Date: 19990216
Docket: 97-2481-GST-I
BETWEEN:
LADY ELLE INC.,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
Reasons for judgment
Lamarre Proulx, J.T.C.C.
[1] The appellant is appealing from the assessment made by the
Minister of National Revenue (“the Minister”) under
the Excise Tax Act (“the Act”) for the
period from November 1, 1991, to July 31, 1995.
[2] The facts on which the Minister relied are set out as
follows in paragraph 2 of the Reply to the Notice of Appeal
(“the Reply”):
[TRANSLATION]
(a) the appellant is a supplier registered for the purposes of
the Excise Tax Act, R.S.C. 1985, c. E-15, as amended
(ETA);
(b) during the period at issue, the appellant operated a
business selling women’s lingerie;
(c) during the period at issue, the appellant failed to record
all of its sales in its cash register and to enter them in its
records;
(d) the appellant failed to collect and remit GST on the
unreported sales and to remit the GST collected on some
sales;
(e) a tax investigation revealed that the goods purchased for
sale were resold at a price that was, on average, 78.07 percent
higher than their acquisition cost;
(f) by increasing by 78.07 percent the cost of the goods
purchased by the appellant for resale from November 1, 1991, to
April 30, 1994, the auditor estimated that the
unreported GST on the appellant’s sales totalled
$6,057.28;
(g) no financial statements were available for the periods
from May 1, 1994, to January 31, 1995, and May 1
to July 31, 1995, so the auditor extrapolated from the data on
unreported GST from previous years to determine that the
unreported GST for these periods totalled $5,773.12;
(h) for the period ending April 30, 1995, the appellant
mistakenly reported $13,257.83 as collectible GST, whereas
$933.86 was entered in its accounting records, and the reported
amount was reduced by an input tax credit of $12,195.38, which
was re-estimated at $1,449.44 following the audit;
(i) the appellant also failed to remit the GST it collected on
making certain taxable supplies that it did not report;
(j) the net tax that the appellant should have reported and
remitted for the period at issue was $7,082.79; and
(k) since the appellant reported net tax credit balances
totalling $4,609.31 during the period at issue, the
respondent, through the assessment at issue, claimed $11,692.10
as unremitted net tax, with interest and penalties;
the whole as will be more fully shown at the hearing with the
worksheets appended to the audit report;
[3] Paul Thomas, the appellant’s principal
shareholder, testified at the request of the agent for the
appellant, Robert Lescouflair, the accountant who prepared
the appellant’s financial statements. Lucie Lacroix and
Benoît Denis testified at the request of counsel for the
respondent.
[4] At the time of her investigation in 1996, Ms. Lacroix had
been a tax auditor for Revenu Québec since November
1990.
[5] Ms. Lacroix explained that, as noted in subparagraph 2(h)
of the Reply, the appellant applied for a $5,790.97 tax rebate
for the period from February 1 to April 30, 1995 (Exhibit I-2).
After the application was received, a tax audit of the appellant
was conducted since, as is shown by Exhibit I-3, the appellant
was claiming a much greater amount than usual.
[6] Exhibit I-3 is a working document containing a table
on the goods and services tax collected by the appellant and the
input tax credits it claimed. It shows that, from January 31,
1992, to April 30, 1995, the net tax balance was always negative
by an average of between $300 and $500. It was when a net tax
claim of $5,790.97 was made that the business was audited.
[7] Ms. Lacroix phoned the appellant to ask to see the sales
journal and all of the sales books. Ms. Gagliardi, Mr.
Thomas’ spouse, answered for the appellant. The
Minister’s officer said that, based on her discussion with
Ms. Gagliardi, she considered her to be the manager of the
business. Ms. Gagliardi told her that she could not come to the
business premises because they were too small but that she could
go to the office of a David Haimovitch, where all of the
accounting records were kept. The auditor thought that Mr.
Haimovitch was the accountant and would be able to answer her
questions, but he was not and was therefore unable to answer any
questions.
[8] Neither Ms. Gagliardi nor Mr. Thomas was present when the
auditor went to Mr. Haimovitch’s office. A few days later,
the auditor went to the appellant’s store, this time
without warning. A customer was being served, and Ms. Lacroix
waited about 10 minutes, looking at the merchandise. The sale to
the customer was made in cash and was not recorded in the cash
register. Ms. Lacroix introduced herself and asked Ms. Gagliardi
whether it was common for her not to record sales. Ms. Gagliardi
said that it was. According to Ms. Lacroix, Mr. Thomas told her
the same thing, explaining that the total of the
appellant’s sales had an impact on the rent it paid. In his
testimony, Mr. Thomas said indignantly that he certainly had not
made this comment, since it made no sense.
[9] Ms. Lacroix said that most of the cash register tapes were
not legible and that, since she had seen an unrecorded
transaction, she decided that there was no point in using the
tapes for her audit and that, in any event, it was impossible to
do so. She therefore proceeded on the basis of estimates.
[10] She had a few purchase invoices and the corresponding
sales invoices at her disposal. Based on the acquisition cost and
the sale price indicated on those invoices, she calculated a
mark-up rate of 78.07 percent. She also compared the price of the
purchased goods with the prices shown on the tags at the time of
her visit on July 6, 1995. For those prices, she calculated
a mark-up rate of 100.44 percent. She then compared the
purchase price of a few goods with the manufacturer’s
suggested price to calculate a mark-up rate of
89.08 percent. Since the mark-up rate was lower for the
goods whose sale was recorded on an invoice, she used that
mark-up rate for the purposes of her assessment. Her report was
filed as Exhibit I-4.
