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Citation: 2005TCC314
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Date: 20050505
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Docket:2003-3693(GST)I, 2003-3694(IT)I
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2003-3695(GST)I, 2003-3696(IT)I,
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BETWEEN:
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HARALD KERN,
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and ELKE KERN
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Appellants,
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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
Miller J.
[1] These informal procedure appeals
by Harald and Elke Kern are from assessments by the Minister of
National Revenue (the Minister) under section 227.1 of the
Income Tax Act and section 323 of the Excise Tax
Act, assessing Mr. and Mrs. Kern as directors of 457189 B.C.
Ltd. (the Corporation). There are two issues common to both the
income tax and the excise tax appeals: first, have the Kerns
proven the defence of due diligence to escape liability as
directors; second, if not, can the Kerns attack the correctness
of the underlying assessment against the Corporation to reduce
their liability? I am convinced that the Kerns did not act with
due diligence and they are therefore liable pursuant to section
323 of the Excise Tax Act and section 227.1 of the
Income Tax Act. The question is, liable for how much, as I
find the Kerns can attack both underlying assessments. I conclude
that for the period 1997 to 1999, the Minister incorrectly
assessed the goods and services tax (GST) pursuant to the
Excise Tax Act, but correctly assessed the Corporation for
source deductions pursuant to the Income Tax Act.
Facts
[2] The Corporation acquired a 57-room
ocean front hotel (the Hotel) in Cowichan Bay, British Columbia
in 1997. Mr. and Mrs. Kern were directors of the Corporation at
the time and remained so throughout the relevant period.
Mr. Kern had some previous experience operating a hotel,
having owned an inn in Campbell River. The Hotel had a restaurant
on the fifth floor and a beer and wine store on the third
floor.
[3] Mr. Kern acknowledged that the
Hotel had financial problems from the outset, in what he
described as a very competitive, tough industry. He cited the
example of the hot water boiler requiring $25,000 of repairs just
a couple of days after acquiring the Hotel. He admitted he was
overwhelmed by the daily problems of running the place - problems
that continued for three years. The Corporation never showed a
profit while under the Kerns' control.
[4] In January 1998, Mr. Kern claims
to have leased the restaurant to Cherry Point Food Services,
operated by Kurt Brown and Mary Carlson. Mr. Kern produced a
one-page photocopy of what appears to be the first page of a
lease of the restaurant commencing January 18, 1998 for a term of
five years. The Respondent has accepted this arrangement, as
restaurant sales were not included in the Corporation's GST
calculation for 1998 and 1999.
[5] Mr. Kern also claims to have
leased the beer and wine store in April 1998 to a British
Columbia numbered company, 546401 B.C. Ltd. (546), again
producing a photocopy of a lease, dated April 14, 1998, signed by
Mr. Kern on behalf of the Corporation and Ms. Bjarnetson, on
behalf of the tenant, 546. Ms. Bjarnetson also worked the
front desk of the Hotel for the Corporation. The Respondent,
although agreeing a lease was signed, requests that I give little
or no weight to such lease, because the Corporation continued,
according to the Respondent, to report beer and wine sales in its
financial statements. The Canada Revenue Agency (CRA) auditor
also testified that from a review of the Corporation's
banking records, monies for 546 were deposited in the same bank
account as the Corporation's deposits.
[6] The Corporation's financial
woes were such that in 1999 Mr. Kern was considering several
different scenarios as to how to create a profitable operation,
including the possibility of a time-share setup. He deemed this
appropriate given there were already separate titles to the rooms
in a condo-like arrangement. Mr. Kern testified that he had
financial worksheets prepared to be included in a prospectus. No
preliminary prospectus was tendered in evidence. These financial
worksheets, he said, were inadvertently faxed to CRA. In fact,
worksheets for 1997 and 1998, which appear in the form of annual
income statements, and which the Respondent refers to as the
Corporation's financial statements, were attached to the
Corporation's 1997 and 1998 tax returns filed in January
2000. The worksheets, or financial statements, for 1999, were
monthly income statements; it is unclear exactly how the 1999
statements came into the hands of CRA. All these statements
include income from the beer and wine store, but the 1998 and
1999 statements do not include revenue from the restaurant. The
1998 statements show beer and wine revenues of $376,555, but an
overall loss from the Hotel operation of $251,336. This figure
was reported on the Corporation's 1998 tax return. While Mr.
Kern admits signing that return, he maintains he did not prepare
nor file it, but it was most likely filed by the Receiver, who
was appointed in early 2000.
