Deschênes v. The Queen, docket 97-3253-IT-I (Informal Procedure)

Date: 19990923

Docket: 97-3253-IT-I

BETWEEN:

TONY DESCHÊNES,

Appellant,

and

HER MAJESTY THE QUEEN,

Respondent.

Reasons for Judgment

Archambault, J.T.C.C.

[1] In his audit of Tony Transport Inc. (TTI), the Minister of National Revenue (Minister) observed that the corporation was not keeping adequate accounting records. The Minister decided at that time to conduct an audit of TTI's sole shareholder Tony Deschênes and made reassessments for the 1992, 1993 and 1994 taxation years using the net worth method of assessment. The Minister included additional income of $16,507 in Mr. Deschênes's income for 1992 and $4,273 for 1993. His audit revealed no unexplained change in net worth for the 1994 taxation year. The Minister also assessed against the appellant penalties of $1,594.09 for the 1992 taxation year and $480.26 for 1993.

[2] Mr. Deschênes instituted appeals from the assessments for the 1992, 1993 and 1994 taxation years (relevant taxation years), claiming that the Minister committed errors in computing the changes in net worth. In particular, he claims that certain assets and related liabilities on the balance sheet to December 31, 1991 were subjected to double taxation on their disposition. According to the explanation which Mr. Deschênes provides in his notice of appeal, there was double taxation [TRANSLATION] "first on the basis of the payments reducing debts in each of the years, and second, on the original value less the value obtained on disposition of the asset." The three assets (three assets) appearing on the balance sheet which the Minister prepared and which are at issue are a Firefly car, a Mallard motor home and a Yamaha snowmobile. Lastly, Mr. Deschênes claims that the purchase price and proceeds of disposition of the motor home are incorrect and that his unreported income should therefore be reduced by $500 for 1992.

[3] Mr. Deschênes's appeals were heard by my colleague Judge Tremblay, who unfortunately died before he was able to render his decision. The parties agreed that the Chief Judge should refer the appeals to another judge of this Court so that the decision could be rendered on the basis of the transcript of the evidence adduced during the hearing, the exhibits filed and the written argument. The appeals were referred to me.

Facts

[4] The exhibits filed at the hearing of the appeals include the statement of net worth prepared by the Minister's auditor, the most relevant parts of which I reproduce below:

Assets	1991	1992	1993	1994
Other assets(1)	146,922	177,278	577,576	654,157
1990 Pontiac Firefly	13,026	13,026
Yamaha snowmobile	7,280	7,280	7,280
Mallard motor home	16,000
TOTAL ASSETS	183,228	197,584	584,856	654,157
Liabilities
Other liabilities(2)	83,574	73,031	444,346	330,750
C.P. St-Jean Folio 3452 Loan #6	6,570	5,170	3,547	1,766
Owed to G.M.A.C. (Firefly)	10,594	7,773
TOTAL LIABILITIES	100,738	85,974	447,893	332,516
Net worth	82,490	111,610	136,963	321,641
Net worth, previous year	0.00	82,490	111,610	136,963
Increase (Reduction) in net worth		29,120	25,353	184,678

Adjustments

Additions	1992	1993	1994
Personal expenses	38,469	57,037	131,139
Loss on disposition of Firefly		6,690
Loss on disposition of Yamaha			4,280
Loss on disposition of Mallard motor home	3,500
Other (3)	1,220	2,072	5,478
Total additions	43,189	65,799	140,897
Deductions
Reported income Tony Deschênes	20,800	47,815	236,192
Reported income Sylvie Hogue	18,539	12,162	27,638
Tax benefits	396	865	550
Claim B. Huot		10,000	10,000
Rental income	12,000	8,000	4,000
Tax refund	1,119	213.00	25
Gift from Robert Deschênes			41,475
Total deductions	52,854	79,055	319,880
Net adjustments	-9,665	-13,256	-178,983
Total income by net worth	19,455	12,097	5,695
For settlement purposes
Personal expenses	2,948	6,229	4,054
Interest, sale of motor home		1,595	1,641
Change in net worth:	16,507	4,273	0.00

(1) I have grouped all other assets under a single heading.

