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Citation: 2005TCC77
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Date: 20050208
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Docket: 2002‑2173(GST)G
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BETWEEN:
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JILLY CREATIONS INC.,
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Appellant,
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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
Lamarre
Proulx, J.
[1] This
appeal concerns an assessment made under the Excise Tax Act
(the "Act") for the period from November 1‑30, 1999.
The assessment is dated May 10, 2002, and the notice thereof bears
number 03110197 (Exhibit I‑1, Tab 8).
[2] The
dispute is about the deduction, in the calculation of net tax, of an amount of
$59,786.62 by reason of a bad debt expense incurred by the Appellant. The deduction
was made pursuant to section 231 of the Act.
[3] A
reassessment dated January 26, 2001, had denied a claim for a deduction
of $88,194.73 (Exhibit I‑1, Tab 2). At the objection stage, a deduction
of $20,150.92 was allowed by the assessment dated May 10, 2002.
Subsequent to this assessment, an additional deduction of $8,257.19 was allowed
(Exhibit A‑3), which explains the current amount at issue.
[4] The
Appellant maintains that the bad debts came about through a fraud perpetrated
against it by an employee.
[5] According
to the Respondent, the Appellant has not demonstrated by way of supporting
documentation the quantum and identity of the bad debts, in accordance with
section 231 of the Act.
[6] Berny Fersten,
president of the Appellant, explained that the Appellant was part of a group of
nine companies operating in the textile industry. The Appellant
manufactures women's and children's clothing. Each company keeps its own
records. The Fersten Group began doing business around 1967. In 1990,
the Group's annual sales totalled approximately 40 million dollars. The
Appellant's sales were in the neighbourhood of six to eight million. It
had more than 200 employees; however, most of these employees also worked
for the other companies. There were inter‑company expenses.
[7] Around
nine or ten individuals, including the comptroller, the accounts receivable and
accounts payable clerks, the payroll clerk and the computer technician, took
care of the administrative side of things.
[8] Mr. Fersten
explained that in 1999 he received a telephone call from his banker, who
expressed some uneasiness about the accounts receivable. The bank was asking
why companies like Zellers, Kmart and Eaton, which usually pay within 30 or
40 days, still owed money after two or three months.
[9] Initially,
Mr. Fersten asked his outside accountant to try to find an explanation for
this state of affairs; however, the accountant was unable to do so.
[10] At the bank's insistence that the Appellant bring in an expert in forensic
audits of records, Mr. Fersten contacted Bessner Gallay
Schapira Kreisman. Philip Levi and Brian Kreisman conducted the
investigation.
[11] Their report was produced as the seventh document in
Exhibit A‑1. It is dated December 1999. The report concludes as
follows:
On the basis of the evidence
examined by us and the confession made by Louise Bennett, we are of the
opinion that the total amount embezzled by the Bennetts amounted to the
total purchased by them, which we have calculated to be $496,924.69.
[12] A confession signed by Louise Bennett is attached to the report.
She admits to embezzling funds totalling approximately $250,000 by directing
customer payments and applying them against her own account and her husband's.
Mrs. Bennett was responsible for accounts receivable.
[13] Mr. Fersten stated that Irving Zwirek, the comptroller,
supervised Mrs. Bennett. Mr. Zwirek apparently retired one year
before the fraud was discovered. Mr. Gold replaced him. Mr. Fersten
explained as well that Mr. Pace, who had met with the auditor from
Revenu Québec, was only in charge of computer systems. He was in no way
responsible for accounts receivable.
[14] Counsel for the Appellant referred to document 8 in
Exhibit A‑1, entitled "Jilly Originals Receivables as at
October 31st, 1999 over 180 days to be written off." It
is on this 137‑page document, apparently compiled by Mr. Levi, that the
claim in this appeal is based.
[15] According to Mr. Fersten, the document reveals the unpaid
amounts. The total of these amounts, which appears on page 137, is
$1,259,422.28. This amount was deducted as bad debts in computing the
Appellant's income. Mr. Fersten says that the Appellant claimed the deduction
on the advice of its accountants and at the bank's request.