[7] A 1999 tax return was not
produced, though, as indicated, a monthly statement for each of
the first nine months of 1999 was tendered in evidence in a
similar format to the 1997 and 1998 annual statements. The
heading of these statements varied: the 1997 and 1998 statements
were headed with the name of the Corporation, while the monthly
statements for 1999 were under the Hotel's trade name.
Further, the nine monthly statements for 1999 showed over
$400,000 profit.
[8] Mr. Kern presented bank statements
for the first quarter of 1997, all of 1998 and three quarters of
1999. The Respondent asked that I give such evidence little or no
weight as they are not supported by accounting documents
necessary to establish their relevance. Yet, for 1997 and 1998 it
appears the bank documents support Mr. Kern's assertions as
to the correct revenue figures, not including beer and wine
sales. The figures provided by Mr. Kern for the last quarter of
1999 appear to relate to revenues of 546, the company operating
the beer and wine store. These figures suggest revenues of
approximately $33,000 a month for beer and wine sales, which is
not far off the average of $38,000 a month for beer and wine
sales shown on the 1999 monthly income statements for the first
nine months of 1999.
[9] During 1999, Mr. Kern realized he
needed an additional $400,000 to stay afloat. He could not raise
the money, and in December the bank started foreclosure
proceedings. In January 2000, a Receiver was appointed. In
February, the Receiver shut down the Hotel but continued to run
the restaurant and the beer and wine store.
[10] With respect to the day-to-day
operations and management of the Hotel, it was clear Mr. Kern was
more involved than his wife. He spent three or four days a week
at the Hotel. He had a desk near the front office where books and
records were kept, although there appeared to have been little in
the way of books and records. There were no separate accounts for
payroll or GST and no list of employees. Mr. Kern claims he
calculated GST remittances, but someone else looked after T4s;
likely the people working at the front desk. He mentioned that
Ms. Bjarnetson was one of those who worked at the front desk. He
claimed that four employees, whose source deductions were paid by
the Corporation, were in fact employees of the beer and wine
store, not of the Corporation. Mr. Kern did not seek
assistance or professional accounting services in attending to
his books.
[11] Mr. Randy Young, the CRA auditor,
testified that he audited the Corporation commencing in May 2000
and continuing until March 2001. The only original books and
records he was able to obtain were documents contained in four
boxes from the Receiver pertaining to the 1997 taxation year.
Included in these materials was the 1997 daily revenue summary.
Mr. Young reviewed the last three months of 1997 and determined
there was a $17,000 discrepancy between what was reported by the
Corporation and what was actually collected as GST. He also
reviewed a provincial sales tax audit conducted by the British
Columbia authorities, who had in turn reviewed the
Corporation's bank deposits. Mr. Young concluded that
the Corporation had understated its GST liability by
approximately $48,000 for the 1997 year.
[12] For determining the GST liability for
1998, Mr. Young again considered the provincial audit, as well as
relying on the financial statements, mentioned earlier, filed by
the Corporation with the 1997 and 1998 income tax returns. He
concluded there was a GST shortfall of $1,137. Mr. Young also
spoke to Ms. Bjarnetson who advised him the GST filings went
through the numbered company (it was unclear from Mr. Young's
testimony which numbered company Ms. Bjarnetson might have been
referring to).
[13] Mr. Young likewise relied on the 1999
monthly financial statements for his 1999 findings, reaching the
following conclusions of GST shortfalls: for the first quarter of
1999, $10,939; for the second quarter, $18,593; and for the third
quarter, $20,144. Mr. Young's testimony of the GST liability
for 1999 differed from that assessed, which was as follows: for
the first quarter, $7,424; for the second quarter, $29,166; for
the third quarter, $24,227 and for the fourth quarter, $12,500.
The Respondent's written explanation was:
... The variance is the result of adjustments made by the
CCRA in the period between January 5, 2001 and February 27, 2002.
When input tax credits were reported in one taxation period, that
credit was applied to GST owing in another period. The $12,500
assessed in the period ending December 31, 1999 in the Notice of
Assessment was based on a notional assessment.
[14] With respect to payroll, CRA compared
employees' T4s with the Corporation's T4 summary,
concluding there were unremitted source deductions. Mr. Kern
accepts the Respondent's position vis-à-vis
source deductions for 1997, but objects to certain amounts in
1998 and 1999.
[15] With respect to the source deductions,
a certificate of registration for the Corporation's liability
was registered on January 8, 2001 in the Federal Court of Canada
in the amount of $36,618.59. The Federal Court issued a writ of
seizure and sale on June 8, 2001, which was returned unsatisfied
in whole on January 31, 2002. The Respondent has since
collected a significant amount towards this liability.