(2) I have grouped all other liabilities under a single heading.

(3) I have grouped other amounts under a single heading.

[5] Appended to Exhibit A-1, which was filed at the hearing, are the purchase agreement and contract of sale for the motor home as well as the contract of sale for the Firefly. The documents show that the purchase price of the motor home was $17,440, not $16,000 as the Minister's auditor indicated in his statement of net worth, that the proceeds of disposition of the motor home were $13,000 (not $12,500) and that the proceeds of disposition of the Firefly were $6,036 (not $6,336). The amount of the loss incurred on the disposition of the motor home was thus $4,400 (not $3,500) and that incurred on the disposition of the car was $6,990 (not $6,690).

[6] It is important to note that the statement of net worth reproduced above represents only the final result of the auditor's work. Before reaching that point, he had prepared a number of drafts which Mr. Deschênes had an opportunity to analyze and regarding which he was able to provide explanations. The first draft revealed unexplained differences of $64,536 for 1992, $20,672 for 1993 and $56,412 for 1994 for a total of $141,620. As a result of explanations provided by the taxpayer or his agent, the Minister agreed to make changes to his calculations and thus reduced the unexplained differences to $16,507 for 1992 and $4,273 for 1993. He completely eliminated the difference for 1994.

Arguments of the two parties

[7] At the end of the hearing, Judge Tremblay asked the parties to file written submissions in which they were to outline their arguments in support of their respective positions. Mr. Deschênes's agent, a chartered accountant, summarized his client's position as follows:

[TRANSLATION]

My argument consists in demonstrating that the technique used by Revenue Canada penalizes Tony Deschênes as it entails double taxation.

(1) The 1992, 1993 and 1994 balance sheets take into account principal repayments on debts incurred during the previous fiscal year or in a current fiscal year and those amounts are taxed.

The amounts in issue:      1992     1993

Firefly automobile A-1     $2,821

Yamaha snowmobile A-2     $1,400    $1,623

(2) On disposition of the assets purchased by means of a loan, the original value less the value obtained on resale (depreciation) is taxed in the year of disposition, and that amount is considered as an addition, a cost of living in the final determination of the change in net worth.

The amounts in issue: 1992     1993 1994

Mallard motor home (DI - 9a) $3,500

Firefly automobile (DI - 9a)     $6,690

Yamaha snowmobile (DI - 9a) $4,280

This technique also adversely affects Mr. Deschênes. The capital cost used is based on the original purchase cost less the value received, without taking into account the time of possession of the asset prior to the years being audited.

For example, consider the case of the Mallard motor home (A-1 and A-2):

According to the explanatory note (A-3), if the two proposed

corrections are not accepted, Revenue Canada makes a claim with respect to depreciation       $5,440

Depreciation should be calculated solely on 9 of the

40 months of possession, that is, the time of possession in 1992:

Original purchase cost (04-04-89) $17,440

Disposed of 12-09-92 $13,000

4,440 x 9/40 = 4,440 999

Excess tax on motor home $4,441

The same is true of the Firefly automobile disposed of in 1993, with respect to which there was depreciation of $1,997 to be corrected and a proposed $300 correction in the respondent's favour, thus reducing the change in net worth by $1,697 (A-1).

Summary of Revenue Canada's position

and that of the appellant

1992 1993 Total

Revenue Canada has established

the change in net worth

(DI - 9a) $16,507 $4,273 $20,780

----------- --------- -----------

Proposal, if accepted, to deduct:

Amounts of tax on principal

repayments:

Firefly automobile A-1 $ 2,821 $ 2,821

Yamaha snowmobile A-2 $ 1,400 $1,623 $ 3,023

On depreciation, portion for

1991 and earlier

Mallard motor home or

Sprinter A-2 and A-3 $ 4,441 $ 4,441

Firefly automobile A-1 _ $1,697 $ 1,697

Total reduction $ 8,662 $3,320 $11,982

----------- --------- -----------

Corrected change in net worth $ 7,845 $ 953 $ 8,798

. . .