[16] According to the witness, this is a case of bad debts because, if the
Appellant requests payment of these debts from the companies indicated in
connection with the amounts due, these companies reply that they have already
paid the amounts in question and they provide proof thereof. The amount of tax
on the $1,259,422.28 was $82,392.11.
[17] Document 9 is a letter from the office of Quebec Attorney General's
prosecutors, to which are attached the minutes of a judge's decision and an
indictment. The letter is dated September 23, 2004; the indictment
and plea are dated May 3, 2004. The indictment is against Louise
Bennett and states in particular that between December 4, 1992, and
June 21, 1999, she fraudulently appropriated a sum in excess of
$5,000. She pleaded guilty to that charge.
[18] With regard to the Appellant, Jilly Originals Inc., Mrs. Bennett
was charged with theft of $5,000. She pleaded guilty to that charge.
[19] On cross‑examination, the witness acknowledged that, as president,
he received monthly reports from Mr. Zwirek, the comptroller of the
companies in the Group. Counsel for the Respondent referred him to the auditor's
report, produced at Tab 6 of Exhibit I‑1, and more particularly
to the passage in which the auditor reports the words
of Richard Pace, the person who met with her at the Appellant's
office:
[translation]
We told Mr. Pace that there
are written‑off debts for which GST has been claimed, although, at the
time, the ETA had not even come into effect yet. The net amount would represent
approximately $753.06 in GST claims to be disallowed. For the rest, we pointed
out to him that the companies shown in the document are large store chains, the
majority of which are still operating. We asked him what steps Jilly Creations Inc.
takes to recover its accounts receivable dating back a number of weeks. He told
us that there are no measures taken for collecting overdue accounts. No one is
assigned to that duty; at most, customers behind in their payments may be
telephoned; however, no follow‑up takes place. For questions relating to
the submitted document, he referred us to his outside firm, as he was unable to
answer our questions on that subject.
[20] Mr. Fersten repeated that Mr. Pace was not the appropriate
person to answer questions concerning internal collection procedures. Counsel
asked him whether he had any examples of attempts that were made to collect bad
debts. Mr. Fersten referred to Exhibit A‑2, which is a copy of
Mr. Fersten's affidavit in support of a motion to extend the time for filing
a claim in the context of a proposed arrangement with regard to Eaton. A law
office was handling this motion. Paragraph 5 of this affidavit reads as
follows:
5. Jilly sold and delivered
children's clothing to Eaton's from time to time. Eaton's is indebted
to Jilly for the children's clothes in the amount of $30,682.65. Attached
hereto to this my Affidavit and marked collectively as
Exhibit "B" are true copies of the invoices rendered by Jilly
to Eaton's, which remain unpaid.
[21] This paragraph indicates that Mr. Fersten attached to his affidavit
copies of invoices totalling $30,682.65 which remain unpaid. These invoices
were not attached to Exhibit A‑2. The Appellant or counsel for the
Appellant said that these documents would be sent to the Court but they were
not.
[22] Mr. Kreisman is a chartered accountant. He stated that in 1999
Philip Levi received a request from Mr. Fersten concerning a problem
with the accounts receivable. Mr. Levi asked Mr. Kreisman to help him
with the investigation. They co‑authored the report that was produced as
document 7 in Exhibit A‑1 and is entitled "The
Fersten Group — Special Report".
[23] They came to the conclusion that the employee responsible for accounts
receivable had succeeded, over a number of years, in defrauding the company of
a total amount of some $500,000. She apparently took monies received from other
customers and applied them against her personal account and her husband's
account. No one ever saw any cheques written by the employee or her
husband in payment of their invoices, and these totalled $500,000. Neither did Mr. Levi
and Mr. Kreisman trace any cheques.
[24] On page 11 of their report they established that the employee had
definitely embezzled a sum of $43,855.14. Based on this proof of embezzlement,
since there was no indication of any payments by Mr. and Mrs. Bennett
themselves, it was logical to conclude that their accounts were paid with
monies embezzled by the employee, Mrs. Bennett. As indicated on
page 9 of the report, the amount involved totals $496,924.69. This is the
amount of fraud they were to some extent able to substantiate. Of this amount,
$446,058.46 was attributable to the Appellant, $34,509.15 to Tops "R" Us Inc.
and $16,357.08 to Fersten Headwear Inc. Mrs. Bennett used a
defrauding technique called "kiting", which apparently consists in
taking money from one account and placing it in another account. She did
not actually take any money; however, she did obtain merchandise without having
to pay for it.