[16] At all relevant times, the Corporation
was registered under Part IX of the Excise Tax Act. On
June 6, 2001 a Certificate of Registration for the
Corporation's liability under the Excise Tax Act was
registered in the Federal Court of Canada in the amount of
$191,797.16, coincidentally with the issuance of a writ of
seizure and sale. On January 31, 2002, the execution was returned
to the Minister unsatisfied in whole. The Corporation never filed
an objection or appealed. On February 27, 2002, the Respondent
assessed the Appellants for the net tax remittable by the
Corporation of $122,617.35 plus penalties of $59,390.97 and
interest of $25,785.50 for a total of $207,793.82, as more
particularly set out in Schedule "A" attached to these
Reasons which was attached to the Respondent's Replies to the
Notices of Appeal.
Analysis
[17] This is a director's liability case
brought pursuant to section 227.1 of the Income Tax Act
and section 323 of the Excise Tax Act. Both these
provisions provide for a due diligence defence. I will address
that issue before dealing with the issue of the underlying
assessments.
[18] Mr. Kern did not strenuously argue that
he or his wife acted with such due diligence as to escape
liability. For good reason. The facts do not support such a
position. Mr. Kern was well aware of the financial difficulties
the operation was facing from the very start of his involvement,
yet he did nothing to establish systems or procedures to
safeguard the interest of the Government in receiving source
deductions and GST payments. Mr. Kern was not a novice in this
industry. He would have been well aware of the requirements, yet
he did not even engage an accountant to assist him. No separate
account was set up. There was not even an employee list. Mr. Kern
displayed a nonchalant attitude towards record-keeping to the
point of suggesting it was really the front desk staff
responsible for such matters. I find Mr. Kern did not exercise
the degree of care, diligence and skill to prevent the failure
that a reasonably prudent person would have exercised in
comparable circumstances. The test has well been established by
case law and Mr. Kern has failed to meet that test.
[19] What about Mrs. Kern? She did not
testify, but it was clear from Mr. Kern's testimony that
she was not actively involved. Indeed, Mr. Kern suggested that
Mrs. Kern did not care much for the place. She might have given
more thought to accepting the position of director in such
circumstances. She was a director. I agree with the comments of
Justice Marceau in Soper v. The Queen[1] where he stated:
Subsection 227.1(1) makes a director liable for the failure of
his or her corporation to remit the monies withheld as taxes and
other source deductions from its employees' salaries, and
subsection 227.1(3) relieves a director of his or her liability
if he or she can show that he or she exercised a certain degree
of care, diligence and skill to prevent such failure. By these
provisions, Parliament, I think, has imposed on a director of a
corporation a completely new, separate and positive duty. Such
duty is owed not to the corporation but to the Crown, and
consists of an obligation to do what one reasonably can to
prevent such failure from occurring. I simply cannot imagine that
such a duty may ever be seen as having been fulfilled by a
director who, as here, has never put his or her mind to the
requirement and has remained completely uninterested and passive
with respect to it.
Mrs. Kern has not fulfilled her duty by remaining completely
uninterested and passive. I find she too is liable.
Right to attack underlying assessments
[20] I turn now to the thorny issue of the
Kerns' ability to question the underlying assessments of the
Corporation. It is clear from a review of cases in this Court
dealing with a director's right to attack an underlying
corporate assessment in a section 323 Excise Tax Act case,
that there are opposing points of view. For those who believe
directors may not attack the corporate assessment, see for
example Schuster v. The Queen,[2] Maillé v. The Queen[3] and the
recent case of Zaborniak v. The Queen[4] (the
"con-position"). For those who believe the directors
may attack an underlying assessment, see Lau v. The
Queen,[5]
Weins v. The Queen,[6] and Parisien v. The Queen[7] (the
"pro-position"). The latter cases follow the lead of
the Federal Court of Appeal in Gaucher v. The Queen,[8] in
which the Court invoked the principles of natural justice:
[6] I am of the
respectful view that the Tax Court Judge was in error in coming
to this conclusion. It is a basic rule of natural justice that,
barring a statutory provision to the contrary, a person who is
not a party to litigation cannot be bound by a judgment between
other parties. The appellant was not a party to the reassessment
proceedings between the Minister and her former husband. Those
proceedings did not purport to impose any liability on her. While
she may have been a witness in those proceedings, she was not a
party, and hence could not in those proceedings raise defences to
her former husband's assessment.
[7] When the
Minister issues a derivative assessment under subsection 160(1),
a special statutory provision is invoked entitling the Minister
to seek payment from a second person for the tax assessed against
the primary taxpayer. That second person must have a full right
of defence to challenge the assessment made against her,
including an attack on the primary assessment on which the second
person's assessment is based.