Two examples demonstrating that principal repayments are taxed

I have reproduced two examples from the respondent's document, one relating to the Firefly automobile, which shows a non-repayment of principal, adding an amount of $2,821 (DI - 8a) to the liabilities of $85,874. This same amount added to the liabilities reduces by $2,821 (DI - 9a) the change in net worth indicated in the handwritten column. This example shows that the principal repayment of $2,821 indeed increased the taxable change in net worth.

The same is true for all the principal repayments I have indicated.

As for the other example, I have considered that there was no debt on the automobile, thus showing a change there as well, and that the increase in net worth for 1992 is $26,299 instead of $29,120 (DI - 8a), so that the taxpayer is taxed on $2,821 as a result of the principal repayments.

Depreciation prior to December 31, 1991

not considered by Revenue Canada

In response to the appendix providing details on the amount of $4,441 in issue in respect of the Mallard or Sprinter motor home, the respondent's representative stated at the hearing of the case that an increase in value of the motor home in the base year was erased in the year of the sale. This is true. In this case, the respondent determined that the proceeds of disposition of the motor home amounted to $12,500 instead of $13,000, thus creating a difference of $500.

The amount of $4,441 in issue breaks down as follows:

Depreciation prior to 01-01-92

$4,440 x 31 months over 40 months = $3,441

Amount received in 1992 not entered in the

cash receipts or deductions section (DI - 9a) $ 500

Difference in computing the proceeds of disposition

Proceeds of disposition (DA - 19) $13,000

Value taken by government

Value (DI – 7a) $16,000

Loss on disposition (DI – 9a) $ 3,500 $12,500 $ 500

$4,441

Your Honour, the taxpayer Mr. Deschênes asked for an explanation as to why he was, as it seemed to him, being taxed on both the repayments and on the depreciation amount on disposition of the assets.

I was unable to show him that he was incorrect. That is why we are before you.

[8] As to Mr. Deschênes's position on the assessment of the penalty, I reproduce the notes written by his agent contained in his letter of September 2, 1998:

[TRANSLATION]

There are weaknesses in this net worth method of assessing unreported income. In this case, the fact that unreported income assessed at $143,620 has been reduced to $20,780 justifies this point of view.

Establishing an individual's cost of living on the basis of statistics or a national average can adversely affect a citizen by attributing to him income he has not earned.

The fact that Revenue Canada is reluctant to apply a negative variation from one year against surplus income from another year shows that extrapolation is done in establishing cost of living. The Department states in this case that the cost of living is too low and is inclined to raise it in order to reduce the difference to zero.

In view of this method of establishing the cost of living and given the very large difference between the proposed assessment amount and the residual amount in issue, it is hard to believe that the appellant knowingly made a false statement or omission in the returns of income for 1992 and 1993.

[9] In his written notes, counsel for the Minister addressed the question as to whether the depreciation of an asset should be considered in the calculation done using the net worth method. As these notes are brief, I reproduce them in full:

[TRANSLATION]

This case was heard on August 7, 1998 in Québec. At that time, it was agreed that written submissions would be sent on the question as to whether the depreciation of an asset was to be considered in the calculation under the net worth method.

Net worth method

Under subsection 152(7) of the Income Tax Act, the Minister may make an assessment in the absence of a return from the taxpayer or without considering information contained therein. This assessment is said to be "arbitrary".