[11] To make her assessment, Ms. Lacroix then relied on the
acquisition cost of the goods sold or the “cost of
sales” as shown in the financial statements. She applied
the mark-up rate to the cost of the goods sold as set out in the
appellant’s financial statements for the first few years at
issue. The financial statements for the 1991-92, 1992-93 and
1993-94 fiscal years, which ended on April 30 of each of those
years, were filed as Exhibit I-1. As noted in subparagraph 2(g)
of the Reply, the financial statements for subsequent years were
not available. The auditor extrapolated based on the data from
previous years.
[12] Exhibit I-5 is the portion of the auditor’s
report that concerns the amount of tax to be collected on the
estimated sales.
[13] Mr. Thomas explained that it was he who testified for the
appellant rather than his spouse, Ms. Gagliardi, because he owned
the appellant and was the one who knew the financial side of the
business. He began his evidence by filing the appellant’s
unaudited financial statements for the years ending
April 30, 1995, and April 30, 1996.
[14] According to the financial statement for the fiscal year
ending April 30, 1995, gross sales totalled $75,434.82 and the
cost of sales was $57,235.59. This means that the mark-up rate
was about 30 percent, the cost of sales ratio more than 80
percent and the gross profit ratio about 20 percent. The other
financial statements show the same ratios for the cost of sales
and the amount of gross sales.
[15] As Exhibit A-2, Mr. Thomas filed the appellant’s
lease with the Centre commercial Côte St-Luc
Ltée for the premises the appellant used for its lingerie
store. It is dated April 26, 1991, and the expiry date is April
30, 1996. Mr. Thomas directed the Court’s attention to
clause 17.2 of the lease, which concerns the consequences of
default by the lessee. He explained that, because of these
provisions, which made it impossible to terminate the lease
before the completion of its term, he had to continue operating
the business even if it was not profitable.
[16] Similarly, as Exhibit A-5, the appellant filed a rent
reduction application it made to the lessor on October 28, 1992,
which was denied.
[17] A sales book was filed as Exhibit A-8 and a few purchase
invoices were filed as Exhibit A-9. The appellant’s agent
asked Ms. Lacroix how she was able to correlate the goods
purchased with the goods sold on the basis of the invoices, which
identified the goods sold in very brief terms. She answered that
she had correlated the two only in cases where she was sure.
[18] Five of the business’s books, which were used to
record purchases and sales, were filed as Exhibit A-10.
[19] As Exhibit A-11, Mr. Thomas filed a handwritten summary
of sources of income other than the store, because it seemed to
him that this was the main point raised by the Minister’s
officers: they had told him that he could not live for several
years in a row with a business that was incurring substantial
losses.
[20] The Court asked Mr. Thomas a few times what mark-up rate
his business used in selling goods. He did not want to answer. He
said that he was not an accountant. At other times, however, he
said that he was a good administrator.
[21] As Exhibit A-7, Mr. Thomas filed a document prepared by
his accountant, Robert Lescouflair, who also acted as the
appellant’s agent at the hearing. The document is a reply
to the Revenu Québec auditor’s preliminary report.
It states the following at page 8:
[TRANSLATION]
As a precautionary measure, following a visit to and a check
with Statistics Canada (Guy Favreau Complex in Montreal), we have
found that, for women’s clothing retail stores, the
average ratio of the cost of sales to gross sales was
about 59 percent in Canada from 1991 to 1994. If the ratio is 59
percent, then the ratio of gross profit to gross sales can be
deduced to be 41 percent. The ratio for net sales (gross sales,
discounts) would be even lower.
[22] This statement, which contradicts the accountant’s
own figures as set out in the financial statements, confirms the
Minister’s position. The cost of sales ratio is 56.16
percent according to the auditor and 59 percent according to
Statistics Canada, but it is 80.76 percent according to the
financial statements. The gross profit ratio is 43.82 percent
according to the auditor and 41 percent according to Statistics
Canada, but it is 19.24 percent according to the financial
statements.
[23] It is my opinion that the auditor correctly determined
the amount of gross sales and therefore the amount of the tax by
taking the cost of sales referred to in the financial statements
(an amount that was not disputed by the appellant) and increasing
it by the mark-up rate of 78 percent, which was consistent with
the cost of sales ratio and the gross profit ratio established by
Statistics Canada. In my view, the 30 percent mark-up rate
indicated by the financial statements over a period of more than
five years has no possible commercial basis, since the
mark-up must be what is needed to pay all of the
business’s operating expenses and generate a profit.
[24] It is hard to believe that Mr. Thomas, who claims to be a
good administrator, had no idea of the mark-up rate used in the
appellant’s business even though he was the sole
shareholder and president of the appellant. It seems to me that
this is a basic concept in the retail trade. I am inclined to
believe that in refusing to answer this question on the pretext
that he is not an accountant, Mr. Thomas did not answer
candidly.
[25] Since the Minister’s position is the one that is
most consistent with reality, since it is based on objective
information, such as the mark-up rate and the cost of sales
determined using the appellant’s own documents, and since
no reasonable explanation was given by the appellant, the appeal
must be dismissed.
Signed at Ottawa, Canada, this 16th day of February, 1999.
"Louise Lamarre Proulx"
J.T.C.C.