[8] This view has
been expressed by Judges of the Tax Court. See, for example,
Actonv. The Queen (1994), 95 DTC
107, at 108 per Bowman, T.C.C.J.; Ramey v. The Queen
(1993), 93 DTC
791, at 792 per Bowman, T.C.C.J.; Thorsteinson v.
M.N.R. (1980), 80 DTC
1369, at 1372 per Taylor, T.C.C.J. While the contrary view
was expressed in Schafer (A.) v. Canada, [1998] G.S.T.C.
7-1, at 7-9 (appeal dismissed for delay (August 30, 1999),
A-258-98 (F.C.A.)), I am of the respectful opinion that such view
is in error. It seems to me that this approach fails to
appreciate that what is at issue are two separate assessments
between the Minister and two different taxpayers. Once the
assessment against the primary taxpayer is finalized, either
because the primary taxpayer does not appeal the assessment, or
the assessment is confirmed by the Tax Court (or a higher court
if further appealed), that assessment is final and binding
between the primary taxpayer and the Minister. An assessment
issued under subsection 160(1) against a secondary taxpayer
cannot affect the assessment between the Minister and the primary
taxpayer.
I wade into the debate on the side of the pro-position, not
just based on principles enunciated in Gaucher, but also
on the basis of statutory interpretation. The sections in issue
under the Excise Tax Act are subsections 228(1), 296(1)
and 323(1), (2) and (3)
228(1) Every person who is required to file a return
under this Division shall, in the return, calculate the net tax
of the person for the reporting period for which the return is
required to be filed, except where subsection (2.1) or (2.3)
applies in respect of the reporting period.
...
296(1) The Minister may assess
(a) the net
tax of a person under Division V for a reporting period of the
person,
(b) any tax
payable by a person under Division II, IV or IV.1,
(c) any
penalty or interest payable by a person under this Part,
(d) any
amount payable by a person under any of paragraphs 228(2.1)(b)
and (2.3)(d) and section 230.1, and
(e) any
amount which a person is liable to pay or remit under subsection
177(1.1) or Subdivision a or b.1 of Division VII,
and may reassess or make an additional assessment of tax, net
tax, penalty, interest or an amount referred to in paragraph
(d) or (e).
323(1) Where a corporation fails to remit an amount of
net tax as required under subsection 228(2) or (2.3), the
directors of the corporation at the time the corporation was
required to remit the amount are jointly and severally liable,
together with the corporation, to pay that amount and any
interest thereon or penalties relating thereto.
323(2) A director of a corporation is not liable under
subsection (1) unless
(a) a
certificate for the amount of the corporation's liability
referred to in that subsection has been registered in the Federal
Court under section 316 and execution for that amount has been
returned unsatisfied in whole or in part;
(b) the
corporation has commenced liquidation or dissolution proceedings
or has been dissolved and a claim for the amount of the
corporation's liability referred to in subsection (1) has
been proved within six months after the earlier of the date of
commencement of the proceedings and the date of dissolution;
or
(c) the
corporation has made an assignment or a bankruptcy order has been
made against it under the Bankruptcy and Insolvency Act and a
claim for the amount of the corporation's liability referred
to in subsection (1) has been proved within six months after the
date of the assignment or bankruptcy order.
323(3) A director of a corporation is not liable for a
failure under subsection (1) where the director exercised the
degree of care, diligence and skill to prevent the failure that a
reasonably prudent person would have exercised in comparable
circumstances.
[21] The director's liability only
arises after a company has demonstrated it cannot pay. Prior to
that time the directors are not liable, and obviously there can
be no assessment against them, against which a director can
object. Certainly the company can object and appeal, but,
practically, a company heading for insolvency is unlikely to do
so. Advocates of the con-position suggest that directors have the
right through the company to attack the corporate assessment and
thus indirectly deal with what might become an assessment against
them. But the directors and the company are distinct and separate
legal entities. I can imagine scenarios where a director may be
unaware of an appeal by the company of its assessment. Yet, must
he or she subsequently be bound by that assessment? I believe
this runs contrary to the basic rules of natural justice raised
in Gaucher.[9]
[22] Is it sufficient to rely on rules of
natural justice to counter the reasoning of Justice Bowie in
Zaborniak[10] in interpreting the legislation? Is the
language as unambiguous as Justice Bowie suggests? He
wrote:
4 In
enacting Part IX of the Act, Parliament made provision whereby
the liability of a registrant to pay net tax, together with any
interest or penalty, may be fixed by the Minister by means of an
assessment made under subsection 298(1). Section 299 is
carefully drafted to provide that the registrant's liability
is precisely fixed by any such assessment. It is deemed to be
valid and binding, subject only to either a subsequent
reassessment by the Minister, or being vacated following the
process of objection and appeal that is provided for in sections
301 to 307. The processes for objection and appeal are available
only to the person who has been assessed. The amount of net tax,
interest or penalty assessed, subject only to reassessment, or
vacating of the assessment as a result of an objection or an
appeal, is a debt due to Her Majesty in Right of Canada, and when
so certified by the Minister under section 316 the certificate is
deemed to be a judgment of the Federal Court.
