank statements for the withdrawals and the deposits into the business account and copies of most of the cheques. In addition, three individuals testified that they had received these cheques and they supported the appellant's explanation.
[29] The question that I have to decide is whether this evidence is sufficient to establish a business connection with the withdrawals. I have considered the evidence as a whole and concluded that it is not sufficient for me to draw this conclusion. My reasons are as follows.
[30] I will comment first on the transfer of funds between bank accounts. The appellant presented bank statements that show withdrawals from the personal account and deposits into the business bank account around the same time. The main problem that I have with the suggestion that these withdrawals were used to make deposits into the business bank account is that the deposits were in large amounts but the actual bills were in different denominations and that were not large.
[31] The deposits are more consistent with a deposit from a cash register. For example, one of the deposits is for $10,500 on December 14, 1999. According to the testimony, $10,000 of this amount was withdrawn from Mr. Nadarajah's bank account the same day. The deposit is in the following denominations: 23 $10 bills, 361 $20 bills, 28 $50 bills and 12 $100 bills. It makes no sense that one would withdraw an amount in these denominations in order to deposit these funds into another account.
[32] As for the withdrawals by cheque, there was no documentary evidence to support the oral testimony that most of the cheques were payments for supplies. Neither the appellant nor the suppliers that were called to testify produced any invoices or other documentation.
[33] Further, the testimony regarding the payments to suppliers left many questions unanswered. The cheques were for even figures between $5,000 and $15,000. It is not suggested by the appellant that these were payments for specific invoices. The testimony was that the payments did not match with a particular invoice and that this is how business is traditionally done in Mr. Nadarajah's home country which is Sri Lanka. It was stated that the business depends on trust and there is very little documentation. If that is true, the question that remains is how people manage to keep the accounts straight. How does one know how much is owing at a particular time? The testimony was not sufficiently detailed to provide a satisfactory explanation as to the business was actually conducted. In general, I found the testimony to be too vague and not detailed enough to be convincing.
[34] Looking at the evidence as a whole, I conclude that it falls far short of satisfying me that the withdrawals should be removed from the net worth calculations.
[35] I now turn to an item referred to as money from father. The net worth analysis included an amount of $7,500 which was a cheque received from a supplier, Mr. Sivalingam.
[36] The appellant suggests that this amount represents part of a loan of approximately $24,000 that was advanced to Mr. Nadarajah by his father in Sri Lanka. The appellant suggests that the net worth statement should be adjusted to reflect this liability.
[37] In support of its position, the appellant submitted into evidence a letter signed by Mr. Sivalingam that indicated that these amounts were owing to Mr. Nadarajah's father and that the father directed that they be paid to his son. In addition, Mr. Sivalingam gave oral testimony.
[38] I have concluded that I cannot accept this evidence. First there were some inconsistencies between the evidence of Mr. Nadarajah and Mr. Sivalingam, such as the time at which they first became acquainted. Secondly, the testimony by Mr. Sivalingam was quite brief and there was not a detailed explanation of the arrangement between Mr. Sivalingam and the father. Further, on cross-examination Mr. Sivalingam backed away from the accuracy of the letter that he had signed. When Mr. Sivalingam had difficulty on cross-examination in explaining the letter, he stated that he did not write it. It is a serious matter for the appellant to provide evidence by way of a signed letter without the person who signed the letter being able to vouch for its accuracy. If Mr. Sivalingam did not have sufficient knowledge of the English language to stand by the letter, then it should not have been offered into evidence. For these reasons, I conclude that there should not be an adjustment to the net worth statement for a loan of $7,500 from Mr. Nadarajah's father.
[39] The last item that I need to consider is an amount identified as a private loan. The appellant submits that it received a loan of $25,000 from a Mr. Suhdev and that Mr. Nadarajah's net worth should be decreased by this amount. Mr. Suhdev did not testify and there was nothing to corroborate the loan other than a copy of a certified cheque for $25,000. There is not a sufficient evidentiary basis on which I can reasonably conclude why this money was given to the appellant. There was no documentation supporting the loan or any repayments of the loan.
[40] As a general comment, I would note that one of the main arguments that the appellant made in this appeal is that there is a plausible explanation for the lack of documentation in this case because it is typical of business practices in Sri Lanka where Mr. Nadarajah lived before coming to Canada. Even if I were to assume that there is a plausible explanation for the lack of documentation, this does not assist the appellant. Our whole system of taxation is founded on the principle of self-assessment and taxpayers are required to keep sufficient documentation so that their income can be verified on audit. The requirement to keep adequate records is mandated by the statute and if a corporation fails to keep adequate records, it is no excuse to say that it has a different way of conducting business.
[41] In the final analysis, the only adjustments to the net worth calculations used for purposes of the assessments that are appropriate are adjustments for RRSP loans totalling $4,000 in 2000 and to remove the entries with respect to the Nissan Pathfinder and related financing, including interest. In other respects, the net worth analysis is upheld.
[42] In conclusion, the appeal will be allowed and the assessments will be referred back to the Minister for reconsideration and reassessment on the basis that the appellant is entitled to capital cost allowance with respect to the Nissan Pathfinder vehicle and that the net worth calculations should be adjusted to take into account the RRSP loans of $4,000 and to remove the entries related to the Nissan Pathfinder, and related financing, including interest.
[43] As success in the appeal was divided and as the matter was heard under the Court's informal procedure, there will be no order as to costs.
Signed at Toronto, Ontario, this 28th day of March, 2006.
Woods J.
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