An arbitrary assessment is usually based on the net worth method. This method is defined by P. Dussault and N. Ratti in L'impôt sur le revenu au Canada, Les Éditions Revue de Droit, University of Sherbrooke, pp. 14-25:

"An arbitrary assessment is usually based on the net worth method, which consists in evaluating the increase of a taxpayer's capital (assets - liabilities) during a given period and adding consumption expenditures during that same period. From the result thus obtained, various tax-exempt amounts such as gifts, bequests, gambling winnings and the non-taxable portion of realized capital gains, as well as any previously reported income, are subtracted. The balance represents the additional income, which is the subject of the 'arbitrary' assessment."

This method thus determines the change in net worth between the start and end of a given year. In referring to the statement of net worth, which was filed as Exhibit I-1, we note that the property at issue, that is, the motor vehicle, the snowmobile and the motor home, were all included in the taxpayer's assets. Under the net worth method, the amount of $7,773 owed to G.M.A.C. for the automobile was included in the taxpayer's liabilities. In addition, on page 3 of Exhibit I-1, adjustments were made for the losses on disposition of the automobile, the snowmobile and the motor home.

The net worth method does not take into account the depreciation of assets. Depreciation or amortization is an accounting transaction which consists in allocating the cost of an asset over its useful life. From the taxpayer's standpoint, there is no cash outflow. Accordingly, this deduction is not computed under the net worth method.

Under the net worth method, we try to determine the increase in the taxpayer's capital. For example, if a taxpayer purchases a motor vehicle for $10,000, there is an increase in his capital and taxation will be computed on the basis of that increase. It would be illogical to allow the taxpayer to deduct depreciation if he has made no monetary expenditure.

We wish to add that an assessment benefits from a presumption of validity and, unless the taxpayer proves that it is incorrect, the assessment will be valid and binding. We submit that the appellant has presented no authority in support of his claims and that the appeals for 1992 and 1993 should accordingly be dismissed. For 1994, the Minister found no unexplained change. Consequently, as there are no grounds for appeal, that appeal should also be dismissed.

The penalty:

The appellant did not report all his income for 1992 and 1993. Since the appellant did not keep accounting records, the Minister had no choice but to use the net worth method to estimate his income. We refer the Court to Kay v. Canada (1993) CTC 2281, in which it was held that the appellant must be considered responsible for his own misfortune if he is unable to discharge his burden of proof as a result of his failure to keep reasonably complete records. The Court also upheld the penalty in that case.

Analysis

[10] There can be no doubt that the net worth method can be appropriate for making an assessment. Moreover, the burden is on Mr. Deschênes to show that the reassessments made by the Minister are incorrect. However, the onus is on the Minister to establish that the penalties he assessed are correct. He must show that Mr. Deschênes knowingly, or in circumstances amounting to gross negligence, made a false statement or omission in the returns of income filed for the 1992 and 1993 taxation years.

[11] Except for the corrections to be made in the statement of net worth to the acquisition cost of the motor home and except for the amount of the loss incurred on disposition of that asset, each of the parties, in my view, has failed to discharge his burden. First of all, Mr. Deschênes did not succeed in showing that in computing net worth the Minister committed an error by considering the principal repayments on the car and motor home loans and by not considering depreciation for the three assets in issue. As for the amounts of the losses incurred on disposition of those assets, it is entirely appropriate to add them as adjustments. I shall return to this point below.

[12] First I wish to address the minor errors made in preparing the statement of net worth. The auditor did not use the right figures to determine the acquisition cost of the motor home or the proceeds of disposition of the motor home and automobile. He undervalued the proceeds of disposition of the automobile by $300, which is to Mr. Deschênes's advantage. The amount of the change in net worth for 1993 should have been $300 higher. As this Court does not have the power to increase the amount of unreported income determined by the Minister, no change will be made to increase the tax assessment for 1993.