5
... The liability that this section imposes on the
directors, jointly and severally with the corporation, is
"... to pay that amount and any interest thereon or
penalties relating thereto"; that amount, read in its
context in subsection 323(1), and having regard to the scheme of
subdivision e of the Act, can only mean the amount of net tax
that the corporation has failed to remit as required. Section 323
only permits the Minister to assess a director where that amount
is either an amount that is deemed to be a judgment debt for
which execution against the debtor has been returned unsatisfied,
or else a claim proved in liquidation or dissolution proceedings,
or in bankruptcy. In the present case it is a (deemed) judgment
debt.
...
7 To
find that the Appellants in this case have a right to dispute the
quantum of the judgment debt would require that I add to
subsection 323(1), by implication, the words "or such lesser
amount as the corporation might have been found liable to remit
following a successful appeal of its assessment". I simply
have no mandate to do that.
I prefer to approach the analysis starting, rather than
concluding, with the director's liability in
section 323. Subsection 323(1) renders a director liable for
the amount of tax required to be remitted under section 228. The
amount of net tax referred to in section 228 is an amount
determined at that stage by the Corporation. The Minister's
authority to assess is found in section 296: if the Minister
disagrees with the Corporation's determination, then the
amount of net tax assessed will obviously differ from the amount
of the determination made by the Corporation pursuant to section
228. Who determines then what is the correct amount or "that
amount" as referred to in subsection 323(1), for purposes of
director's liability?
[23] The Corporation is liable for the
amount determined by the Government, and such amount is a tax
debt due by the Corporation. But because one of the conditions
precedent in subsection 323(2) has been met, that does not
validate the Government amount as "that amount" for
purposes of subsection 323(1). The conditions set out in
subsection 323(2) are conditions precedent only; effectively,
timing provisions. They do not, by their very occurrence, justify
the Government's amount as the correct amount for purposes of
director's liability. If one of the conditions is met, a
director is liable for an amount, an amount in this case which
represents the Government's assessed amount - an amount not
subjected to judicial scrutiny. Clearly a company, by not
objecting on a timely basis, has foregone the right for that
judicial review; and does indeed have a certificate deemed to be
a judgment against it for a certain amount. But where does the
Act say that a director has foregone such a right? It does
not.
[24] In this case, the Government has
assessed the directors based on its unchallenged determination of
the amount required to be remitted under subsection 228(2). It is
a fact that the Government assessed that amount; it is a fact
that the Corporation did not object or appeal and is liable for
that amount; it is not a fact, however, that the assessed amount
under such circumstances is the correct amount to have been
remitted under section 228 for purposes of director's
liability pursuant to section 323. The amount for which the
directors are ultimately liable is the amount of net tax required
to be remitted under subsection 228(2), not the amount
certified and deemed a judgment against the Corporation where
there has been no challenge of that amount. Unless the assessed
amount has been judicially tested, the Government cannot fairly
impose its unchallenged assessment against third parties, the
directors, on the basis that "that amount" in section
323 reflects the correct amount of the unremitted net tax. I do
not believe one needs to imply any words into section 323 to
qualify "that amount" to mean something lesser than
assessed by the Government. The object of the exercise,
vis-à-vis the directors, is that they be liable for
the correct amount of unremitted tax; and if the company does not
take the steps to have that correct amount judicially determined,
then "that amount" remains open to be challenged by the
directors by an appeal to this Court.
[25] I recognize that this result, while
different from the result in Zaborniak,[11] does perhaps not go as far as
what might be drawn from Gaucher.[12] It must be left to the Federal
Court of Appeal to clarify how Gaucher is to apply to
director's liability pursuant to the Excise Tax Act.
The foregoing approach would not benefit the director, who, for
whatever reasons, is out of the loop and is unaware his company
has appealed and lost an assessment of its net tax owing under
the Excise Tax Act. Under those circumstances, I believe
the fact of the amount of net tax owed by the company has been
established; that is, "that amount" for purposes of
section 323 has indeed been determined, and the unaware director
is out of luck. The Gaucher case may throw a lifeline to
such a director; I do not have to make that determination in this
case.