[25] The financial statements for the year ending on
November 30, 1999, were filed as document 10 in Exhibit A‑1.
Page 4 shows a deduction for bad debts in the amount of $740,004 for 1999
and of $403,444 for 1998. The witness stated that he was not involved in
the preparation of the financial statements; it was, however, their firm that
had prepared them. Mr. Kreisman had the opportunity to review the relevant
files at his office the day before the hearing. The amount of $740,004 includes
a deduction of $645,000 relating to the alleged bad debts concerned in
this appeal. For 1998, the amount of $403,444 includes a deduction of $330,000.
Thus, the amount of $1,300,000 was split over the two years 1998 and 1999, and
there is another charge somewhere in the 1998 financial statements.
[26] With regard to document 8 in Exhibit A‑1, on which the
claim herein is based, the witness clearly stated that no one could find a
semblance of logic to this document. He was unable to explain it.
[27] Auditor Sylvie Dontigny, whose report appears in Tab 6
of Exhibit I‑1, explained that the audit period was from
November 1, 1999, to November 30, 1999, because the deduction
claim at issue fell within that period. Her audit began on
April 4, 2000.
[28] She telephoned the Appellant to make an appointment with the
individual who was responsible for the accounting and who would be able to provide
her with information concerning the Appellant's return for November. It was Richard Pace
who met with her.
[29] The deduction claimed following the write‑off of some bad debts was
$88,000. The auditor asked to see proof of those bad debts. Mr. Pace
provided her with document 8 in Exhibit A‑1, the 137‑page document.
He told her that, to obtain answers to her questions, she would need to call
the outside accountants who prepared the document.
[30] She was surprised by the fact that, on the face of the document, the
companies whose debts were written off were still in business, with the exception
of Eaton. Even for Eaton, no claim was included on the list of creditors. She
wondered how bad debts could be claimed for companies that were still in
existence and reputed to be good payers. Furthermore, in the document, there
were amounts that predated the coming into effect of the GST. In addition, a
number of the amounts were statute‑barred given the dates on which the
claims therefor arose.
[31] Even so, the auditor attempted to understand the document. She asked
the accountants to provide her with the vouchers that gave rise to the entries.
She proceeded by way of a sampling. What was provided to her did not prove
anything. The invoices had been paid. She asked for the registers of accounts
receivable by customers. That information was not located or else simply not
provided to her.
[32] The auditor was given no evidence of any collection measures having been taken
concerning these supposedly outstanding debts.
[33] At the objection stage, the Minister accepted the report produced as
document 7 in Exhibit A‑1. He considered the debts of
Louise Bennett and those of her husband to be bad debts, as determined in
the report.
Analysis and conclusion
[34] In the present case, document 8 in Exhibit A‑1 forms
the basis for the claim for a deduction for bad debts in the computation of net
tax. Mr. Kreisman, a chartered accountant, stated that document 8
made no sense and he refused to comment on it. He was not the person who prepared
it. In the case of the 1998 and 1999 financial statements, however, while it
was not he who had prepared them, he was able to explain their content, as he
had informed himself on the subject at his office the day before. Nor is there
anything in writing by the person who prepared document 8 that explains
its nature as being that suggested by the Appellant. Furthermore, the document turned
out to be incomprehensible to the auditor as well, in spite of all her efforts.
[35] In addition, various strange facts are noteworthy in this case.
Mr. Fersten stated that Mr. Pace, who met with the auditor, knew
nothing about the Appellant's accounting. Why then did the comptroller not see the
auditor? It should also be noted that neither of the two comptrollers was in
Court to testify and explain the absence of information regarding the accounts
receivable. There is no evidence that an effort was made to collect the bad
debts. The motion for an extension of the time for filing a claim in the Eaton
case, in Exhibit A‑2, is dated February 9, 2001, which is two years
after the deduction claim at issue.