[13] The errors relating to the cost and proceeds of disposition of the motor home must be corrected by changing the amount of the loss computed by the Minister's auditor from $3,500 to $4,440, which represents a net increase of $940. However, if the cost of the motor home which appears in Mr. Deschênes's assets as of December 31, 1991, that is, the base year, is increased by $1,440, the result is an increase in his net worth for 1991 ($82,490 + $1,440 = $83,930) and, consequently, a reduction of $1,440 under the heading "Increase (Reduction) in net worth" for 1992 [($111,610 - $83,930 = $27,680) and ($27,680 - $29,120 = -$1,440)].

[14] The net result of all these changes is to reduce the change in net worth by $500 [940 - 1,440 = -500]. This $500 figure essentially represents the additional amount which Mr. Deschênes received on disposition of the motor home: that is, $13,000, not $12,500. As the origin of this $500 amount has been determined and it does not represent income for tax purposes, it is entirely appropriate for it to be excluded from the change in net worth calculation for 1992.

[15] I would now like to explain why Mr. Deschênes's agent is incorrect in his two main reasons for objection. First of all, he is mistaken when he states that the method adopted by the Minister adversely affects Mr. Deschênes because it does not take into consideration the duration of possession of the asset prior to the years concerned by the audit. In other words, he wrongly criticizes the Minister for failing to take depreciation into account.

[16] I entirely agree with the remarks by counsel for the Minister that the depreciation of an asset is immaterial in computing changes in net worth. It is important to keep in mind that the purpose of this method is not to determine in accordance with generally accepted accounting principles the amount of profits realized by a taxpayer in operating a business. If that were the case, it would be wholly appropriate to take into account capital cost allowance to allow for the depreciation of the assets that an entrepreneur uses in operating his business. Here the sole purpose of the net worth method of assessment is to quantify, on circumstantial evidence, the income that the taxpayer has received and not reported.

[17] For example, if the cost of the assets owned by a taxpayer were observed to increase by $100,000 in a given year relative to the cost of his assets for the previous year, that might indicate that the taxpayer's wealth increased by $100,000 during that year. Questions would then have to be asked about the origin of that enrichment. A number of scenarios are possible.

[18] The taxpayer may have acquired new assets entirely on credit. In that case, a $100,000 increase in liabilities would mean that there would be no increase in the taxpayer's net worth, which would indicate that his wealth had not increased. However, if the cost of those assets was not financed in this way, the money to pay for the assets might have come from a gift or bequest. The burden is then on the taxpayer to prove such gift or bequest. Here the Minister accepted the fact that there was a gift of $41,475 and this amount was included in the adjustments which reduced the change in net worth.

[19] It is also possible that the taxpayer received income of $100,000 and that he used that amount to purchase the new assets in question. If the taxpayer reported this income to the tax authorities, the amount will be included in the adjustments reducing the change in net worth. If, in our example, the taxpayer reported only $10,000 of income, the net worth method will reveal an unexplained change of $90,000. Failing a reasonable explanation, this $90,000 figure will be added to the taxpayer's income.

[20] This example clearly illustrates the irrelevance of the depreciation of assets owed by a taxpayer at the start of the relevant period (the period subject to an audit by the Minister), since all the net worth method is designed to quantify is the net increase in the cost of a taxpayer's assets, an increase which could reveal unreported income. What is important is that the method used to value the assets appearing on the balance sheet (the original cost of the assets) is the same for all the years covered by the statement of net worth. There is no evidence that this method was not used for each of the relevant years appearing in the statement of net worth.

[21] A net increase in assets is not the only indicator of the existence of unreported income. If a taxpayer's liabilities for a given year declined relative to the previous year, that could also indicate that the taxpayer received income during the year. For example, if a taxpayer borrowed $10,000 one year to purchase a car and repaid no principal during that year, and if it were observed that the unpaid balance of the loan at the end of the following year was $8,000, that might show that there was an outlay of $2,000 the origin of which would also have to be explained. As in the case of a net increase in assets, an unexplained decrease in liabilities is treated as unreported income: it was therefore entirely appropriate for the Minister's auditor to take into account the reduction of Mr. Deschênes's liabilities in his statement of net worth.