[26] Relying solely on Gaucher may
provide broader opportunities for a director to attack an
underlying assessment. Relying on a statutory interpretation of
section 323, while considering principles of natural justice
leads to a somewhat narrower result. To be clear, if the
Corporation had appealed the assessment and lost, the directors
may well be precluded from attacking the assessment on a section
323 appeal, even if the director may have had no involvement in,
or even knowledge of the Corporation's appeal. In such a
case, resort may only be to principles of natural justice.
[27] Based on the reasoning in Gaucher,[13] and
similar statutory interpretation as outlined above, I would also
allow the Kerns to attack the underlying assessment under the
provisions of the Income Tax Act.
GST underlying assessment
[28] Having determined I can review the
underlying assessment, I turn first to the underlying GST
assessment. I believe there are two questions to be determined in
assessing the correctness of the Minister's GST assessment:
first, whether the Corporation's sales involve sales from the
beer and wine store; second, whether the annual financial
statements of 1997 and 1998 and the monthly income statements for
the first nine months of 1999 are to be accepted as accurate for
purposes of determining the GST liability.
[29] The Respondent relies heavily on the
fact that the 1998 financial statements filed with the
Corporation's 1998 return in early 2000 contained the beer
and wine sales figures. From this, the Respondent wants me to
conclude that the Corporation must include such sales in
calculating its GST liability. Contrary to that conclusion is the
fact that there was a lease between the Corporation and 546.
Also, there is evidence of bank deposits confirming that in the
last quarter of 1999, 546 recorded deposits of an average of
$33,000 a month. This compares reasonably to the monthly revenues
from the first nine months of 1999, which averaged approximately
$38,000.
[30] I also note Mr. Kern's comment that
"once you have a significant loss, the numbers for tax
purposes are somewhat academic". It was clear he cared
little about the accuracy of the income tax returns as no tax was
exigible. So, if those financial statements showed beer and wine
revenues that rightfully were revenues of another company, but
still led to no tax owing, Mr. Kern simply would not have
been concerned. This would especially be so if that other company
was related. Mr. Kern presented bank materials for 546: he
included revenues of that company in the overall operation. This
is consistent with a finding that Mr. Kern had some involvement
with both the Corporation and 546, notwithstanding that
Ms. Bjarnetson signed the lease on behalf of 546. This seems
a more plausible explanation as to why the two companies'
numbers were together on financial statements prepared by Mr.
Kern, than his story that the numbers, certainly for 1997 and
1998, were for prospectus purposes. I conclude beer and wine
revenues were not revenues of the Corporation, but of 546.
[31] The monthly 1999 income statements were
not tendered in evidence as having been attached to a 1999
return. The 1999 statements were no longer titled with the
Corporation's name (as in 1997 and 1998) but were headed
"Howard Johnson at the Water Income Statements". They
were prepared at a time (1999) when financial matters were a
serious problem for Mr. Kern. He needed to find an additional
$400,000. Yet the monthly figures shown on the monthly income
statements give revenues from the Hotel (not including beer and
wine sales) in July alone of $233,000. This is two-thirds
of all the revenues from the Hotel in all of 1998. Those
statements go on to show considerable profit. I find that these
monthly financial statements for 1999, unlike the yearly
statements for 1997 and 1998 which were filed with income tax
returns, are projections only. They do not accurately reflect
realistic Hotel revenues for the period. To extrapolate Hotel
revenues over the full 1999 year based on those figures would
yield revenues of approximately $1,150,000. Compared to the 1998
figures taken from the financial statements that the Respondent
wants us to accept, this represents an increase from
approximately $324,000 of revenue (not including beer and wine
sales) for 1998 to $1,150,000 for revenue (not including beer and
wine sales) in 1999. This simply does not make any sense for an
operation that was heading into insolvency. Yet this is what the
Respondent relies upon. I appreciate the Respondent was thwarted
by lack of originating accurate ledgers, books and records from
the Appellants. I also appreciate the Respondent relied to some
extent on the work of a provincial auditor, from whom I received
no direct evidence. Yet, an element of commercial common sense
suggests the numbers relied upon in 1999 by CRA are wildly out of
whack with reality.
[32] What then to conclude about a possible
correct assessment? I will deal in rough numbers, as it is clear
from both sides, accuracy is unattainable. First, I remove from
the GST calculation from April 1998 to December 31, 1999 the beer
and wine sales. For 1998, this would more than offset the amount
owing of $1,137.11. For 1999, this would result in a reduction of
approximately $24,000 for the first three-quarters of 1999, (that
is, 7% on beer and wine sales from statements of approximately
$343,000). With respect to the GST on the Hotel for the first
three-quarters of 1999, the Respondent assessed based on
additional sales over the reported sales of the Corporation, of
$526,000 from the Hotel alone (this is the $869,000 projected
less the $343,000 from beer and wine sales). This results in GST
of 7% on $526,000 or $36,820. Based on bank deposit information
provided by Mr. Kern, the Hotel operations in the first
three-quarters of 1999 yielded approximately $450,000, which is
approximately what the Corporation reported. Those figures are
more in line with the two prior years' revenues, but still
represent some increase in revenues in 1999. I find the
additional extra half-million revenue set forth in the 1999
income statement was a fiction, and should not have been relied
upon by the Respondent.