[36] Subsection 231(1) of the Act reads as follows:
231(1) Bad debts — Where a person has made a taxable supply
(other than a zero‑rated supply) for consideration to a recipient with
whom the person was dealing at arm's length, to the extent that it is
established that the consideration and tax payable in respect of the supply
have become in whole or in part a bad debt, the person may, in determining the
net tax for the person's reporting period in which the bad debt is written off
in the person's books of account or for a subsequent reporting period, deduct
the amount determined by the formula
A x B/C
where
A is the tax payable in respect of the supply,
B is the total of the consideration, tax and
any amount that can reasonably be attributed to a tax imposed under an Act of
the legislature of a province that is a prescribed tax for the purposes of
section 154 (referred to in this section as "applicable
provincial tax") remaining unpaid in respect of the supply that was
written off as a bad debt, and
C is the total of the consideration, tax and
applicable provincial tax payable in respect of the supply,
provided the person reports the tax collectible in
respect of the supply in the person's return under this Division for the
reporting period in which the tax became collectible and remits all net tax, if
any, remittable as reported in that return.
[37] Subsection 231(1) of the Act provides that where a person
has made a taxable supply for a consideration, to the extent that it is
established that the consideration and tax payable have become in whole or in
part a bad debt, the person may, in determining the net tax, deduct the tax
payable but not paid. That subsection sets out the conditions to which a claim
for such a deduction is subject.
[38] A supplier of goods and services is required first of all to refer the
Minister to an invoice or to any satisfactory evidence establishing that an
amount of tax billed to a recipient was not paid by that recipient. On the
evidence in this appeal, the Appellant failed to get beyond this initial step.
[39] Second, the deduction may be claimed for the reporting period in which
the supplier wrote the debt off in the supplier's books because it had become a
bad debt. The Minister may require proof that it was in fact a bad debt.
[40] A third condition is that the supplier have reported the tax
collectible in a return filed for the reporting period in which the tax became
collectible and have remitted all net tax reported in that return.
[41] In Equinox Realty Ltd. v. Canada, [1997] T.C.J.
No. 1210 (Q.L.), Judge Mogan of this Court made the following
statement:
7 In my opinion, the Appellant cannot succeed
in this appeal because the Appellant did not satisfy the basic condition in
subsection 231(1) which might otherwise permit the deduction. That basic
condition is expressed in the last few lines of the subsection immediately
following the formula; and the important words are:
... provided that the person reports the tax
collectible in respect of the supply in the person's return under this Division
for the reporting period in which the tax became collectible and remits all net
tax, if any, remittable as reported in that return.
[42] In Ciriello v. Canada, [2000]
T.C.J. No. 829 (Q.L.), Judge Rip of this Court said the following:
3 Mr. Ciriello also claims that the Minister
did not give credit to R&V for bad debts. No evidence was led by the
appellant with respect to the bad debts. For R&V to receive a refund or
adjustment of tax subsection 231(1) of the Act requires that not only
must the taxpayer have made a taxable supply in the course of a commercial
activity and for consideration, but also that the taxpayer have filed a return
accounting for and remitting tax under Division II in respect of that supply;
finally, the consideration and
[43] As previously mentioned, subsection 231(1) of the Act
allows the recovery of amounts of tax that a recipient was charged but did not
pay. Such amounts must however be proven. In the present case, not only are
there no relevant invoices, there are no registers of accounts receivable by
customers either. We do not know who the debtors are or the amounts of their
respective bad debts. The Appellant's president said that requests for payment
had been made but the recipients' response was that they had already paid. He
complained of a fraud scheme set up by an employee.
[44] It must be understood that the purpose of section 231 of the Act
is, unfortunately, not to refund a supplier of goods and services amounts of
tax that were paid to the supplier by recipients and subsequently apparently
stolen on the supplier's premises.
[45] Reference must also be made to section 286 of the Act,
which obliges every person who is required to file a return and every person
who applies for a rebate or refund to keep records in such form and containing
such information as will enable the establishment and determination of the
person's obligations and of any rebate or refund to which the person may be
entitled.
[46] For all these reasons, the appeal must be dismissed with costs.
Signed at Ottawa, Canada, this 8th day of February 2005.
Lamarre Proulx J.
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