[22] To be quite clear, I entirely agree with Mr. Deschênes's agent that the reduction of the unpaid balance of the loans for the motor home and automobile resulted in increases in net worth for 1992, 1993 and 1994. However, contrary to what the agent asserts, I believe that this result is completely appropriate and does not adversely affect Mr. Deschênes. Mr. Deschênes was able to explain the origin of the amounts in question, that is, $2,821 for the repayment of the car loan in 1992, and $1,400, $1,623 and $1,781 for the repayment of the motor home loan in 1992, 1993 and 1994. He also succeeded in providing an explanation for 1994 and no additional income was assessed for that year. He failed however with regard to 1992 and 1993.

[23] As to the second point raised by Mr. Deschênes's agent, I can understand that he might have had difficulty explaining to his client why the inclusion of the loss incurred on the sale of the three assets in computing the changes in net worth does not constitute additional income for his client. Indeed, one may have the impression that this increases Mr. Deschênes's cost of living and that could be tantamount to an increase in unreported income.

[24] And yet this is a false impression. First of all, it is important to understand that, contrary to what the agent stated, this adjustment does not constitute an increase in Mr. Deschênes's cost of living. It cannot be otherwise because whatever "cost of living" is added—essentially living expenses—represents outlays that a taxpayer would have made for food, housing, entertainment and so on.

[25] The loss incurred on disposition of the three assets gave rise to no outlay. The outlay occurred either at the time of the purchase of those assets or when Mr. Deschênes repaid the loans obtained in order to finance the purchases. When Mr. Deschênes incurred the $6,390 loss on the sale of his car in 1993, he did not lay out $6,390, but rather repaid his loan of $7,773, a larger amount than $6,390. Assuming that Mr. Deschênes paid cash for the car when he purchased it in 1991, he disbursed nothing in 1993 when he sold it.

[26] In any case, the acquisition cost of a car is not an expense included in cost of living. Instead it is included in the cost of the assets appearing on the balance sheet, the preparation of which is the first step in the calculations culminating in the statement of net worth. If that cost were included in cost of living, the cost of the car would then be accounted for twice.

[27] Why then is the amount of the loss in respect of each of the three assets added to the adjustments to be made to the differences resulting from the increase in net assets? The simple answer is that this addition constitutes only a technical adjustment necessary in order to respect the integrity of the calculations made in accordance with the net worth method of assessment.

[28] To clearly understand why it is necessary to make such an adjustment when computing changes in net worth, one need only consider the example presented by the Minister's auditor as Exhibit I-2. The assumptions used in this example are as follows: the taxpayer has $10,000 in cash and a car with an acquisition cost of $12,000; the taxpayer's cost of living is equal to the salary he earned and reported; the car is ultimately sold for $4,000 in the third year, which results in a loss of $8,000. If the net worth method is correctly applied, the results are as follows:

19x0 19x1 19x2

Cash 10,000 10,000 14,000

Car 12,000 12,000     0

Net worth 22,000 22,000 14,000

Net worth for the year 22,000 22,000 14,000

Net worth for previous year      (22,000)      (22,000)

Increase (reduction)

in net worth (1)      0 -8,000

Plus: Cost of living (2) 25 000 25 000

Loss on disposition (2)     0    8,000

Less: Salaries (3)    (25 000) (25 000)

Change in net worth [(1) + (2) - (3)]    0      0

[29] This example shows that, if the amount of the loss on the car is added to the adjustments, we obtain a result consistent with the actual situation: the statement of net worth shows no change. This is not surprising since the taxpayer reported all his income. If no adjustment had been made to increase the net worth by $8,000, that is, by the amount of the loss on the car, a negative change of $8,000 would have been obtained. By adding the amount of the $8,000 loss, we caused the negative change to disappear. This is entirely appropriate since we are seeking only to establish positive changes which might reveal unreported income. Having determined why there was a decrease in net worth, it is important to add the amount of the loss in order to eliminate that change the cause of which is known. This then is strictly a technical adjustment designed to reduce the change to zero.