[33] With respect to the last quarter of
1999, the only evidence from Mr. Kern appears to relate to beer
and wine sales of 546. Further, Mr. Young, the CRA auditor, gave
no evidence as to how the $12,500 tax liability was derived,
though the Respondent's counsel suggested it was a
"notional assessment". If revenue figures for the last
quarter of 1999 are extrapolated from the first three-quarters of
1999, the revenue upon which GST should have been reported would
be $150,000, resulting in a tax liability of $10,500.
[34] With respect to the 1997 GST liability,
Mr. Kern acknowledged the Corporation was running all aspects of
the operation in that year (Hotel, restaurant, beer and wine).
Mr. Young's review resulted in a GST liability based on sales
of approximately $940,000. This is very close to the total sales
reflected in the 1997 income statement of the Corporation. As I
have previously stated, I find the 1997 and 1998 annual income
statements titled "457189 B.C. Ltd. Income Statement"
are not simply working papers for prospectus purposes, as Mr.
Kern suggests. The 1999 monthly statements are another
matter.
[35] Mr. Young testified that for 1997, he
did review three months worth of daily revenue documents he
gleaned from boxes obtained from the Receiver. From this, he
concluded there was a shortfall for the last quarter of 1997, and
upon comparing this to the results of the provincial audit
conducted by his British Columbia counterparts, he extrapolated a
shortfall for the 1997 year of $48,000 GST liability. What is
somewhat curious is that this reflects a significantly higher
revenue than indicated on the 1997 income statement, attached to
the Corporation's 1997 income tax return.
[36] While I have some doubts about the
accuracy of the numbers contained in the 1998 statement and
serious concerns about the numbers in the 1999 monthly
statements, I have no other information for 1997 other than the
1997 statements, to provide a breakdown among Hotel revenues of
30%, restaurant revenues of 30% and beer and wine store revenues
of 40%. Based on those breakdowns, to accept the Respondent's
additional $48,000 tax liability would mean accepting additional
Hotel revenues of 30% of $685,000, or $205,000. The 1997 income
statement suggests Hotel revenues of approximately $290,000, so
on this basis the Minister is indirectly suggesting a more
accurate figure of $495,000 annually for Hotel revenues. I find
this is more in accordance with what I have found to be the 1999
Hotel revenues of $600,000. All to say that given this result,
and given this assessment of 1997 was based on original
Corporation's records, I accept the Respondent's
assessment of tax for 1997 of $48,161.85.
[37] In summary on the GST assessments, if
this result appears to the parties as a rough and ready solution,
they are absolutely right, but they have left me no other option.
In a suit with in excess of $200,000 at stake for the Appellants,
neither side chose to take the general procedure, where exchange
of documents and examinations for discovery would have afforded
both sides a much greater opportunity to establish what truly
happened. Instead, they chose to role the dice by putting limited
information before me, much of which I have found inaccurate.
This is an informal procedure case; it is not an audit, and I am
not an auditor. I have decided based on what makes the most
commercial sense from the sketchy evidence provided, with no
apologies for what might be perceived as rough edges. The numbers
I have arrived at are founded on the following conclusions:
(i) In 1997, the Corporation
operated all three aspects of the business: Hotel, restaurant and
beer and wine store;
(ii) After April 15, 1998, the
Corporation only operated the Hotel;
(iii) The CRA auditor had books and
records for October, November and December 1997 from which he
drew reasonable conclusions, confirmed by the results of a
provincial audit;
(iv) In 1998, the removal of the
revenues from the beer and wine store offset any additional GST
liability the Respondent assessed; and
(v) In 1999, it was inappropriate to
rely on the monthly income statements; the bank deposit
information is more persuasive in concluding that Hotel revenues
were approximately $600,000 for the year.
[38] Based on these conclusions, the
correct assessments for which the Kerns are liable as directors
are as follows:
(a) For 1997, the Respondent's
position is accepted that the Corporation is liable for
$48,161.85 of tax plus interest and penalties as assessed.
(b) For 1998, no tax, penalties or interest;
and
(c) For 1999, the Corporation is liable for
$10,500 tax in the last quarter only, plus interest and penalties
of $1,233.65 and $1,474.82, respectively.
Income Tax
[39] Mr. Kern agreed with the assessment
against the Corporation for the failure to remit in 1997. He
spent considerable time in examining the Respondent's witness
regarding what has been collected by CRA in connection with the
unremitted source deductions. As I tried to clarify with Mr.
Kern, this Court deals with the assessment itself and not the
follow-up collection matters. However, I do appreciate Mr.
Kern's frustration knowing that a significant amount has been
paid towards this account, without a crystal clear trail of what
the amount left owing actually relates to. That however is not
the purview of this Court.
[40] At issue is the underlying assessments
for failure to remit an amount of $759.68 in 1999, plus the
penalty of $78.96 for a total of $835.64, and for failure to
remit an amount of $5,753.61 in 1998 plus interest of $1,242 and
penalty of $574.35 for a total of $7,569.96.
[41] With respect to the 1998 failure to
remit, of the $7,509.96 at issue, Mr. Kern only disputes
$4,654.63, as the Respondent provided no supporting detail how
that amount was derived. The balance was related to two specific
employees: Mr. Kern accepts the Corporation's failure with
respect to them.
[42] Mr. Kern also raised at his appeals the
concern that the Corporation has made source deduction payments
incorrectly for employees of the other company, 546, in the
amount of $8,668.26. He wants to have this amount offset against
the Corporation's assessment resulting in a zero liability.
This I cannot do. It is one thing to allow the review of an
underlying assessment on a director's liability case, but
this does not provide a director the opportunity to then open
issues which were not the subject of the assessment under attack.
For 1998, the assessment of the Corporation pertains to
unremitted source deductions tracked to two specific employees, a
failure Mr. Kern acknowledges, plus an unidentified non
remittance of $3,559.67 plus interest and penalties for a total
$4,654.63. It is only that amount that Mr. Kern can now properly
dispute.
[43] What is Mr. Kern's argument
regarding the $4,654.63 in 1998 and the $835.64 in 1999? It is
that the assessment of these additional amounts by the Minister
is without any detailed explanation as to which employee they
relate to, and in what amounts. The CRA auditor's evidence
was that a "big portion of the debt was in regard to T4s
being issued which were not included on the T4 summaries".
Mr. Kern obtained T4 summaries from CRA. Copies of T4s were not
however reproduced by either party. Mr. Kern's position
appears to be that because the Minister has not produced T4s
identifying exactly how the discrepancies of $4,654.63 for 1998
and $835.64 for 1999 arose, that they have failed to prove on
balance the assessments were correct. Mr. Kern needs to
appreciate that it is up to him to prove these assessments are
incorrect; that is, to demolish the Respondent's assumptions
that the Corporation failed to deduct and remit those amounts.
The Corporation did not retain books and records which might have
helped Mr. Kern in this regard. Indeed, I am not satisfied that
the Corporation kept adequate employee records. All Mr. Kern has
are the T4 summaries obtained from CRA. Can he now, under these
circumstances, argue that it is up to the Respondent to provide
the T4s issued by the Corporation to prove the correctness of
their position? Certainly where an Appellant provides a
reasonable, supportable rebuttal of a Crown assumption, the onus
may shift to the Respondent to prove their position. But in this
instance, all Mr. Kern can say is that he believes the Respondent
is wrong. That is not sufficient to shift the onus. On balance I
accept the Respondent's position that there was a shortfall
in source deduction remittances in 1998 and 1999.
Conclusion
[44] Neither Mr. nor Mrs. Kern exercised due
diligence sufficient to escape liability as directors pursuant to
section 323 of the Excise Tax Act and 227.1 of the
Income Tax Act of the Corporation's liabilities. They
can however attack the underlying assessments giving rise to the
directors' liability. In so doing, they have not satisfied me
that the Respondent's assessments of the Corporation for
failure to deduct or remit source deductions were incorrect. The
Kerns' appeals pursuant to the Income Tax Act are
therefore dismissed. With respect to the GST matter, the Kerns
have satisfied me that the amounts set forth in Schedule
"A" to the Respondent's Replies are incorrect and
the appeals pursuant to the Excise Tax Act are allowed and
the matters are referred back to the Minister on the basis
that:
(i) The Appellants are liable
for 1997 unremitted net tax of $48,161.85, interest of $2,557.47
and penalties of $3,443.61;
(ii) There are no taxes,
interest or penalties for the period April 1, 1998 to September
30, 1999, for which the Appellants are liable; and
(iii) The Appellants are liable for
1999 unremitted net tax of $10,500 with interest of $1,233.65 and
penalties of $1,474.82.
I
make no award of costs.
Signed at Ottawa, Canada, this 5th day of May, 2005.
Miller J.
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