[30] To understand even more clearly the importance of adding the amount of the loss incurred on the sale of the car, we will alter the auditor's example as follows. We will add to the previous assumptions the fact that the taxpayer earned unreported income of $8,000 in 19x2 and that he used that amount to purchase a snowmobile in that year. His net worth for 19x2 would be once again $22,000 ($14,000 + $8,000) and the statement of net worth would be amended as indicated below. To clearly illustrate the importance of adding the loss, the first 19x2 column does not include the loss while the second does:

   19x1 19x2 19x2

Cash     10,000 14,000 14,000

Car    12,000     0    0

Snowmobile      0    8,000 8,000

   ______ ______ ______

NET WORTH    22,000 22,000 22,000

Net worth of previous year    (22,000)    (22,000)

Increase (Reduction)

in net worth (1)       0     0

Plus: Cost of living (2)     25,000 25,000

Loss - car (2)       0 8,000

Less: Reported salaries (3)    (25,000) (25,000)

Change in net worth [(1) + (2) - (3)]      0 8,000

[31] When the $8,000 loss is not added to the first 19x2 column, no change is computed and the unreported income of $8,000 is not reflected, whereas, when it is added to the second 19x2 column, we obtain an $8,000 change which appropriately reflects the fact that the taxpayer did not report income of $8,000. I believe this example clearly illustrates the necessity of adding the amount of the $8,000 loss that occurred in 19x2, otherwise the unreported income of $8,000 would be concealed.

[32] There remains the question of the penalty. I do not believe that the Minister showed that Mr. Deschênes knowingly, or in circumstances amounting to gross negligence, made a false statement or omission in his returns of income for the 1992 and 1993 taxation years. At first, the auditor indicated a total of $143,620 in unreported income in his first draft statement of net worth. When the first reassessments were made, the total amount of unreported income was reduced to $93,971. In response to the taxpayer's notices of objection, the Minister made two further reassessments, again reducing the amount of unreported income and lowering the total amount to $20,780, including $16,507 for 1992 and $4,273 for 1993. He also entirely eliminated the unreported income for 1994.

[33] In view of the large figures that he arrived at in the first reassessments, I can understand why the auditor might have believed that the taxpayer had knowingly, or in circumstances amounting to gross negligence, made a false statement in his returns of income. Ultimately, however, the amount of unreported income was considerably reduced.

[34] In assessing the circumstances surrounding the preparation and filing of Mr. Deschênes's returns of income, one must consider not only the amounts that he did not report, but also those he reported. The unreported amounts arrived at by the net worth method represent 6 percent of the income that Mr. Deschênes should have reported. The income which he reported for the three taxation years in issue amounted to $304,807. In view of the size of the income reported relative to that not reported by Mr. Deschênes, I do not believe he clearly attempted to evade paying his taxes. Nor do I believe that the taxpayer knowingly, or in circumstances amounting to gross negligence, made a false statement in his returns of income. In short, the Minister failed to discharge his burden of establishing that the penalties are justified.

[35] For these reasons, Mr. Deschênes's appeals for the 1992 and 1993 taxation years are allowed and the assessments are referred back to the Minister for reconsideration and reassessment on the basis that the amount of additional income for the 1992 taxation year amounts to $16,007 (not $16,507) and that the

penalties must be set aside. The appeal for the 1994 taxation year is dismissed, the whole without costs.

Signed at Ottawa, Canada, this 23rd day of September 1999.

"Pierre Archambault"

J.T.C.C.

[OFFICIAL ENGLISH TRANSLATION]

Translation certified true on this 28th day of July 2000.

Erich Klein, Revisor